Bankruptcy News New Bankruptcy Legislation would aid lenders and borrowers
The US Treasury report entitled “Making Home Affordable Program Servicer Performance Report through July 2009” notes that total loan modifications through the program amounted to no more than 9% of eligible loans.
Mortgage loan modifications for individual lenders as a percentage of eligible modifications were even worse. Bank of America, for instance, came in at 4%; Wells Fargo Bank, 6%. On the other hand, Citibank modified 15% of mortgages under the program, a result worth mentioning.
The low modification rates are leading Congress to consider revising bankruptcy law to allow judges to modify home mortgages and allow cram down of the principal balance. In other words, a bankruptcy judge would be able to lower the principal of the mortgage loan to the home’s value and/or lower monthly payments through modification of interest rates, term of loan, etc.
The principal objection of mortgage servicers was that the uncertainty in the credit markets due to the revised bankruptcy law would lead to higher interest rates to compensate them for the risk. Also, other editorials have noted that lenders have no incentive to work with borrowers to modify their mortgages and only forego default and foreclosure fees in the process.
The answer is that bankruptcy law could allow cramdown but in only certain situations. New bankruptcy legislation could allow bankruptcy judges to impose a permanent cramdown of the mortgage. However, to satisfy lenders against a second default in bankruptcy, there could be a provision that the debtor would have to make an adequate showing that he or she could perform the new mortgage. In other words, the “adequate assurance” language found in the code already, could be applied to cramdowns.
Currently under section 365 of the bankruptcy code, a trustee may assume an unexpired lease that is defaulted only if the trustee can cure the default or provide “adequate assurance that the trustee will promptly cure the default.”
If the debtor could not give such “adequate assurance” of future performance under the modified mortgage, then the bankruptcy judge would not allow the cramdown. Presumably, the debtor would present evidence of updated income and expenses at a preliminary or final hearing to prove adequate assurance. Similarly, if the debtor defaulted in mortgage modification payments after the grant of modification by the bankruptcy judge, the loan modification would be nullified.
Lenders’ uncertainty would be satisfied as they would know pre-bankruptcy if the debtor would qualify for a bankruptcy cramdown. Also, the lender would have an incentive to work with borrowers before bankruptcy if it looks as if the borrower would qualify for a cramdown from the outset. If there is a second default of the modified loan in bankruptcy, the lender is restored to his pre-bankruptcy mortgage.
