Remember this chart? It’s old, but still relevant.
Those are second-lien (or just plain second) mortgages held by US banks — also known as remortgages or home-equity withdrawals in the UK. The top four, for those curious, are Bank of America, Wells Fargo, JPMorgan Chase and Citi.
We bring it up because there’s (finally) been some movement on this second-lien issue — which has been one of the sticking points in modifying US mortgages.
Here’s a quick recap.
Normally second lien mortgages rank subordinate to the first mortgage (first lien). In principle, that means if the property is sold or the borrower defaults, the first lien lender is first in line to get the resulting money, followed by the second lien lender.
When mortgage modifications like the US Treasury’s Hamp programme come into play, that traditional priority order is reversed. The borrower is paying the Hamp-modified (i.e. lower) first lien amount, and the full second lien amount, so the second lien effectively becomes senior to the first. Second-lien holders are thus disincentivised to work with first-lien holders and agree to modify their own (second lien) loans since it would mean resubordinating them to the first mortgages.
In other words, you don’t get much of an improvement in a borrower’s overall financial position, since often the first loan is modified without touching the second
To complicate matters, lots of these second-lien mortgage-holding banks are also mortgage servicers — which means they’re able to dictate the fate of the loans. Banks don’t want to have to write down their (still hefty) portfolios of second lien mortgages. (It’s worth noting too, there was some talk that the recent foreclosure crisis could be used to force banks to take aggressive writedowns on their second-lien mortgages).
Anyway, over to MarketWatch with that second-lien regulatory update:
Responding to a growing wave of foreclosures, the Federal Deposit Insurance Corp. is considering whether to impose new disclosure requirements on big banks seeking to package and sell mortgage securities to investors.
And specifically:
Regulators may soon want banks issuing primary mortgages for securitization to disclose in pooling and servicing agreements with mortgage investors what happens to the second lien they own if the first lien is in trouble.
With this kind of disclosure, Sommer insists, investors would only agree to buy mortgage securities from banks that agree in advance in the PSAs to completely write off or proportionately write down the second-lien loans in situations where the primary mortgage comes into distress.
A bit more background here — servicers in private-label mortgage securitisations have to abide by those PSAs, which dictate that they must consider the benefits to investors of a mortgage modification compared to foreclosure. However, those PSAs are often open to servicer interpretation, and the servicers themselves may be incentivised to foreclose instead of modify as they may collect higher fees that way.
What it looks like the FDIC is trying to do then is harden or codify that original PSA sentiment. Force mortgage servicers to spell out exactly what happens to the second lien, which should make it more obvious to investors when servicers aren’t acting in the best interests of the securitisation, for instance, by refusing to modify.
Admirable, FDIC.
Related links:
Sacrificing servicers on the altar of Hamp - FT Alphaville
From foreclosure to writedowns – FT Alphaville
The second-lien sticking point – FT Alphaville
A second (lien) helping of Hamp – FT Alphaville