Fixed Income Recap

Today Fannie and Freddie announced a new streamlined plan to modify mortgage loans they hold and guarantee in hopes of curtailing the rising trend in home foreclosures. In addition to the GSE’s, private label mortgage originators Citigroup Inc., Bank of America, J.P. Morgan and Wells Fargo have recently announced plans to renegotiate the terms of loans that they originated. However, the vast majority of mortgage debt is packaged in mortgage backed securities and sold to investors, which presents a major bump in the road for private label originators when is comes to restructuring a troubled loan.

The streamlined effort announced today but not expected to start until December 15th will target Fannie and Freddie loans that are 90 days or more past due. They will modify interest rates, extend the terms of the loans and in some cases forgive portions of the principle in order to bring monthly payments close to a target of 38% of gross household income. The problem of the homeowner selling the house at a later date for a gain was not addressed specifically in today’s announcement but earlier discussion leans towards the agencies being entitled to at least part of the appreciation in the value of the home. To initiate the process the homeowner must provide a written statement to the servicer of the mortgage showing they have encountered some hardship. The servicer, along with the FHFA, will then evaluate their specific situation and make the judgment of eligibility.

An investor who owns a Fannie or Freddie pool consisting of loans that are restructured will likely never notice. A restructured loan, regardless of the form of restructuring, will appear to the bondholder as a simple refinance. The bond holder will then be made whole and the loan will either be repackaged in another security and sold or held on Fannie or Freddie’s books. If there is a loss on the principle due to the restructuring then Fannie and Freddie, who guarantee payment, will absorb the shortfall.

It is much more difficult to restructure the loans securitized by J.P. Morgan, Wells Fargo and the like because they do not stand behind the credit as Fannie and Freddie do. The banks, which act as only a servicer of many mortgage backed securities, are currently in talks with investors who hold large amounts of these bonds. Renegotiating loans that have been packaged and sold upstream would modify the bonds held by banks, hedge funds and other holders of this type of debt. Because of this I would expect the banks to concentrate first on restructuring debt they hold on their books first, and then move on to the more complicated securitized debt.


Cliff J. Reynolds Jr.
Junior Analyst