Principal reductions by servicers now account for nearly 40% of total modifications, a sharp rise from 2011 and 2010 when the share was 25% and 11%, respectively, analysts at Amherst Securities Group said.

Other types of modifications include interest rate and capitalization.

Amherst reviewed data from the Office of the Comptroller of the Currencydrawn from nine national banks and federal savings banks, representing the largest servicers, to examine the drivers of successful loan modifications

More than 25% of modifications completed in the fourth quarter resulted in reduced principal on loans servicers held in their own portfolios, compared to 17.8% one year prior (click on the graph below to expand).

Servicers reduced principal on investor-held loans for 16% of the modifications, compared to 1.8% one year ago.

No modifications of Fannie Mae, Freddie Mac or Federal Housing Administration mortgages resulted in a principal reduction in either quarter.

“There is no question that principal modifications have been the most effective form of modification on a year-by-year basis,” Amherst stated in its report.

The GSEs do not permit principal reductions on loans backed by them. A bipartisan bill introduced in the House of Representatives last week directs the Federal Housing Finance Agency and the Department of Housing and Urban Development to develop pilot programs that allow write-downs on GSE and Federal Housing Administration loans.

Principal reductions are more likely to be done on loans with higher loan-to-value, lower FICO borrowers, who are more likely to default, which Amherst said might understate the success of principal reductions. Second and subsequent modifications are more common when a borrower has a lower FICO score, which also might understate the modification success rate of lower FICO borrowers versus their higher FICO counterparts.

And how early in the delinquency process a borrower obtains a modification is a key driver of modification success. The average number of months a borrower is delinquent at the time of modification is on the rise.

“If a borrower is offered a 30% pay reduction immediately upon becoming delinquent, that person is apt to feel very good about the new modification — he is getting a ‘deal,’” Amherst reports. “Offering the same modification after a 15-month period of mortgage non-payment is going to appear less attractive. While it is still a 30% cut in payment from the pre-modification amount, it represents a huge payment increase over the ‘zero’ amount the borrower is currently making.”

In 2008, less than 5% of borrowers received modifications when they were less than 12 months delinquent — that number is now above 40%. That trend is like to continue considering the Home Affordable Refinance Program gives larger modification incentive if a modification is done when the borrower is less delinquent.

Amherst also recognized more payment relief, a declining redefault rate of first modifications and FICO scores as drivers of modification success.






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