More Real Estate Bubble management that will greatly exacerbate the size & duration of the bust.
Loan Modification Programs Are Helping Homeowners Soften Blow of a Slowdown
October 30, 2001
By PATRICK BARTA
Staff Reporter of THE WALL STREET JOURNAL
Kathryn Blake's trouble started when her one-ton truck was totaled in a
head-on collision. The deteriorating economy made matters worse.
Before last winter, business was booming for the 39-year-old plumbing
contractor in Greensboro, N.C. But Ms. Blake was left with no savings after
she had to spend $10,000 to replace the truck. Then new-home construction
came to a near standstill, cutting her income in half. By summer, Ms. Blake was
eight months behind on the mortgage on her 7.5-acre horse ranch just outside
of town.
During past economic downturns, this episode probably would have ended
badly, with Ms. Blake losing her home and possibly heading to bankruptcy
court. But instead of pushing Ms. Blake into foreclosure, Wells Fargo Home
Mortgage, a unit of Wells Fargo & Co. of San Francisco, offered to "modify"
her delinquent loan. The lender tacked the $14,000 in missed payments onto
the top of her existing $160,000 mortgage, while making a slight reduction to
her monthly payment.
'A Ton of Bricks'
"I didn't care what they did. I didn't want to lose my animals. I didn't want to
lose my home," she says. "A ton of bricks came off my shoulders." Ms. Blake
has since snagged a lucrative contract to do the plumbing for a new fire station,
and she's back on track with her mortgage, without completely wrecking her
credit.
In an aggressive attempt to keep the housing market afloat at a time of
economic distress, mortgage lenders are ratcheting up the use of "loan
modification" programs. Designed to keep homeowners from defaulting on their
loans, the programs also help the mortgage industry -- including the giant
mortgage-finance companies Fannie Mae and Freddie Mac, which have
backed the trend -- by reducing real-estate write-offs.
If the programs work as designed, they should prevent the kind of real-estate meltdown that can
accompany an economic downturn. If they fail, the widespread use of loan-modification programs
could exacerbate such problems. Often, borrowers who undergo loan
modifications wind up with bigger mortgages that carry higher long-term interest
costs, and in some cases, the borrowers wind up in default anyway.
"When you do lots of these things, you're buying people some more time, but
you don't know if you're solving the problem," says Diane Swonk, the chief
economist at Bank One Corp. in Chicago. As a result, she warns,
loan-modification programs could "create a long-term time bomb" that could
explode when bad borrowers reach the end of their ropes.
But early evidence suggests that by reducing the prevalence of foreclosures,
loan modification is playing a key role in keeping consumers from falling into a
deep financial morass, at least for now. The programs, which are similar to
commercial-loan "workouts" that banks have offered for decades to help
distressed corporations restructure their debt, should "bridge us between
economic recession and economic prosperity," says Sung Won Sohn, the chief
economist at Wells Fargo & Co.
A Huge Drag
Foreclosures are a huge drag on any economy. They force banks to rein in
lending to home buyers and flood the market with homes at fire-sale prices. At
the same time, families that go into foreclosure typically wind up with seriously
impaired credit. When foreclosures get bad enough, they can wreak even
greater havoc: In the late 1980s and early 1990s, for example, a tidal wave of
foreclosures helped sink scores of lending institutions in California, Texas and
parts of the Northeast.
When used properly, loan modification "holds up home prices and makes a
recession less bad than it otherwise would be," says Maury Harris, the chief
U.S. economist at UBS Warburg in New York.
With unemployment
rising and the economy
stumbling toward a
recession, there's little
question that banks are
expanding the programs
just in the nick of time.
Until recently, the
housing market played a
critical role in propping
up an otherwise weak
economy, but now the
sector's strength appears
to be fading. Sales of
existing homes fell nearly 12% last month, the sharpest decline in six years, and
credit problems are on the rise.
Tara McCarthy, a housing counselor at Auriton Solutions Inc., a national
credit-counseling company based in St. Paul, Minn., says she's seeing a
growing number of people with good credit histories who can't pay their
mortgages. One recent case, she says, involved a Minneapolis graphic designer
who lost his $100,000-a-year job, and now faces $1,400 in monthly mortgage
payments -- plus $1,600 in minimum monthly bills for his dozen credit cards --
without any significant savings.
"They're not the stereotypical people you'd think were on welfare and can't pay
their mortgages," says Ms. McCarthy of many of her latest clients. Given the
state of the economy, "it's going to get worse," she says.
At the end of the second quarter, the most recent period available, 4.6% of all
residential mortgages were delinquent, up from 4.4% in the first quarter,
according to the Mortgage Bankers Association of America. But the numbers
vary sharply depending on the credit standing of the borrowers.
For example, some 2.9% of all "prime" mortgages for borrowers with strong
credit -- about 85% to 90% of the overall market -- were delinquent during the
second quarter. That was up from a 27-year low of 2.4% at the end of 1999
and in the first quarter of 2000 but far below the 3.4% level reached during the
1990-1991 recession.
Delinquencies on government-insured mortgages, which are popular among
people who can't easily qualify for a conventional mortgage, are far worse.
Nearly 11% of borrowers who got loans through the Federal Housing
Administration program, mainly first-time buyers, were delinquent during the
second quarter, an all-time high. The percentage of seriously delinquent
"subprime" loans for borrowers with spotty credit, meanwhile, is abnormally
high at 6.9%, according to LoanPerformance, a San Francisco mortgage-data
firm.
So far, foreclosure rates have remained low -- just 0.9% of all mortgages were
in foreclosure in the second quarter. That's in part because of loan-modification
programs but also because the housing market has remained relatively healthy
even as the economy has weakened. Foreclosures generally only become
widespread when home prices stop growing or decline -- as many experts
believe they are likely to do in some areas -- because as long as home prices
are rising, borrowers who get into trouble can usually sell their homes without
taking a loss.
It's hard to estimate how much higher foreclosure rates would be without
loan-modification programs. But last year, about 16,000 of Fannie Mae's
30,000 seriously delinquent loans went through some kind of "workout"
program, an industry term used to describe the various methods of resolving
bad loans, including loan modifications. In 1997, by contrast, about 12,000 of
the company's 34,000 seriously delinquent loans went through workout
programs. Less than 10% ultimately wound up in foreclosure, Fannie Mae said.
"If [the modifications are] done properly, you're not masking a problem, you're
helping a customer," says Steve Rotella, president and CEO of Chase
Manhattan Mortgage Corp., a unit of J.P. Morgan Chase & Co.
The programs seem to have helped Warren Vrba, a 31-year-old
lighting-equipment salesman in Houston, and his wife, Stacy. Two years ago,
she gave birth to a premature son whose medical care cost $100,000, $10,000
of which came out of their pockets.
The hit from the unexpected expense eventually caught up with them, and by
this summer, the Vrbas were some $11,000 in arrears on their house. Their
lender, Chase Manhattan Mortgage, put together a new mortgage, adding
$3,000 to the balance of the Vrbas' loan and collecting an additional $8,500 in
a lump-sum payments. Now, the Vrbas' monthly bill is about $1,240 a month,
compared with about $1,250 before -- and the clock on their 30-year
mortgage begins again. Although Mr. Vrba says he feels "a little bit used," since
the bank charged some fees for the service, he's glad it's all straightened out. "It
put my mind at ease," says Mr. Vrba.
Deeper Holes
But some economists believe the programs will do little more than put
borrowers into deeper holes, postponing the inevitable. Others contend that
lenders are pushing loan modification in part to hide unwise lending decisions
made during the late 1990s, when underwriting standards were eased to allow
more marginal borrowers to qualify for loans. While those efforts helped boost
the nation's homeownership rate to a record 68%, some economists and
mortgage experts believe bankers are more exposed to borrowers with weak
credit histories than in prior periods.
"What [banks] are doing is basically moving a delinquent item to a performing
item in a manner that belies the real condition of their earning assets, and that's a
really dangerous precedent," says Doug Kass, a general partner at Seabreeze
Partners, a hedge fund based in Palm Beach, Fla. Mr. Kass has worked as a
housing analyst on Wall Street and actively trades stocks in the sector.
What's more, the programs could make it harder for economists and regulators
to gauge the health of the mortgage market at a critical juncture, warned a
report released this summer by securities research firm Graham Fisher of New
York. Since lenders aren't required to publicly report which loans are
undergoing modifications, "it may be months [after the fact] before we know if
[credit] problems are worse or intensifying," says Keith Gumbinger, a mortgage
market analyst at HSH Associates in Butler, N.J.
Loan modifications weren't unheard of a decade ago. But their use became far
more prevalent in the latter half of the 1990s, in large part because of pressure
from Fannie Mae and Freddie Mac, the quasi-governmental companies that
buy massive quantities of mortgages from lenders to hold in their portfolios. In
the mid-1990s, the two companies began requiring lenders to at least consider
offering a loan workout to every distressed borrower. Fannie and Freddie pay
banks $500 or more in incentives for every loan that undergoes a workout.
To help banks do that, Fannie Mae introduced in 1997 a software system
known as Risk Profiler, which lenders use -- free of charge -- to identify at-risk
borrowers, in some cases before they're even delinquent. Consumers who are
at risk of foreclosure still deal directly with their lenders, rather than with Fannie
and Freddie.
Protective Programs
Fannie and Freddie have pushed the programs in part because they help
consumers. But the programs also help Fannie and Freddie by keeping their
own credit losses down. That protects their stock prices and shields them from
criticism in Washington, where they have come under attack from critics who
believe they're growing too fast and taking on too much risk. In their quarterly
earnings reports released earlier this month, Fannie and Freddie both reported
that credit losses have dropped over the last year, despite a weaker economy,
and now reside near historic lows.
Banks that push loan modifications look good, too: At Wells Fargo, for
example, foreclosures have dropped 40% since it implemented a software
system in 1998 that helps staff identify clients who can benefit from loan
workouts.
Whether that kind of success can continue will depend a lot on people like
David and Patricia Stephens of Rahway, N.J., who were saved from
foreclosure earlier this year but could easily slip back into trouble if their
fortunes change.
Over the past three years, Mr. Stephens, a 45-year-old chiropractor, has
struggled to stay employed. After an unsuccessful attempt at running his own
chiropractor's office, he took a series of odd jobs, including working as a
tree-cutter, that didn't work out. His wife stays home to take care of their seven
children.
By this summer, the Stephens family had missed 17 consecutive $1,400
monthly payments -- a total of nearly $24,000 -- on their three-bedroom
Colonial home. At one point, Mr. Stephens found himself collecting his final
unemployment check before his eligibility ran out.
Finally, in May of this year, Mr. Stephens found new work as a chiropractor,
with an after-tax salary of about $56,000 a year. Chase modified his mortgage
loan, less than two weeks before the house was to be auctioned off. The bank
required Mr. Stephens to pay $8,500 up front, which Mr. Stephens was able
to do by borrowing money from a state housing-assistance program. The bank
tacked the remaining $16,000 to the principal of his old mortgage, and charged
about $500 in fees. Now, Mr. Stephens has a home loan for $144,000 --
larger than the $137,750 mortgage he took out seven years ago to buy the
house -- and he can expect to pay nearly $10,000 more in interest over the
next 30 years. He also pays about $230 more a month, including $160 or so to
handle the loan he got to cover his up-front charge.
"We got hammered, and we lost all our equity," says Mr. Stephens. He
acknowledges that there's a chance his current job won't work out, which
would put him in a pinch again. On the other hand, he admits, "they could have
kicked us out."
Write to Patrick Barta at patrick.barta@wsj.com2 |
