The six big agencies that regulate most of the nation's banking system issued "guidance" Tuesday encouraging mortgage servicers to work with borrowers to mitigate loan losses and keep families in their homes where "possible and appropriate."

The Federal Deposit Insurance Corporation, Board of Governors of the Federal Reserve System, Office of the Comptroller of the Currency, Office of Thrift Supervision, National Credit Union Administration, and the Conference of State Bank Supervisors issued a joint statement directed at federally regulated institutions (and with the Conference of State Bank Supervisors (CSBS) signing on, many state-supervised entities as well) entitled Statement on Loss Mitigation Strategies for Servicers of Residential Mortgages.

The federal agencies have issued two previous statements which attempted to apply gentle pressure to lenders as subprime problems mounted and borrowers began to experience problems making payments. In April of this year they issued A Statement on Working with Mortgage Borrowers and in July Statement of Subprime Mortgage Lending both of which asked lenders to work constructively with borrowers who were flirting with default. CSBS and its companion agency the American Association of Residential Mortgage Regulators (AARMR) have mirrored earlier federal statements with similar guidance for their state regulated constituents.

The earlier statements were intended to encourage flexibility for mortgage loans held in the portfolios of banks and credit unions. This statement is aimed at companies that are servicing subprime and other mortgage loans that have been sold or transferred into securitization trusts. A number of the servicing companies (Wells Fargo and WaMu for example) are subsidiaries of government regulated banks

While the statement is not binding on the servicing companies, it asks that they review the governing documents for the securitization trusts to see how much authority they have to restructure loans that are in risk of default. The statement points out that these documents may permit the servicer to be proactive in contacting borrowers and, where appropriate, apply loss mitigation strategies. It outlines four areas where servicers could be proactive:

  • Identifying borrowers at heightened risk of delinquency or default;
  • Contacting borrowers to assess their ability to repay;
  • Assessing whether default is "reasonably foreseeable;"
  • Exploring a loss mitigation strategy that avoids foreclosure or other actions resulting in the loss of homeownership.

The statement said that loss mitigation is generally less costly than foreclosure, particularly when undertaken early in the process. Such strategies can include loan modifications; deferral of payments, extension of the loan term, conversion of ARMs into fixed rate or fully amortizing ARMs, capitalization of delinquent amounts, or a combination of solutions.

The statement urged services to consider the borrower's ability to repay the modified mortgage over the long haul, taking into account not only the mortgage payment but taxes and insurances as well as other obligations and resources.

Servicers were encouraged by the regulatory agencies to refer borrowers to appropriate homeownership counseling services or to government programs such as those run by FHA.

The statement also noted that reduction or forgiveness of debt may result in tax liabilities for the borrower as such forgiven amounts can be treated as other income by the IRS and it was this subject that President George W. Bush returned to in his regular Saturday radio broadcast.

The President, while stating again as he had on Friday that the Federal government will not bail out lenders or speculators nor would it step in to redeem borrowers who made a decision to buy homes they knew they could never afford said he has made it a priority "to help American homeowners navigate these (present) financial challenges so that as many families as possible can stay in their homes." He called again on Congress to change the Federal tax code so that borrowers who lose their homes to foreclosure or are forced to sell them for less than the mortgages balance do not have to pay taxes on the forgiven debt. He also called on Congress to act quickly on legislation that will restructure the Federal Housing Administration and allow more Americans qualify for the insurance available through it.