The mortgage industry is already beginning to benefit from the Supreme Court's holding last week that bankruptcy law doesn't allow consumers to "cram down" their home mortgages, and analysts say a bill moving through Congress could help home lenders even more.
Credit-rating agencies say they are studying whether to reduce the current reserve requirement in mortgage-backed securities pools for potential bankruptcies. Fitch Investor Services Inc., for example, reaffirmed several days after the ruling its $100,000 borrower bankruptcy requirement for triple-A and double-A rated MBS. It also said it was thinking of reducing its reserve requirements for cramdowns because of the ruling made in Nobelman vs. American Savings Bank, No. 92-641.
Fitch analysts said the Nobelman decision, combined with bankruptcy legislation now working its way through Congress, could result in a lowering of the $100,000 set aside for each MBS pool.
And, if Congress fails to act, the agency could move to lower the set aside based on Nobelman alone if bankruptcy data for the first six months of the year justify it, the analysts said.
In the unanimous decision, the high court ruled that debtors could no longer split their home mortgage loans into secured and unsecured portions, which had the effect of allowing those filling under Chapter 13 of the Bankruptcy Code to reduce the principal on their mortgages after they emerged from bankruptcy. The decision affirms a ruling of the 5th Circuit Court of Appeals, based in New Orleans.
Moody's Investors Services Inc. said it was still studying the decision, primarily for its potential impact on MBS backed by second mortgages. But a Moody's staff official cited comments several weeks ago which said that, "if the court affirms the decision, the bankruptcy cramdown risk in mortgage pass-throughs will be decreased substantially."
Fitch said it was studying a reduction in the borrower reserve requirement because the high court not only ruled in favor of investors in Nobelman, it also had ruled in a 1992 decision, Dewsnup vs. Timm that cramdown was not available under Chapter 7 filings.
Therefore, protection under bankruptcy laws for first mortgages on a debtor's principal residence are available only under Chapter 11 filings. But, Fitch said, "Chapter 11 filings across the country last year represented only .35% of all individual filings, and only three more cases than in 1991."
Fitch's also noted that Rep. Mike Synar, D-Okla., recently introduced legislation that would make filing under Chapter 13 available to almost all individual debtors. It would do that by increasing the total debt limit for an individual to $1 million from its current cap of $350,000 secured debt and $100,000 unsecurred debt. Individuals with greater total debt and may not file under Chapter 13, but must choose between Chapter 7 and Chapter 11.
"Therefore, this legislation, if adopted, is likely to prevent significant increases in Chapter 11 filings by individuals," Fitch said. "Moreover, the Synar bill would expressly prohibit cramdown of first mortgages on primary residences under Chapter 13."
Covering the Chapter 11 loophole is a primary objective in the bankruptcy bill of the Federal National Mortgage Association, said Dean S. Cooper, associate general counsel. Otherwise, he said, the guarantor "is very happy with the Nobelman result. Those filing for Chapter 13 can no longer make the cramdown argument for residential home mortgages."
But there remains some division as to whether the ruling also applies to second mortgages. The issue was raised during oral arguments before the court but was not mentioned in the court's unanimous decision.
"It says ~mortgage'." said Michael Crotty, deputy general counsel for litigation for the American Bankers Association in Washington. "That's incredibly good news. In light of the serious concerns that some of the justices expressed during the oral arguments, we think that if they wished to preserve the question of second mortgages to a case actually presenting such situation, they probably would have said so, at least in a footnote."
"Silence means the court deliberately didn't want to comment or saw it as irrelevant," said Roy Englert, a partner in the Washington bankruptcy practice of Mayer, Platt & Brown. "Therefore, it is not safe to comment with full authority on the potential impact of the court's decision on second mortgages."
However, he added, "my own view is that the statute gives the same status to holders of second mortgages as it does to first mortgages." Englert also said he is somewhat surprised at the strength of the court's decision.
The practical effect was to reinstate the full mortgage obligation of Leonard and Harriet Nobelman for their Dallas condominium. Another case in the 9th Circuit, which the Supreme Court had been asked to review, is also likely to be overturned.
However, losses to banking institutions or MBS stemming from In re Bellamy in the 2nd Circuit, In re Hart in the 10th Circuit, Wilson vs. Commonwealth in the 3rd Circuit and In re Hoagland, in the 9th Circuit will not be changed because those bankruptcy cases are final rulings.
The decision rejects current law in four appellate court circuits that had ruled that those in bankruptcy could, under the bankruptcy law. split, or bifurcate, to the chagrin of lenders.
"For the part of the banking industry involved in home mortgages, it is a powerful holding," Englert said. "It puts the mortgagor in line ahead of other creditors by ruling that a mortgage holder has an unalterable right to the mortgage securing the loan."
The ruling also says that in most cases state law is controlling in determining the property rights in the assets of a bankrupt's estate."
"This unanimous decision vindicates the assumptions lenders had until the novel argument of bifurcation was first adopted in the 9th circuit in 1989," said Robert McKew, general counsel of the American Financial Services Association in Washington. "The argument was irrational from the beginning."
He added that the latest decision "will lend further stability to the mortgage market."