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""Bank of America's"":https://www.bankofamerica.com/index.jsp earned principal forgiveness program, which ""DSNews.com previously reported on"":http://dsnews.comarticles/bofa-to-offer-principal-forgiveness-some-underwater-homeowners-2010-03-24, has already come under inspection. ""Barclays Capital"":http://www.barcap.com/ released a ""first-pass"" analysis on Wednesday, examining the new modification plan's implications for non-agency mortgage-backed securities.
[IMAGE]The program targets only Countrywide/BofA option adjustable rate mortgages (ARMs), subprime, and prime 2/1 hybrids with more than 120 mark-to-market loan-to-value (MTM LTV) ratios. According to BarCap, for securitized subprime and option ARMs, about 40 percent to 45 percent of delinquent borrowers and 20 percent to 25 percent of current borrowers have MTM LTV ratios above 120 percent.
If all of these borrowers see forbearance of about 30 percent and the loss is recognized immediately, it could result in a write-down of the bottom 9 percent to 10 percent of the capital structure, BarCap said. However, researchers believe the effect will be somewhat smaller in reality. An NPV test will be used to determine which borrowers to modify, but BarCap said all the eligible borrowers are unlikely to get the modification.
It is not clear if the forborne amount will be recognized as a loss upfront. But given the administration's stance on Home Affordable Modification Plan (HAMP) forbearance, BarCap's inference is that it should be. The only argument
[COLUMN_BREAK]against not recognizing the loss is the likelihood of recovery of forborne principal if and when the loan is paid in full. BarCap notes that under this program, BofA is explicitly giving up the notion of recovering at least 60 percent of this balance.
As for valuation implications, BarCap said the program could lead to more moral hazard, especially to other sectors such as jumbo hybrids, with more borrowers purposely going delinquent to receive forgiveness. Overall, BarCap said it is a ""clear negative"" for junior mezzanine and subordinates but could be a ""mild positive"" for super-senior tranches (SSNRs) if moral hazard is controlled.
BarCap said SSNRs would benefit assuming that forbearance is treated as a loss similar to HAMP, thus writing down subordinate and mezzanine bonds and stopping cash flow from leaking to these bonds. But if moral hazard flares up, BarCap said this will likely counter the benefit and reduce the overall principal recoveries on the deal, which will hurt SSNRs.
Most subprime Countrywide deals have sequential Triple-As, which could lead to lower last cash flow prices and, if this ends up improving re-default rates, should benefit the front cash flows as well, BarCap explained. On pro-rata deals, BarCap said it should hasten crossover on low credit enhancement deals and could lead to slower crossover on deals with high credit enhancement.
Researchers at BarCap believe the program could be a positive for second-lien holders, especially monoclines that have wrapped this risk. Because the first lien mods would not be considered HAMP mods, BarCap noted that BofA, a participant in HAMP's second-lien modification program, may not be required to modify the second liens behind these loans.
Even if BofA offers the same level of debt forgiveness on second liens, the monoclines will gladly trade off an upfront loss of 30 percent plus annual loss on interest of 8 percent to 9 percent to avoid an upfront 100 dollar loss on each second lien loan, BarCap concluded.
