Servicers to Receive Credits for Principal Writedowns of Loans

American Banker’s Kate Berry reports that mortgage bondholders are now threatening legal action over the $25 billion national mortgage settlement, which provides the five largest servicers with “credits” for principal writedowns. The settlement’s final terms, released last week, offer banks incentives to write down the principal of loans they own themselves, but also offers what may be a far more alluring incentive to them: credits for principal writedowns of loans that they don’t own!

Yes, believe it or not, the biggest banks get to reduce their settlement obligations by reducing the amounts owed on loans held in securitized trusts. Never mind that investors in those trusts are not parties to the settlement agreement, and therefore certainly never signed off on this arrangement.

Now those investors are, not surprisingly, objecting to being forced into taking losses — to the banks’ great benefit — as part of that agreement to which they are not parties. The settlement allows servicers to receive 45 cents of credit for every dollar of principal reductions paid for by investors.

Sure, that’s not as much of a credit as the $1 that the banks will receive for every dollar of principal write downs on the mortgages they own. But why decrease their potential income when they can reduce the income of investors with whom they are not affiliated?

Bank of America spokesman Dan Frahm says mortgage investors had previously agreed to give the bank authority to modify loans.

Mr. Frahm, do you think the investors ever thought that BofA would be so clearly incentivized to work off its own debt by driving up investors’ losses? Not to mention that four other servicers would also work out a backroom deal affording them the same perverse incentive.