IMGCAP(1)]
While many in the banking industry oppose mortgage bankruptcy legislation enabling judges to modify primary home mortgage terms, some believe bankers may benefit from the law. At press time, Congressional leaders were hashing out fine points of the law but it was widely expected to pass.
"Cramdown" legislation gives servicers justification to pursue principal reductions – something investors holding loans have long resisted. It also may address a key issue prolonging the housing downturn: Half of all borrowers who receive loan modifications end up defaulting again, leading to more foreclosed properties.
Rod Dubitsky, a mortgage analyst at Credit Suisse Group, says the legislation will be "a net positive" for the banking industry, and could reduce foreclosures by 20%.
Modifications that result in lower payments tended to re-default at half the rate as plans under which payments were higher or remained about the same, his research has found.
"Bankruptcy cramdown is expected to increase principal reduction modifications," he wrote in a report earlier this year. "For the many borrowers who are close to the edge, the new bankruptcy law would give them both equity and payment relief."
Because many delinquent borrowers cannot pay their mortgage anyway, the losses for lenders "would not seem to be any higher under the bankruptcy proposal and may in fact be lower," says Dubitsky. "We don't believe the bankruptcy reform will materially impact the pricing or availability of mortgage credit."
Mortgage industry groups have strongly opposed mortgage bankruptcy legislation in the past but opposition is faltering as foreclosures continue to drive the dramatic drop in home prices.
Troubles in the housing market – existing-home sales dropped in January to the lowest level since mid-1997 – have helped to fuel the deep recession, and economists say reducing mortgages is a key to recovery.
Democratic Congressional leaders tried last year to change the bankruptcy provision but were unable to overcome strong Republican opposition in the Senate and the threat of a veto from former President George W. Bush. A Democratic sweep in November and President Obama's support for Chapter 13 modifications changed the outlook.
The legislation limits the new bankruptcy rules to existing mortgages. Homeowners would have to seek a voluntary modification from their mortgage holder at least 15 days before filing for bankruptcy. The bill would require the homeowner to share the profits from a home sale with the lender if it takes place within four years of the bankruptcy. The sharing would come on a decreasing scale from 80% of the profit in the first year to 20% in the fourth.
Citigroup endorsed the legislation in January, providing a strong boost to supporters such as Sen. Richard Durbin, D-Ill., who has pushed for the change for two years.
Although the American Bankers Association opposes the change, it also is working to tighten some provisions to limit any negative impact. It wants, for example, better assurance that homeowners attempted to contact their lender/servicer regarding a loan modification 15 days before filing for bankruptcy. Otherwise, a bankruptcy judge only can reduce the interest rate or extend the term of the loan.
"If we're going to make changes in the bankruptcy code, how can we insure that bankruptcy is the last resort, not the first option?" says Floyd Stoner, the trade group's executive vice president for congressional relations.
The Congressional Budget Office estimated that more than one million households would benefit financially by filing for bankruptcy protection if the legislation is approved. But based on studies of how many individuals who could benefit from such protection actually file for bankruptcy, the office estimated that the change would lead to 350,000 additional cases over the next decade – with two-thirds coming by 2012.
In a filing under Chapter 13 of the federal Bankruptcy Code, the mortgage would be reduced to the property's net present value, and the reduction would be treated as an unsecured loan that gets paid back over three to five years.
The amount of the unsecured claim that can be recovered in bankruptcy is based on the borrower's disposable income and other claims that are discharged in bankruptcy.
Proponents believe cramdowns are necessary because banks and mortgage companies, because they have the option to foreclose, often are unwilling to offer delinquent borrowers serious loan modifications. Opponents counter that cramdowns will increase already widespread losses for banks. One problem: Interest rates on future mortgages will be pushed higher, they say, even for individuals who boast good credit.
Adam J. Levitin, an associate professor at Georgetown University Law Center, questioned claims that the legislation will cause mortgage rates to rise and further restrict lending. "Because lenders face smaller losses from bankruptcy modification than from foreclosure, the market is unlikely to price against bankruptcy modification," he tells American Banker, a Collections & Credit Risk sister publication. "Bankruptcy modification offers immediate relief, solves the market problems created by securitization, addresses both problems of payment reset shock and negative equity, screens out speculators, spreads burdens between borrowers and lenders and avoids both the costs and moral hazard of a government bailout."
Another hot-button issue is how a bankruptcy court determines a property's net present value. Before 1994, when the code was changed to eliminate rewriting of mortgages, judges often handled property valuations as they do now for commercial properties. Lawyers typically agree on a net present value based on evidence from appraisers and comparable sales data, meaning judges would not decide all valuations. CCR
