[Update 1: adds specific estimations, analysis]
Federal Housing Finance Agency Acting Director Edward DeMarco said principal reductions could save Fannie Mae and Freddie Mac up to $1.7 billion if used under the expanded government-led mortgage modification plan.
DeMarco released preliminary findings from an FHFA analysis in a speech at the Brookings Institution Tuesday. He stressed the findings were early, and the risk of strategic default was very real and could easily wipe out any benefit.
According to the early results of a potential pool of nearly 700,000 borrowers, Fannie and Freddie are expected to lose $63.7 billion on those loans if they are not modified. With the tripled incentive payments to reduce principal under the updates to the Home Affordable Modification Program, the losses would be $53.7 billion if some principal is forgiven, compared to $55.7 billion through forbearance.
The Treasury could potentially send $3.8 billion in incentive payments to Fannie and Freddie after redefaults are factored in. Based on net-present-value models, reducing the principal on significantly underwater mortgages would save the GSEs $1.7 billion, resulting in a $2.1 billion cost to taxpayers for the program.
“Because the Enterprises would receive the tripled incentive payments for principal forgiveness, PRA is better for the Enterprises [and] reduces Enterprise losses by $1.7 billion,” DeMarco said. (Click to expand)
The amount of potential assistance is limited as well.
Of the estimated 11 million underwater borrowers, roughly 2.5 million hold Fannie or Freddie mortgages at 115% LTV, based on FHFA analyis of ZIP code level data. Of that, DeMarco said, roughly 2 million are still paying their mortgage every month.
“That would leave the borrowers who are delinquent in the order of 500,000 to 600,000. But the 2 million who are underwater and current is our main concern,” DeMarco said.
The FHFA is still concerned about moral hazard, as well.
Three in four underwater Fannie and Freddie borrowers are still current. There is no modeling as of yet that could fully anticipate how many borrowers would default in order to get principal written down. DeMarco called them “strategic modifiers.”
The FHFA considered the sample of nearly 700,000 potential HAMP borrowers with an average $51,000 in principal forgiveness. If, they said, 5% are current borrowers still making payments but decide to fall into delinquency, the average loss per loan would $18,870 with the Treasury paying 63 cents to Fannie and Freddie for every dollar written down.
“This leads to the result that if about 90,000 borrowers decided to strategically modify the NPV benefits of $1.7 billion to the Enterprises would be eliminated,” DeMarco said.
But this implies 100% of these borrowers would be accepted through HAMP. If 25% of the borrowers went through such a program, or 172,750 homeowners, DeMarco said if only 20,000 were “strategic modifiers” then it would offset any cost to the GSEs.
There is also the problem of second liens.
DeMarco previously said such a principal reduction program would unfairly push borrowers to pay back these debts largely owned by the banks, making it another bailout. He said information on how many second liens are tied to GSE loans is still murky, but estimates show roughly 50% of underwater Fannie and Freddie mortgages have some third-party share of the credit risk, either a second lien or mortgage insurance.
“In the case of principal forgiveness the Enterprises’ bear all the losses of the write down and share the benefit of the lower probability of default with the third party. In the event of a subsequent foreclosure, the Enterprises’ bear all the losses of the write down and the third party realizes all the benefits of it before incurring losses, if any,” DeMarco said.
The Treasury said the 2MP initiative under HAMP allows servicers to write down principle on these second liens as well. DeMarco said in his speech said roughly 25% of GSE mortgages modified under HAMP have a second lien eligible for 2MP.
“Whether Fannie Mae or Freddie Mac forgive principal or not, the universe of Enterprise borrowers potentially eligible for a HAMP PRA is well less than one million households, a fraction of the estimated 11 million underwater borrowers in the country today,” DeMarco said. “The far larger group of underwater borrowers who today have remained faithful to paying their mortgage obligations are the much greater contingent risk to housing markets and to taxpayers. Encouraging their continued success could have a greater impact on the ultimate recovery of housing markets and cost to the taxpayers than the debate over which modification approach offered to troubled borrowers is preferable.”