Bank of America, saddled with tens of billions of dollars in troubled residential mortgages, largely stemming from its ill-fated acquisition of Countrywide Financial in 2008, has announced a series of initiatives designed to deal aggressively with this still-mounting problem. Perhaps it would be useful to examine and critique some of these initiatives in the interests of helping or guiding other institutions with similar mortgage portfolio problems.
Last year, Bank of America announced that it was setting up a separate unit called Legacy Asset Servicing which would be the repository for tens of billions of dollars of troubled mortgages largely focused on subprime mortgages originated by Countrywide. Separating an institution burdened by toxic loans into a bad bank/good bank structure was a useful remedy for banks during the S&L crisis of the early 1990s. The segregation of troubled assets should enable banks to develop processes to handle these loans with greater expertise and efficiency.
So far, so good. But if the Legacy Asset Servicing group is only focused on expediting the classic payment collection and/or foreclosure model, nothing much will be accomplished. On the other hand, if mortgage lenders and servicers undertake the challenge of developing teams of highly trained loss-mitigating experts, each able to professionally and sensitively work through an increasingly complex range of loan modification, restructuring, or short sale options with troubled borrowers, then real progress can be made.
Furthermore, when there is no reasonable solution and foreclosure is the only option, banks must develop far greater expertise and sophistication in the process of disposing of these properties. There is emerging evidence that banks are often liquidating foreclosed properties at far less than realizable market prices. It is especially urgent that banks with large mortgage portfolios such as Bank of America develop project teams which are fully equipped to handle the process for selling repossessed homes, so as to minimize losses to the lender and, at the same time, avoid unnecessary destruction of neighborhood property values. Each project team should have expertise in appraising, renovation or home improvement, and real estate sales. Each property in the "real estate owned" inventory should be promptly and carefully inspected with a determination made as to whether or not the property is ready to be put on the market and at what price. In the case where a property has been neglected, abused or damaged, the project team need to make a judgment about what repairs or improvements need to be made before listing the home to maximize net realizable value to the bank. Otherwise, banks will be inviting more devastating losses on property disposition than necessary, a process which only benefits bottom-feeding speculators and damages community housing values. If Bank of America is building this kind of expertise into the Legacy Asset Servicing unit, the company is to be highly commended.
More recently Bank of America has stated its intention of moving more aggressively in seeking to negotiate principal reductions, pursuant to the recently announced $26 billion settlement between the five leading mortgage servicers and the states attorneys general. As I wrote here in January, "There is no fair or equitable way to selectively reduce the unpaid principal balance of a mortgage without creating moral hazard." The mainstream press has recently reported that both members of Congress and Administration officials are frustrated that Fannie and Freddie are not more aggressively pursuing principal reduction to alleviate the foreclosure problem. But Edward DeMarco, the Federal Housing Finance acting director, is wisely skeptical of this approach. He doubtless knows that the minute a borrower, who has signed a personal note obligating him or her to the terms of a mortgage, is suddenly relieved of a portion of that obligation, every similarly situated borrower will expect the same treatment.
The only way selective principal reduction is feasible is by going through the following two step process: first, by determining that the borrower was encouraged or induced to commit to an easily misunderstood, complicated type of mortgage instrument; and secondly, by securing the amount of principal reduction with a nominal interest rate second mortgage payable out of the excess funds from the ultimate sale of the property. Simply reducing principal for a troubled borrower without undertaking this process will lead to greater, not lesser, chaos in the marketplace, and DeMarco is justified in resisting the pressure from policy makers.
Most recently, Bank of America began testing a pilot program known as "Mortgage to Lease" in which borrowers facing foreclosure are offered a rental arrangement for up to three years in return for conveying title to the property to the lender. This initiative (which follows closely my recommendation in the aforementioned January article) could conceivably avoid tens of thousands of foreclosures if expanded nationally, with enormous benefits not only to the original borrowers and their families, but to the entire community by preserving property values.
Ultimately the lenders will benefit hugely as disposition of the rented properties is postponed several years when, presumably, more normal housing market conditions prevail.
Alexander R. M. Boyle is the retired vice chairman of Chevy Chase Bank. He has worked in mortgage lending and consumer banking for 30 years.