Mortgage modifications may be likelier to succeed when the servicer holds the loan on its books, according to a study regulators released Monday.
As expected, the report by the Office of the Comptroller of the Currency and the Office of Thrift Supervision also found high failure rates for modifications across the board. Comptroller John Dugan mentioned that finding in a speech two weeks ago.
The report went further by breaking down redefault rates by investor type. Loans in private securitization pools fared the worst — in 42% of such loans that were modified in the first quarter, the borrower had fallen behind again after three months, and in 60.8%, the borrower had done so after six months.
For banks and thrifts that held the loans they serviced, 35% of the loans redefaulted after three months, and 50.9% did so after six months.
The portfolios of Fannie Mae and Freddie Mac performed better than private pools and worse than servicer-held loans.
"The lower redefault rate for loans held by servicers may suggest that there is greater flexibility to modify loans in more sustainable ways when loans are held on a servicer's own books," the report said.
Observers said different incentives for servicers that own the loans — giving them a clear economic stake in credit performance — and those that are handling loans for investors might play a role in the effectiveness of modification efforts.
"If you're a captive of a bank where the bank has originated the loans and you're servicing them, there certainly will be more suasion by the bank to modify these loans than a totally disinterested third party," said Thomas Healy, a senior managing director with Insight Capital Partners LLC, a Fort Lauderdale, Fla., mortgage investment banking firm.
"I don't think it's really a matter of the people who manage the modifications department, the collections department, saying, 'Well, I'll give this customer of my own bank better service than I give somebody else,' " Mr. Healy said. "But I do think it would be much easier for them to negotiate expense reimbursement from their own bank."
Susan Wachter, a professor at the University of Pennsylvania's Wharton School, said there is a "lack of incentive for servicers to optimally modify loans" that are sold to third parties. "They're paid in full for foreclosure. … They are also exposed to the risk that investors could sue." One solution might be a law to relieve servicers of the threat of lawsuits from investors, she said. Legislation could also "direct servicers to optimize the net present value of their pools."
Alan White, an assistant professor at Valparaiso University School of Law, said the objective of getting "cash flowing again" is an incentive for servicers of securitized loans to perform modifications. "On the other hand, they make a lot of advances for delinquent loans," and as a result, "they have an incentive to get to the finish line, and that usually means moving ahead to foreclosure," when they recover advances.
"As much as investors threaten to sue servicers for modifying too aggressively, I think there's going to be some talk among some investors about suing the servicers who foreclose too aggressively" because of a sharp increase in foreclosure-related losses, he said.
Overall, the report found that 37% of modified loans redefaulted after three months, and 55% did so after six months. It did not break down performance by the type of modification (for example, principal reductions versus term extensions). An OCC spokesman said that the agencies had just started collecting data on the types of modifications being performed, and that they hope to include it in their next quarterly report.