Though Merrill Lynch & Co.'s $1.3 billion purchase of First Franklin Financial Corp. is now roundly regarded as a bust, the remaining piece of that subprime mortgage outfit has been rapidly expanding and testing unusual ways to work out bad loans.
In the year and a half since the deal closed, Home Loan Services Inc., First Franklin's loan-servicing operation in Pittsburgh, has quintupled the staff in its loss mitigation division, to 220 employees. The unit is ramping up a loan modification program for borrowers with two mortgages that is designed to mitigate losses on both loans. And while many servicers have reached out to borrowers whose adjustable-rate mortgages were scheduled to reset, in hope of averting foreclosures, Home Loan Services has long cast a wider net, contacting all borrowers it has determined to be at risk.
This month, Merrill said it was discontinuing originations at First Franklin, which was based in San Jose, and that it was exploring a sale of Home Loan Services. The New York company spent December and January raising $12.8 billion to strengthen its balance sheet after reporting massive writedowns in the third and fourth quarters related to its mortgage businesses.
John A. Thain, who took over as chairman and chief executive officer after Merrill posted a third-quarter net loss, has said he plans to pare the company's mortgage-related businesses and to emphasize its more traditional retail brokerage businesses and international activities.
Melissa Lucas, the director of loss mitigation at Home Loan Services, said Tuesday that it has expanded its palette of alternatives to foreclosure.
"In the past, we did a lot more short sales" — in which the home is sold for less than the amount owed — "because only a few modifications were available," she said. "Now we have more ways."
In September, Ms. Lucas introduced the "principal reduction" or "postponement" modification for borrowers whose equity has been depleted by tanking home values. In these deals Home Loan Services will drop most of the monthly payment on a second lien but collect on the loan in full if the home is eventually sold.
"We look at those loans and figure out a modification on the first and second lien so the borrower has affordability and the investor continues to get paid," she said.
Home Loan Services can do this because in most cases it services both the first and second mortgages. Even when the loans are held by different investors, the unit's pooling and servicing agreements let it lump them together to create a more effective workout, Ms. Lucas said.
She said she was not sure whether Home Loan Services is the first company to offer such modifications, but "we definitely have been out in front, as many peers have called me asking me how to set up" a program. Home Loan Services plans to offer more principal reductions because the unit's staff is now better trained to offer them to distressed borrowers, she said.
Phillip E. Comeau, the head of Synergystic Associates Inc., a mortgage industry consulting firm in Great Falls, Va., said Home Loan Services is acting in its "enlightened self interest" because principal-reduction plans secure both immediate and eventual payment for investors while avoiding foreclosure, which is much more expensive.
"Given what Melissa has been doing, it sounds like they are not unduly constrained by the pooling and servicing agreements. Their attorneys are apparently willing to be reasonable on this stuff," said Mr. Comeau, a former executive at Freddie Mac.
Ms. Lucas has been "very creative" in her approach to servicing, Mr. Comeau said. "What she is doing is very much cutting-edge, but it needs to be done. It's not widespread, and it's not as widespread as it needs to be." (His consulting firm does no work for the Merrill unit.)
To date, Home Loan Services has completed 70 to 80 principal reductions, Ms. Lucas said. The unit services about 330,000 loans, totaling $47 billion. (National Mortgage News ranks it No. 8 among servicers of subprime loans.) Home Loan Services works out about 47% of its loans where there is a risk of the home being repossessed, she said.
Merrill would not give an update on its plans for Home Loan Services, but it contradicted reports suggesting it would combine the unit with Wilshire Credit Corp., a Beaverton, Ore., servicer that the company bought in 2004.
A spokesman for Merrill Lynch said the two platforms service different types of subprime loan. Home Loan Services works primarily on loans originated by First Franklin and, to a lesser extent, by National City Corp. (which sold First Franklin to Merrill) and Nationspoint (a defunct online lender in Lake Forest, Calif., that First Franklin owned). But Wilshire is mainly a third-party outsourcer.
