Lehman Brothers has announced a new loan modification programme for its European mortgage business, replicating similar measures that it had previously adopted in the US. It entails several alternative strategies that can be applied to borrowers in danger of defaulting. These include payment deferrals, maturity extensions, amendments to interest rate terms, capitalization of arrears and acceptance of a shortfall on sale. "We have many customers facing rate resets," says Adrian Mitri, director of servicing at Lehman Brothers. "This programme will enable us to work with customers with more options to avoid having to go through the repossession process and people leaving their homes."
Mitri says the programme is focused on the UK market, where many of the rate resets he refers to are due. Some 10,000 Lehman customers are facing resets in the next few months, and with present interest rates it will not be uncommon for customers paying £700 a month to face monthly payments of £1,000 ($3,900) or more once their rates reset. As the affordability of mortgages continues to be stretched (see chart), it is Lehman’s opinion that the state of the UK housing market will make things extremely hard for these customers. "Clearly the availability of credit to customers has changed, and the idea that they can refinance is no longer a possibility," says Stephen Staid, head of European mortgage servicing at Lehman. "If the value of homes declines further, it will become even tougher, and this is all in addition to these rate resets."
Lehman is not alone in its bleak appraisal of the UK housing market. Credit Suisse has just launched a new quarterly research piece focused on the UK market and what it calls "the potential for a significant decline in house prices and mortgage volumes this year". The Swiss bank expects house prices in the UK to fall by 10% in 2008. In particular, it points to the "reduced appetite of lenders to apply forbearance policies if the value of the collateral is falling".
First mover
Lehman is going against the trend with its loan modification programme and the forbearance it exhibits, and it remains to be seen what kind of an impact it will have. Fitch Ratings viewed it positively in its report on the programme but noted that it "will be difficult to gauge going forward without improved reporting information". Lehman admits that there is more cloudiness around things than in the past but maintains that it is well prepared. "We have developed an extra suite of reports to feed through to the ratings agencies," says Mitri. "These reports will contain information on which loans have been modified, the type of modification and its performance thereafter."
| Affordability continues to be stretched |
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Mortgage payment as % of monthly net (after tax) household income |
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Source: Datastream, Woolwich affordability index |
Lehman will certainly be hoping that the programme will cure many ills. It has enjoyed some success in the US but not enough to save the business. Lehman announced on January 17 that it would "substantially reduce its resources and capacity in the US residential mortgage origination space in light of the dislocation in the mortgage markets". At a cost of $40 million, the bank has suspended its US mortgage lending activities through its Aurora Loan Services subsidiary. "It was necessary for us to structure our mortgage origination business in the US to reflect the change in industry dynamics," said Ted Janulis, global head of mortgage capital at Lehman, in a recent press release. "We will continue to make technology and infrastructure investments in this space, as we reposition the business to reflect the changing industry."
Lehman has been quick to point out, though, that it does not expect to do the same in the UK, and that the introduction of the modification programme is to be thought of as an insurance policy. It claims to have learnt from its US experience that it is better to be prepared for an event than to have to react to it.
Citi consolidation
Other US mortgage providers are also changing their approaches to the business. Citi has announced that Bill Beckmann, head of consumer mortgage operations, has been given the task of creating an end-to-end US residential mortgage business, including origination, servicing and capital markets securitization execution.
This will effectively bring all of Citi’s separate mortgage businesses in the US under one roof, and although it is a cost-cutting measure that will mean job losses, it is clear that Citi does not share Lehman’s wholly discouraging outlook on the US residential mortgage market. It remains to be seen if Lehman’s strategy or Citi’s proves the smartest play in the face of declining mortgage values in the US and elsewhere.