ISGN Corp. of Bensalem, Pa., has been one of the largest providers of services and technology to the mortgage industry for more than a decade. Among its more than 1,100 customers are global banks and even the top 10 lenders in this country.
So, it would seem ironic that ISGN decided to create a program to address principal reduction, which has been, as everyone knows, an anathema to mortgage lenders since the beginning of time.
Even with the Obama administration introducing a principal reduction plan earlier this year and then Bank of America proclaiming it, too, is getting on the bandwagon, there is still no real oomph for lenders to get behind this effort.
As I noted in a previous column, most loan modification efforts have been about reducing interest rates or extending terms of the loan. There is another way — by reducing the amount of principal on loans that are underwater — but lenders have always been reluctant to go in this direction for moral reasons (why reward irresponsible borrowers who bit off more than they could chew) and capitalistic reasons (hey, we are going to lose money).
However, there are a number of academics, economists and mortgage industry insiders who support the concept of principal reduction. Bill Garland, senior vice president at ISGN, would like to add his name to the list — mostly because he feels his company has a better idea.
ISGN is partnering with EquityRock of San Francisco to offer a program called RESET, which stands for "Real Estate Shared Equity Transaction." The key to RESET is that it gives borrowers who are qualified for a loan modification a principal reduction in exchange with lenders for a share in any future equity (home-value appreciation).
With RESET, in addition to modifying or refinancing a borrower’s mortgage, the lender writes down the borrower’s principal balance so that the borrower no longer owes more than the property is worth, which ensures when all is said and done there will be at the very least some equity in the property.
In exchange for relief, the lender gains a stake in any future appreciation should the property be sold or refinanced.
When the transaction is completed, the borrower gets to stay in the home and continues to have a monetary stake in the property.
As ISGN started to build out its loss mitigation and loan modification programs two years ago, Garland explained, "It became evident to me that negative equity was something we were going to have to deal with. Even back then we knew homeowners were running out of steam, writing mortgage payments for houses that no longer represented an investment or equity."
Two years ago, like today, the industry was focusing its efforts on loan modification programs. "In early discussions about principal reduction, I more or less was told to take it out of the room," Garland laughed.
However, Garland continued to believe in the concept of principal reduction and when he came across a mortgage investment program being used by EquityRock, he knew he found the right partner to create what has since become RESET.
Formerly known as REX & Co., the residential real estate consumer finance and investment management company had been for years trying to unlock the mystery of why residential real estate was not an "investible" asset class for institutional players.
"This was the largest asset class in the world and institutional investors had no way to directly invest in residential real estate equity," said James Riccitelli, co-CEO of EquityRock. "They could invest in residential debt easily enough as there were plenty of mortgage products and derivatives out there."
As a result, EquityRock developed a product that allowed for the efficient transfer of value between a homeowner and investor, where the homeowner would receive a cash payment and in return share a portion of the future positive change in the value of the home with the investor.
This kind of program works well in a rising market, but when home prices started dropping like a big stone plunked into a lake, EquityRock stopped originating in this space.
"In the meantime, we realized there was another application of everything we built," said Riccitelli. "We spent a huge amount of money perfecting a contract that allowed this transfer, and we learned a lot about how the assets — residential real estate — behaves, what homeowner’s think, etc. We manage a portfolio of these contracts and we figured we could implement equity sharing into a loan modification situation."
The mortgage loan transfer concept had proved valid and, in the end, malleable. RESET simply tweaks EquityRock’s original model to make it useful in combating the plague of foreclosures that continues to weaken the residential housing market
"Today, if a borrower doesn’t quality for HAMP or falls out of HAMP, there are always short sales or deed-in-lieu programs," said Garland. "But we see those as home abandonment strategies, not home retention strategies."
With RESET, Garland and Riccitelli suggest there could be another arrow in the quiver of home retention programs because, in particular circumstances, borrowers could achieve the ability to stay in their home while reducing debt service and the impact of negative equity.
"Something like 5 million to 6 million foreclosures are likely to occur," Garland noted. "A lot of those outcomes could be more favorable in RESET than in foreclosure."
Nevertheless, the banks remain a challenge.
In the end, RESET may end up as a product less general and more geographic-specific to places like Las Vegas where home-price depreciation has been so severe; the lenders would have to wait at least a decade to see a pricing comeback; and in the meantime a tremendous amount of lender losses and homeowner defaults would have to be accounted for.