If your company invested in mortgage-backed securities, changes to existing law are in the works that will have a big impact on your investments.
The first is a proposal that would allow for “strip-downs” on mortgages when the borrower declares bankruptcy. What is a stripdown? Previously, when a debtor declared bankruptcy, courts would allow the debtor to strip-down the value of the lender’s secured claim to the present fair market value of the house and treat the remainder of the lender’s loan that was formerly secured by the mortgage as unsecured. For example, suppose a debtor borrowed $100,000 to buy a $120,000 house. At the time of bankruptcy, the debtor could show that the house’s fair market value was only $60,000. The bankruptcy courts would allow the debtor to strip-down the value of the lender’s claim to $60,000 and make new payments based on the reduced loan value. The lender would be left to get pennies on the dollar on the now-unsecured $40,000.
The Supreme Court stopped this practice in a 1993 decision. As a result, now when debtors declare bankruptcy they have no choice but to continue to pay the full loan value or lose their property. A proposal has already passed the United States House of Representatives that would reverse the Supreme Court’s decision and once again give bankruptcy courts the power to strip-down mortgages.
Proponents argue that this change is necessary and would help prevent hundreds of thousands of foreclosures each year. They argue the plan is necessary because even though lenders have offered to voluntarily try to workout troubled loans, the numbers have shown that few people have been able to take advantage of the workouts. They argue the new law would put mortgage lenders on the same footing as all other secured lenders, who are already subject to strip-downs in bankruptcy.
Opponents argue that the new law would remove certainty from lending. The result would be that costs of new home loans would be driven up, to the point that they would be out of reach for new buyers, which would further drive down current home values. Worse, opponents claim that the law would shift more losses to already-hurting financial institutions. A company that is heavily invested in mortgages could find the value of their investment slashed as debtors take advantage of the new law.
The second change has already been passed by Fannie Mae and is in the comment period. The new guidelines would make it easier for debtors to refinance their homes. Interest rates have fallen, but many debtors cannot take advantage of the new rates because the downpayment they made on their home has been lost due to declining property values. Under Fannie Mae’s proposed guideline change, if the original loan did not require private mortgage insurance, the new loan would not require private mortgage insurance even though the loan-to-value ratio is above 80%.
Lewis and Roca’s lawyers can help you in two ways. First, government relations lawyers can help your voice be heard by the Senate and Congress considering the new law. Second, if it passes, our lawyers can help your business negotiate with debtors in order to minimize your losses, or perhaps avoid them altogether.
This Client Alert has been prepared by Lewis and Roca LLP for informational purposes only and is not legal advice. Readers should seek professional legal advice on matters involving these issues.
View the entire article in PDF format here.