New Report by Influential Credit Suisse Cautiously Supportive of Chapter 13 Mortgage Cramdown Legislation

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

My most recent Bulletin, titled The Very Latest on the Chapter 13 Mortgage Cramdown Legislation, highlighted a report on this cramdown legislation by the highly respected Fixed Income Research group at Credit Suisse. Since most of the public discussion of this legislation has been by those with strong opinions on either side, this report deserves a closer look because of its objective analysis and dispassionate tone.

The Report's Overall Conclusions About the Cramdown Legislation

1. "will be a net positive in terms of foreclosure reduction, as it may be an effective way to improve both home equity and affordability"
   
2. "several attractive features relative to other loss mitigation alternatives": a) "comprehensive debt restructuring," b) "less moral hazard," and c)"direct dealing with second liens"
3. but also has "unintended consequences": a) "many more borrowers filing than who qualify," b) "bankruptcy bar ramping up its marketing machine," and c) "new defaults created by borrowers who believe (falsely or otherwise) bankruptcy will be their salvation"
4. "will provide about a 20% reduction in foreclosures"
5. "will increase loan mod[ification]s, particularly principal reduction mod[ification]s, as it is likely to both pressure and also give justification to servicers to more actively pursue principal reduction mod[ification]s"

Key Positives

1. "provides a useful tool to address both the affordability and equity issues borrowers face today"
2. "lack of equity potentially is an important driver of today’s performance deterioration [the failure to make mortgage payments] and many such borrowers may be motivated by the cram-down feature"
3. debtors will have less incentive to file Chapter 13's because of the close oversight required on debtors' finances," and because of "the cram-down benefit being contingent on completion of the bankruptcy plan"
4. non-bankruptcy mortgage modifications will increase, including those reducing loan principal amounts, both because of the threat of a Chapter 13 filing and because this will give servicers a more easily defensible justification to do modifications.
5. "forces all creditors to the table," and "will let other lenders share the mortgage burden."

Key Negatives

1. debtors may succeed in paying less in Chapter 13 than if they did not have that option, meaning creditors will get less
2. bankruptcy courts may not be able to handle to potential volume of cases, although the system may have some available capacity now

Overall Impact of Cramdown Option
The report judged the overall impact to be "modestly positive." "The Chapter 13 bankruptcy [cramdown option] has some attractive features compared to other loss mitigation alternatives." And "[w]e are not very convinced that the current bankruptcy reform alone will drag the mortgage and housing markets down further."

The Report's "Bottom Line"
Chapter 13 mortgage modification proposal would add "an important new tool in the foreclosure avoidance arsenal and will likely result in a marginal reduction of foreclosures."

There is so much more to this Report than I can summarize here. I again urge anybody interested in a non-partisan, competent and thorough discussion of this issue to look at it.

To tantalize you, beyond what I've outlined above, the Report also contains:

1) an analysis comparing Chapter 13 cramdown generally favorably against two of the biggest voluntary modification programs, the FHA's Hope for Homeowners and the FDIC's and Fannie Mae/Freddie Mac's Streamlined Modification Plan;

2) a detailed hypothetical of a Chapter 13 mortgage cramdown, showing the costs and benefits to the debtors and creditors, with clear graphs and charts, plus insightful observations drawn from the hypothetical;

3) discussion about the very controversial issue about whether cramdown will increase mortgage interest rates and fees, with the conclusion that the study authors "don't believe [it] will materially impact the pricing or availability of mortgage credit";

4) an analysis of the anticipated effect of the cramdown law on creditor losses compared to the alternatives, with the conclusion that cramdown "has potential to reduce losses to investors"; and finally,

5) a focused and exhaustive analysis of an arcane but critical issue, the impact of the cramdown proposal on Residential Mortgage-Backed Securities, particularly how the cramdown loss would be "recognized and allocated in the cash flow waterfall," and how this allocation would differ among various kinds of deals--subprime, ALT-A, and prime ones, which have different loss allocation arrangements.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

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