The direct connection between borrowers and bankers had in effect disappeared. This not only made it difficult for troubled borrowers to know where to begin with loan modification, but it also created a tricky proposition for mortgage brokers looking to help borrowers negotiate these modifications.

Back to servicing

Mortgage brokers who advise their clients on loan modifications can build their reputation and help borrowers escape bad financial situations. To offer good advice, however, brokers must first understand the layers involved in securitization and how those layers affect modification attempts.

For starters, many homeowners send their mortgage payments to servicing agents rather than to the lender that initially extended them credit. These servicing companies collect monthly payments and distribute them to investors -- whoever they might be. Many borrowers don’t know who owns their mortgage or its components, long since stirred into a securitized stew.

Servicing agents carry out their duties pursuant to pooling-and-servicing agreements, which place heavy restrictions on servicing agents’ ability to modify mortgages in their care. These restrictions include limits on the types and the number of modifications permitted. They sometimes forbid modifications altogether. If servicing agents attempt to extend their authority without the consent of the MBS-holders, they risk being sued.

Pooling-and-servicing agreements were created to meet a variety of considerations, which had little to do with borrowers’ underlying needs. Moreover, modifying these agreements can impact the tax status of the underlying trusts holding the MBS interests. Changes also can impact the bankruptcy remoteness of the trust, which protects the trust’s assets from creditors as well as MBS-holders from liability for the trust’s actions.

Even if some of MBS-holders wanted to make loan modifications easier, changes to pooling-and-servicing agreements frequently require approval by two-thirds of the MBS-holders. Convincing two-thirds of the investors to agree to take losses by reducing the value of a loan pool represents a huge undertaking.

Servicing agents also often make more money by foreclosing upon homes than they do by modifying loan conditions. This isn’t to say that servicers lack any incentive to make loan modifications. Write-downs, for example, help them reduce their cash outlays, or advances, on loans they service. But financing these outlays has become more difficult and costly as credit markets have tightened. Servicers also face increasingly severe government regulations related to the upkeep of vacant homes in their control.

Insurers also involved

Mortgages are often secured by private mortgage insurance that the borrower or lender purchases. This insurance is designed to protect MBS investors from losses and can enhance the value of the securities. If a loan is modified, it frequently loses its insurance, which can reduce the loan’s value.

There are also layers of insurance. Mortgage payments made by borrowers in a pool often exceed the dividends paid to MBS investors. This extra amount is called net interest margin, and separate net interest margins themselves were securitized and insured by financial institutions. The insurers of net-interest-margin securities took a position similar to an equity-holder in a loan pool.

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