The FINANCIAL — London-05 September 2011: Fitch Ratings says in a new special report that data it has received suggests that loan modifications programmes are currently not providing benefits to all parties to RMBS loan transactions.
Loan modifications are becoming prevalent across the major European residential mortgage markets following the formal introduction of the programmes into UK RMBS in January 2008. Loan modification programmes are generally offered to borrowers to help improve their financial position and their ability to maintain mortgage payments, in the short to medium term.
From the data provided by mortgage servicers and banks across Europe, Fitch notes that 52% of UK loan modifications are in the form of capitalisation of interest arrears, increasing the outstanding mortgage balance. Furthermore, 17% of modifications represent a transfer of the loan type from a repayment loan to interest only.
Throughout Europe, Ireland has seen the most widespread use of loan modifications, with over 8% of outstanding loans being modified. More than half of the loans being modified in Ireland are for performing borrowers who anticipate future payment problems. Of the total loans being modified, around 80% of those actions are aimed at reducing borrowers' monthly payment amount, with the rest being a temporary payment holiday or capitalisation of arrears.
Italian banks use loan modification schemes for RMBS transactions, within the limitations of the transaction documents and government schemes are available which offer aid to borrowers. In Spain, 3.2% of loans in RMBS transactions have been modified, however in the Netherlands, loan modification programmes are virtually non-existent, with traditional resolution methods remaining preferable.
"Europe is experiencing a low interest rate environment that effectively provides the biggest 'loan modification' of all to borrowers, but it also creates challenges for lenders and servicers in developing effective modification strategies for loans in arrears," says Mark Wilder, Associate Director in Fitch's Operational Risk Group. "The agency notes that potential loan modifications are being declined by the borrower, implying that they are finding sufficient relief from low interest rates."
Fitch believes that in the current environment, utilising a loan modification programme and not transferring delinquent loans to foreclosure may benefit some parties, as: (i) the borrower may keep their house; (ii) the lender may lose less money, as house prices have fallen; and (ii) RMBS transactions, particularly the junior notes may avoid the hefty costs associated with enforcement and higher losses due to declining house prices. However, while a transaction servicer's ultimate role is to maximise recoveries and minimise losses through loan management, an implemented loan modification programme could increase stress for a transaction, putting the interests of the senior and junior noteholders at odds with each other.
"If house prices increase, the appetite for loan modifications reduces and ultimately the banks' economic best interests may be to implement foreclosure," adds Ketan Thaker, Head of UK RMBS at Fitch. "This could be implemented, providing it is in line with regulatory guidelines and all other workout strategies have been assessed fairly. However, in the longer term, loan modification programmes should prove valuable to some if they are successful in rehabilitating borrowers and preventing defaults rather than merely postponing the default."
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