May 20, 2011 / 4:16 PM / 8 years ago

UPDATE 1-US mortgage company urges plan for principal cuts

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By Al Yoon

NEW YORK, May 20 (Reuters) - American Home Mortgage Servicing, one of the largest subprime mortgage servicers, is urging the U.S. Treasury to organize a plan to boost principal reductions for up to 1 million homeowners by unlocking loans from securities.

The servicer is asking for amendments to contracts that govern treatment of delinquent loans in mortgage securities. Currently, most contracts don’t allow sales of loans prior to foreclosure, and in many cases don’t permit a servicer to lower principal when a loan is modified.

American Home’s plan formalizes an idea it first floated within the industry more than two years ago. It hopes to draw more attention now as the government’s efforts to ease payments with loan modifications have had limited impact, foreclosures are still high and home prices have resumed falling.

American Home contends its proposal could provide a boost to the Obama administration’s Home Affordable Modification Program, in which many borrowers failed to qualify because a principal reduction would be needed, but not possible if a loan was tied up in a bond.

The plan “should provide a material benefit to borrowers by giving them the one last clear chance that HAMP was intended to provide, but appears unable to deliver to many homeowners,” American Home’s chief legal officer, Jordan Dorchuck, and others wrote to Treasury on Thursday.

There are about $1.25 trillion in loans contained in the so-called private-label mortgage securities packaged by Wall Street during the housing boom. The distressed balance is nearly $400 billion, with half of that representing loans that are both in default and whose loans are underwater, or bigger than the value of the property, they said.

Based on an average loan size of about $200,000, there are about 1 million borrowers in default and under water.

The number of underwater loans may grow as home prices have resumed their decline after a reprieve in 2010 due to temporary tax breaks for first-time home buyers. Borrowers who owe more than their homes are worth are prone to default, and feeding a vicious cycle of foreclosures and home price drops.

Across the entire mortgage spectrum, there are nearly 2 million loans that are more than 50 percent underwater, and will likely become part of the supply of distressed homes as borrowers default, according to CoreLogic.

Reducing principal for borrowers is also being advocated by U.S. state attorneys general as part of a settlement with large servicers over sloppy foreclosure practices.

Success of the plan may hinge on adoption by large banks such as Bank of America Corp (BAC.N) that service two-thirds of all home loans. Changes to contracts are now possible after a 2010 change in accounting rules that allows sale of a trust’s assets without forcing the seller to consolidate them on its balance sheet, the paper said.

The plan’s authors also include James Lockhart, a former top U.S. housing finance regulator and currently vice chairman at WL Ross & Co, the owner of American Home Mortgage, the 15th largest U.S. servicer. Pete Mills, managing director of policy consultant Mortgage Banking Initiatives, is the third author.

Investors whose losses have grown due to foreclosure delays and hasty modifications would benefit, even as the loans are sold at a discount, the group said. Investors have warmed to principal reductions to cut losses, but their preferences have been stymied by holders of second-liens that won’t agree to full or commensurate write-downs.

For servicers, unwinding of securities could alleviate their growing costs of funding payments to bond investors, which contracts mandate even if a loan is in default. Advances to investors are recovered as a loan is modified or foreclosed, but delays in the processes have required servicers finance the payments for long periods. (Editing by Kenneth Barry)

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