HAMP Creates Cash Flow Implications for Securitization: Amherst

The administration’s Home Affordable Modification Program (HAMP), which allocates federal incentives to servicers, lender/investors and borrowers that participate in mortgage modifications, is creating significant repercussions for the secondary market. HAMP failed initially to address the treatment of forborne principal and the manner in which modifications should be handled in terms of delinquency triggers among securitizations, according to market insight this week from Amherst Securities Group. The forbearance question has to do with the treatment of a forborne — not forgiven — amount of principal of a mortgage within a securitization. Confusion arose among industry players that were divided on whether the forborne principal — which carries a 0% interest rate and becomes payable at the end of the loan’s life — should be realized as loss and written down immediately, or written off at the end of the contract’s life. “If losses on the forborne principal are not realized until the payment comes due, the junior tranches are not written down, and will receive cash flow if there are sufficient funds,” Amherst noted in market commentary Tuesday. “Alternatively, if forborne principal is taken as a realized loss when the loan is modified, the junior tranches are written down more quickly. It is in the senior-most investors’ interests to have the loan written down immediately -– that is, to have principal forbearance treated the same as principal forgiveness.” The US Treasury Department later issued guidance on the program, clarifying forborne principal should be realized as loss immediately upon forbearance. Amherst noted a recent Mortgage Investors Coalition, however, found only one of four major servicers plan to adhere to the Treasury’s guidance. Another issue raised by HAMP on the issue of securitizations is the treatment of modified mortgages in terms of delinquency triggers. Once a loan is modified, Amherst noted, it is typically considered current for purposes of delinquency triggers. Counting modifications as current may allow delinquency triggers to pass. This would release cash flow to lower-rated tranches and possibly disadvantage senior cash flows, Amherst said, which lose some enhancement if cash is released to the junior tranches. “Since the loans being modified are those in grave danger of default, it may not make sense to count these loans as if they are current for the purposes of the delinquency triggers,” Amherst noted in the market insight report. “Aha, you might say, since the recidivism rate on modified loans is quite high, don’t we capture these loans in the cumulative losses upon their eventual re-default? Yes, but if we modify loans that will later re-default, you can still release cash flow to junior tranches, for a period of time, to the detriment of the senior cash flows,” Amherst concluded. “Certainly this issue deserves closer scrutiny.” Write to Diana Golobay.