FHFA’s Watt: Principal reduction is ‘most challenging’ decision agency faces

Expects to give YES or NO within 30 days

Despite a report from Joe Light at The Wall Street Journal earlier Monday stating that Fannie Mae and Freddie Mac may start offering principal reductions to a select number of borrowers, the director of the federal agency that oversees the government-sponsored enterprises said Monday there is, in fact, no official decision on principal reduction yet.

The director adds that taking principal reductions “off the table entirely” is still an option.

The truth will be revealed in about a month.

In a speech given Monday at a public policy luncheon hosted by the Women in Housing and Finance, Mel Watt, the director of the Federal Housing Finance Agency, said that the issue of principal reduction has been the “most challenging” that the FHFA has faced in his two years there.

“FHFA has received substantial criticism, both before and since I became the Director, for not allowing the Enterprises to offer principal reduction as a part of our loss mitigation strategy,” Watt said in his speech.

“For the two years that I have been the Director, FHFA has been methodically studying this issue,” Watt continued. “My objective, as I have said on numerous occasions, has been to determine whether we could find a ‘win-win’ strategy employing principal reduction that would benefit both borrowers and the Enterprises.”

And finding that “win-win” strategy has been incredibly challenging, Watt said.

“It would not be an overstatement to say that this has been the most challenging evaluation the Agency has undertaken during my time as Director,” Watt said.

“Many have asked why it has taken so long to reach a conclusion,” Watt said. The direct answer is that making this determination involves consideration of an extremely complicated set of factors.”

According to Watt, those factors include “balancing the decreasing number of borrowers who are both underwater and seriously delinquent with the cost and significant operational complexity for the Enterprises and servicers to implement a principal reduction program.”

Watt told the audience Monday that the FHFA is not prepared to announce a decision on principal reduction, despite the contradictory report from the Wall Street Journal.

“We are, however, drawing close to the end of this difficult process, and I expect to announce a decision within the next 30 days about whether we have been able to find a ‘win-win’ principal reduction strategy or whether, on the other hand, we will take principal reduction off the table entirely,” Watt said.

In his wide-ranging speech, Watt also touched a number of issues facing the GSEs and what the FHFA is doing to address those issues.

Watt spoke on the sale of non-performing loans to private investors, a practice that has come under scrutiny by a number of groups, including prominent figures in the federal government, like Sen. Elizabeth Warren, D-Mass., and Rep. Mike Capuano, D-Mass., who loudly criticized the program last year, as well as the U.S. Conference of Mayors and other groups.

In his speech, Watt provided an update on the GSEs’ sale of non-performing loans and said that the FHFA will soon be releasing more data about the results of the non-performing loans, stating that the FHFA believes that the sale of non-performing loans, when done “the right way,” can help borrowers stay in their homes.

Watt said that as of the end of February, Fannie Mae and Freddie Mac sold more than 29,000 mortgages with a total unpaid principal balance of $5.8 billion through their NPL sales.

“To put this in context, approximately 200,000 Enterprise borrowers were at least one-year delinquent on their mortgages at the end of 2015,” Watt said.

Watt said that on average, loans included in Enterprise NPL sales were 3.1 years delinquent. Almost half of the loans in the NPL pools have been 3 or more years delinquent, Watt said, adding that 9% of the loans sold were at least 5 years delinquent.

“Selling these seriously delinquent loans to new owners is a way to create a fresh start for loss mitigation purposes,” Watt said.

“Purchasers of these loans have a financial interest in working with borrowers to avoid foreclosure and to help borrowers re-perform on their mortgage,” Watt continued.

“The new owners generally contract with specialty servicers that have extensive experience and better track records at offering loss mitigation solutions to seriously delinquent borrowers, and we believe they will be more likely to get better results,” Watt said. “Given the impasse with the prior servicer, borrowers may be more likely to respond to outreach and loss mitigation solicitations by a new servicer using new techniques.”

Watt said that the FHFA is currently working with Fannie Mae and Freddie Mac to publish the first round of publicly available data on borrower outcomes from the Enterprises’ initial NPL sales.

“Some advocates and municipalities have criticized or expressed concerns about Enterprise NPL sales, and we look forward to having a dialogue and ongoing engagement with stakeholders about these results and about how to improve the process,” Watt said.

“I do think it is important, however, to emphasize that these are the most difficult delinquencies to resolve. While we know how critical it is to have strong loss mitigation standards in place for these sales, we also know, unfortunately, that no strategy will help every deeply delinquent borrower stay in his or her home,” Watt said.

“We certainly expect NPL sales by the Enterprises to yield better results for borrowers than simply allowing the regular process to run its course,” Watt said. “But everyone should also acknowledge that the long durations and adverse circumstances associated with most of these delinquencies will lead a number of them to result in foreclosures or foreclosure alternatives, such as short sales.”

Watt also spoke about the future of loss mitigation, as the Home Affordable Refinance Program and the Home Affordable Modification Program are both set to end this year.

Watt said that the FHFA is working with the GSEs, as well as the mortgage servicing industry, consumer groups, and other stakeholders to develop post-HAMP loan modification options for borrowers.

“In addition to ensuring that the Enterprises’ loss mitigation options are consistent with what we’ve learned during the crisis, we are also thinking critically about ways the post-crisis era will look different from the period we’ve just lived through,” Watt said.

“For example, if we anticipate that interest rates will rise, this would impact how the Enterprises go about reducing borrower payments in loan modifications,” Watt continued. “We are also considering what loss mitigation adjustments would be appropriate given the stronger economy compared to the high unemployment rate during the crisis. Additionally, our analysis will consider the implications of loss mitigation changes for investors in the Enterprises’ credit risk transfer transactions.”

Watt also said that as HARP winds down this year, the FHFA is also working to make sure that borrowers with high loan-to-value ratio loans have a refinance option in the future.

“While we hope never to see another widespread crisis of the kind we have experienced, having a solution in place will be important in the event there are regional or localized economic disruptions that lead to negative equity in future home loans,” Watt said. “Having a permanent program available that is capable of refinancing borrowers with underwater mortgages will add needed liquidity in the market in these situations.”

Watt said that the FHFA is “currently conducting outreach” to lenders, mortgage insurers, and investors to “understand the operational impacts and feasibility of a high-LTV program” after HARP expires.

“During our outreach discussions, we are reminding industry participants that borrowers who previously completed a HARP refinance will not be eligible to refinance under a new high-LTV program,” Watt said. “When we conclude our outreach, the Enterprises will publish an announcement that reflects the eligibility guidelines and product terms that we believe will meet the needs of high-LTV borrowers in the future.”

Watt also reminded that the FHFA is engaging in a push for all HARP-eligible borrowers who have not taken advantage of the HARP program to do so by the end of 2016.

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