On March 17, 2009, a group of mortgage bond investors worried about the losses they could suffer as a result of U.S. foreclosure prevention plans asked top bankers to share the pain by taking some write-downs on $450 billion in home equity loans.
But the bankers said they would talk only after the investors first allowed modifications on their primary loans as prescribed under the Obama administration's Home Affordable Modification Program, according to a trader who attended the meeting at the American Securitization Forum in New York.
Thus began a year of frustration for the investors, such as asset manager BlackRock Inc., who claim their rights as primary mortgage holders have been trampled by the foreclosure program that let second-lien holders off the hook. Most agreed that the program, known as HAMP, was good policy, but balked at who sustained losses and when.
"It doesn't make sense," said Scott Simon, a managing director at Pacific Investment Management Co., in Newport Beach, Calif. "You'd think if you are first lien holder you'd be in first lien position."
More than a year later, investors whose losses would be lessened if banks took write-downs on second-lien mortgages are getting some attention, after being stonewalled by banks and regulators, according to the trader who attended the meeting with bankers. The change comes as they are being asked to help restore private credit to the U.S. housing finance system, which is costing taxpayers a bundle.
Some $126 billion of government bailouts for top U.S. mortgage finance companies Fannie Mae and Freddie Mac has raised an awareness of the cost of defaults and loan modifications. And Fannie and Freddie have warned that they will continue to need further government support through 2010.
The need of the deserted private mortgage finance market, where investors assume credit risks, has come into sharp focus as the Federal Reserve ended its support of U.S.-backed mortgage bonds last month.
"The tide has certainly changed, and there is more momentum now than three or four months ago," said Barbara Novick, vice chairman at BlackRock in New York.
"We see HAMP unfortunately as subsidizing the banks and doing it though Fannie's and Freddie' balance sheet, and through pension funds and insurance companies," Novick said. "These are people that should not be shouldering the burden."
Regulators and lawmakers including Representative Barney Frank, chairman of the House Financial Services Committee, are among those taking notice. Frank is soon expected to press bank executives on why the presence of second-liens has hindered success of loan modifications aimed at stabilizing housing.
More than half of private mortgage bonds, which at the height of the housing boom exceeded government-related funding, are encumbered by seconds, according to Amherst Securities.
"There's been some movement since we announced the hearing," Frank told Reuters. "Bank of America is talking about what they are doing, saying 'we are ready to negotiate.' The regulators are talking about forcing write-offs."
Barbara Desoer, president of Bank of America Home Loans, in prepared testimony, said the bank modifies home equity loans, and has taken $10.5 billion in write-downs over two years. However, she said the bank "would advocate" an industry policy in which the second lien is cut proportionate to the first.
In February, a group including Fortress Investment Group — run by former Fannie Mae chief Daniel Mudd — told Frank they would cede ground and share write-downs with second lien holders to motivate banks and break an impasse gumming up loan modifications. New programs planned in Washington could work if investors, first-lien or second, "jump in the pool at the same time," said Micah Green, an attorney with the Washington law firm Patton Boggs, which represents the Association of Mortgage Investors.
Sharing losses is unlikely to satisfy some investors in primary mortgages who are adamant that contract law not be tinkered with. First mortgages should not take any loss until a second is wiped out, investors said.
Chase Home Mortgage said in its testimony for Tuesday's scheduled hearing said that a distinction exists between payment priority and lien priority. Second lien holders have rights equal to a first lien holder in terms of a borrower's payments, except under a foreclosure, David Lowman, Chase's chief executive, said in prepared text. It does modify seconds, he said.
Investor voices have been drowned out in Washington by banks that have played a role in writing modification plans, analysts said. The top four banks own the lion's share of second mortgage debt, but also service the first mortgages, in what investors see as a conflict of interest.
"The rules are to protect the 800-pound gorilla," said the trader close to talks with banks and regulators. "If you were to mark-to-market those loans, the probability is that you would have" to write down half the value.
"I don't think the financial system can take another $200 billion write-down," the trader added.
Investor gripes may already be reflected in the private market, which is percolating with a possible bond from Redwood Trust, a California real estate investment trust. Issuers may find demand too weak to generate profits for them as investors weigh added risks, investors said.
While bonds will likely contain safe loans, that doesn't address angst over who takes losses in times of stress.
"There is significant fear in the investor community about the erosion of the seniority of first lien relative to the second," said Vincent Fiorillo, a portfolio manager at DoubleLine Capital in Los Angeles.
"There is evidence that the priority of the first lien has been damaged," he said.
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