Wells Fargo Introduces An “Interesting” Mod Strategyby Tim Manni
Wells Fargo is betting that improving home prices and an increase in consumer income will make their new loan modification strategy a success. The nation’s fourth-largest bank (in terms of assets) has introduced a new, and frankly quite interesting, strategy to modify their large portion of Payment Option adjustable-rate mortgages (ARMs).
If you recall the latest mortgage metrics report, Payment Option ARMs are failing at a rate of three times more than the other products in the marketplace, causing trouble to lender and borrower alike.
Here’s how Payment Option ARMs work.
Wells’ strategy is to take their book of payment option ARMs — $119.7 billion worth inherited from their merger with Wachovia — and modify at least some of them to an interest-only payment structure for six to 10 years:
Wells Fargo is wagering that an eventual rise in housing prices in the worst-hit regions of the U.S. and a rise in consumer income, will eventually cover the bank’s underwater Pick-A-Pay debt. “We’re banking on the fact the economy will improve and recover over time,” Michael Heid, co-president of Wells Fargo Home Mortgage, said in an interview.
Wells Fargo has written $2 billion off Pick-A-Pay balances for borrowers, or nearly $46,000 per modified loan. The bank has modified 43,500 Pick-A-Pays so far this year through September, and said the program is effective at keeping borrowers in their homes. The program eliminates the nearer-term risk for borrowers of sharply ballooning payments, according to the company.
This isn’t going to be a one-way ticket to solvency for either the borrower or the lender. “Both the bank and the borrower are giving up something,” said HSH VP Keith Gumbinger. “Yet, it’s better than the potential outcomes for both: the loss of a borrower’s home and a more substantial loss to Wells Fargo.”
Both falling home prices and minimum-payment loan products (i.e. payment option and interest only) have pushed thousands of homeowners underwater. Extending the period of time that borrowers continue to make non-amortizing payments prolongs the chances that the homeowner will remain underwater. However, nothing prevents the borrower from paying more than just the interest to help rebuild equity, if their financial situation improves over time.
As for Wells Fargo, despite the fact that they will be writing off billions in debt (spending nearly $46,000 per mod), this strategy allows them to stretch out their losses over time, instead of dealing with a wave of possible defaults when the existing payment option ARMs recast.
A surge of expected losses would mean that Wells would need to substantially increase their loan-loss reserves, eating up precious capital and impairing their ability to do much new lending.
Wells is certainly throwing their borrowers a bone here, but it’s a temporary effort – a Band-Aid if you will — to get them through the next couple years. After that…we’ll have to wait and see.