The Securities and Exchange Commission says lenders don’t have to put mortgage loans they hold through securitization trusts back on their balance sheets if the trusts that service the loans engage in workouts with troubled borrowers.
The SEC’s opinion — on an accounting rule that governs the terms under which lenders can move loans off their books, allowing them to make still more loans — may help some borrowers avoid foreclosure. But it could also allow lenders to put off acknowledging the losses they may eventually realize on such loans.
The SEC opinion came in the form of a letter to Rep. Barney Frank, D-Mass., who was concerned that the accounting rule might prevent lenders from engaging in workouts with borrowers facing foreclosure until after their loans went into default.
Lenders sometimes agree to modify the loan terms of borrowers who are having trouble making their mortgage payments by reducing interest rates, extending loan terms or granting other concessions in the hopes of avoiding the costs associated with foreclosure.
But lenders who securitize loans in order to move them off their books are prohibited from managing the trusts that service the loans. That led some to question whether allowing the trusts to engage in workouts would trigger a requirement that the lenders put the loans back on their books.
In a letter to Frank, the SEC said that as long as workouts are allowed under the contractual provisions in the governing documents establishing the securitization trusts, workouts are allowed under Financial Accounting Standards Board Statement 140 (FAS 140).
“In the treatment of securitized residential mortgage loans, the issue in practice is whether an entity’s having or exercising the ability to modify the terms of a securitized mortgage loan is an activity that demonstrates that the entity has not given up control over the loan, thereby precluding off-balance-sheet accounting for that loan,” SEC Chief Accountant Conrad Hewitt wrote in a July 18 memo to SEC Chairman Christopher Cox. “FAS 140 does not directly address the impact on off-balance-sheet treatment for modifications to the terms of a loan when default is reasonably foreseeable (but prior to delinquency or actual default).”
The Mortgage Bankers Association stated a similar position in a recent white paper, noting that the loans most often mentioned as likely to go into default are 2/28 and 3/27 adjustable-rate mortgage loans that carry payments that will adjust upward in coming months.
Frank called the SEC’s position “a constructive approach that will allow mortgage lenders to provide help at the earliest possible moments to people who might otherwise be trapped in bad loans or forced into foreclosure.”
But some critics say the move will allow lenders to engage in workouts for the purpose of concealing mounting losses on mortgage-backed securities.
Bloomberg News commentator Jonathan Weil called “gain-on-sale” rules that allow lenders to book profits on loans they have moved off their balance sheets “the financial world’s equivalent of crack cocaine.”
Weil said that if the Financial Accounting Standards Board eliminated off-balance-sheet trusts, lenders would have to treat the transfer of loans to securitization trusts as secured borrowings.
If that step had been taken before the housing boom, “the securitization industry might look very different today,” he said, in part because mortgage lenders would have been forced to use tighter underwriting standards if FAS 140 hadn’t allowed them to “front-load their profits and show smaller balance sheets to investors.”