WASHINGTON — The Federal Deposit Insurance Corp.'s takeover of IndyMac Bancorp Inc. is giving the agency the chance to practice what it has preached on loan modifications.
Shortly after the FDIC assumed control July 11, Chairman Sheila Bair, who has urged bankers to engage in broad-based modifications since last year, said it would freeze foreclosures on the thrift company's mortgages while it evaluated which loans could be renegotiated.
Many observers say IndyMac's mortgage portfolio gives the agency a chance to show the industry, which has struggled to modify loans, a better way to do the job.
"The box is relatively small in terms of what the [private] servicers are willing to experiment with," so "having the FDIC undertake a grand experiment using IndyMac as a test case is probably not a bad idea," said Rod Dubitsky, a managing director of fixed-income research and structured products at Credit Suisse Securities LLC. "There's probably a lot more that can be done" servicing troubled loans.
The modification efforts are broader than the agency first announced. Ms. Bair said the formal foreclosure suspension would apply to the $15 billion portfolio of about 45,000 loans still owned by IndyMac. But FDIC officials said this week that they also would seek to modify some of the loans that IndyMac serviced but did not own.
IndyMac had serviced about 740,000 mortgages worth $184 billion.
"Over 60,000 of these borrowers are 60 or more days behind on their payments," John Bovenzi, a senior FDIC official now serving as IndyMac's chief executive, wrote in an e-mail to its employees Tuesday. "The new program is designed to establish an affordable and sustainable payment level for many of these borrowers."
Several observers called the freeze — and the potential for modifications — a prudent step to capture whatever value is left at IndyMac. The Pasadena, Calif., thrift company was hammered by defaults on alternative-A mortgages, and the agency's ability to sell off the portfolio will be crucial in mitigating the resolution cost, estimated at $4 billion to $8 billion.
"They're trying to get their arms around what they've got, so that they can figure out how to sell it," said Robert Hartheimer, a special adviser at Promontory Financial Group LLC and a former resolutions director at the FDIC.
Michael Krimminger, a special adviser for policy to Ms. Bair, said in an interview that the primary aim of the foreclosure ban is to attract maximum value for the portfolio, minimizing resolution costs.
"In the current market, foreclosure is not a good option," he said. "Using our approach, loan modifications will not increase our costs, but only improve the performance and return on the mortgages."
The FDIC may also be trying to prove something Ms. Bair has long argued: that broad-scale modifications are workable. Regulators have said the industry is moving too slowly in modifying on a case-by-case basis — a method bankers have said is the only way to alter loans.
Mr. Krimminger said the agency would use an overarching standard to classify which loans can be modified and then restructure them systematically.
"Based on our analysis, taking a systematic approach to modifying delinquent mortgages, using an identifiable metric such as debt-to-income ratios, is the best way to maximize our recoveries by turning nonperforming into performing loans," he said.
He stopped short of saying servicers have not been up to the challenge.
"There has been a lot of work done by servicers to try to find ways of working around some of these issues, and we fully respect the work they've done," Mr. Krimminger said.
However, "we think that in today's market and with the size of IndyMac's portfolio, that we need to take some systematic action."
Making systematic modifications work could help other industry participants figure out how to follow suit.
"Given the FDIC's outspoken support for modifications, it may view the IndyMac portfolio as an ideal test case with which to trigger a paradigm shift in how servicers deal with loan mods," Mr. Dubitsky and other Credit Suisse analysts wrote in a report issued last month.
Still, the FDIC faces limits, Mr. Dubitsky said in the interview. For example, any modifications must comply with a federal statute requiring the least-costly resolution, he said.
"I don't think they can be so experimental that they forgive half of the balance of the loans."
The FDIC also has some advantages over lenders, he said. Banks and thrifts have complained that many troubled borrowers do not return phone calls, fearing the institution is calling to foreclose, but the FDIC is more likely to be trusted, so if the mortgages are "owned by the FDIC, the borrower is maybe more likely to call them back."
An executive at a large banking company, who spoke on the condition of anonymity, agreed that the IndyMac case could serve as a testing ground for modifications, especially in an environment where falling home prices make widespread foreclosures unattractive. The foreclosure moratorium is "fresh thinking that's not encumbered by the way we've always done it."
But the executive agreed that the FDIC may have an easier time justifying modifications than a private lender. "While a lender would look at a particular loan specifically on its own merits to figure out the best value … you could argue that the FDIC has a larger role" as a regulator of addressing "the impact on communities."
Others were more wary of the FDIC's plans and said the agency could discover the industry has been right all along. The industry has been criticized for favoring subtle repayment plans over full-scale alterations that could lower a borrower's interest rate.
Brian Chappelle, a former Department of Housing and Urban Development official and now a mortgage industry consultant and partner at Potomac Partners, said attempting extensive modifications at IndyMac will give the FDIC a better understanding of how difficult they are.
"It's going to validate the industry's efforts," Mr. Chappelle said. "I don't think the FDIC is going to be able to do any better."
James Chessen, the chief economist for the American Bankers Association, said the agency will likely find that workout plans are a subjective process.
"Banks have been saying that working through cases on an individual basis is in fact exactly what you've got to do," he said. "They will find that it's a one-on-one situation — that every mortgage has unique elements and requires a different solution."
