How Much Will Principal Reduction Affect Servicers?

The controversial principal reduction program announced by the Federal Housing Finance Agency (FHFA) last week is expected to moderately increase expenses for mortgage servicers who handle delinquent Fannie Mae or Freddie Mac loans, but overall the impact of the program on servicers is expected to be minimal, according to a report from Fitch Ratings on Monday.

Facing intense pressure from advocacy groups and from borrowers at risk of foreclosure, FHFA Director Mel Watt announced last week a one-time offering for approximately 33,000 eligible homeowners with Fannie Mae and Freddie Mac loans. To be eligible for principal reduction, applicants must be owner-occupant borrowers who are 90 days or more delinquent as of March 1, 2016; their mortgage must have an outstanding unpaid principal balance of $250,000 or less; and their mark-to-market loan-to-value ratios must exceed 115 percent.

According to Fitch, servicers handling GSE loans may see a moderate increase in expenses due to the principal reduction program, but overall they do not expect the program to affect rated RMBS transactions. The program will likely result in an uptick in the number of distressed borrowers contacting servicers to inquire about eligibility, which may raise the cost of customer service for the short term. Also, borrowers who are eligible for the program must receive a solicitation letter from their servicer containing modification terms before October 15, 2016, which may increase technology costs for servicers, according to Fitch. Expenses are expected to decline after that date and the program is not expected to affect Fitch’s servicer ratings, Fitch reported.

Factors that will limit the impact of the principal reduction program include:

• The number of underwater borrowers has been greatly reduced by home price appreciation
• Many underwater borrowers have already been helped by the government’s Home Affordable Refinance Program (HARP) and Home Affordable Modification Program (HAMP)
• Servicers have a brief window for solicitation. To qualify, borrowers must be 90 days delinquent as of March 1, 2016, and the solicitation period for servicers ends on December 31, 2016, along with the expiration of HARP and HAMP.
• Non-Agency mortgages are ineligible for the program
• Borrowers included in Fitch-rated Agency risk-sharing deals are unlikely to qualify for the program, since those transactions typically perform well and have low delinquencies

Predictably, the announcement that the FHFA would offer principal reduction drew mixed reactions from lawmakers. Sen. Jack Reed (D-Rhode Island), a senior member of the Senate Banking Committee, praised the program.

“I am pleased that FHFA, under Director Watt’s leadership, has finally chosen to give families still struggling from the wake of the financial crisis one more chance to save their homes,” Reed said. “I commend FHFA for carefully analyzing this issue, which included efforts to ensure this program is also consistent with the statutory mandate to preserve and conserve the assets of the enterprises. This decision is long overdue and offers meaningful foreclosure relief to hundreds of families in Rhode Island and tens of thousands more nationwide.”

Rep. Jeb Hensarling (R-Texas), Chairman of the House Financial Services Committee, had a different take on the issue, calling the principal reduction program a “Washington scheme” and a continuation of the “boom-bust-bailout cycle.” Hensarling quoted Yogi Berra in saying that it was “déjà vu all over again.”

“Contrary to the fable told by the Left, the root cause of the financial crisis was not deregulation but dumb regulation,” Hensarling said. “Regulations and statutes that ultimately put people in homes they could not afford to keep and led to the bailout of Fannie Mae and Freddie Mac, the biggest taxpayer-funded bailout in history. We need to build a sustainable housing finance system that protects both homeowners and taxpayers. But instead, the FHFA is helping Washington roll the dice again with another scheme founded on perverse incentives. Principal reductions exacerbate the same moral hazard problems that left taxpayers holding the bag for the government’s failures. Further, the FHFA itself previously warned us that principal reduction would be very costly for taxpayers, who already have spent hundreds of billions to bail out Fannie and Freddie.”