Loan modifications will grow to 15% of 2005-2007 vintage securitized mortgages over the next twelve months from virtually none, according to Fitch Ratings. This projection is based on the modifications done by banks on their own loans and the level of inquiry Fitch has received on proposed changes to transaction documents that expand the servicer's ability to do modifications.

To date, there have been few bank announced foreclosure moratoriums and modification programs that will apply to securitized mortgages; the bank announcements so far apply only to mortgages owned by the bank and sitting on its balance sheet. However, Fitch is aware of several servicers of securitized loans who are modifying loans within the scope of existing transaction documents. Recent bank data indicates that the 14 largest banks and thrifts modified 187,000 mortgages in the first half of 2008. "There will be increases in securitized loan modifications if only to ensure that borrowers in a securitized pool are being treated equally to borrowers whose mortgages are held by a bank, as well as to fulfill the servicers' duties to maximize returns to the trust" said Group Managing Director and U.S. RMBS group head Huxley Somerville.

Recently, California has passed legislation requiring servicers to delay foreclosing on homes, while banks like JP Morgan Chase and Citibank have voluntarily announced that they will temporarily stop foreclosing on properties. These steps are designed to allow borrowers and servicers additional time to modify troubled loans and allow borrowers to stay in their homes.

Foreclosure moratoriums can also provide additional time for the servicer to continue their outreach efforts to those borrowers that have been difficult to contact. Historically, lack of contact with borrowers has been one of the biggest obstacles to achieving successful workouts. Even if the results of the contact are short sales of the properties, avoidance of foreclosures can diminish costs to servicers and therefore reduce losses to bondholders. Foreclosure moratoriums in and of themselves will not resolve the problems facing lenders and borrowers and the critical next step is the design of loan modifications.

Generally, the original documentation governing securitized transactions are either silent on modifications, or restrict the number or type of modifications allowed. In the current high delinquency environment, changes to the documents are being sought for deals that have modification limitations. One way to change the documents is for rating agencies to confirm the current ratings with the contemplated document change, which Fitch has been asked to do in several instances. The changes to the documents being considered allow the servicer a greatly expanded authority to modify a greater number of loans than currently exists. Fitch will publish a report detailing the different types of loan modification options being considered in the coming weeks.

"Modifications, when properly done, can benefit both U.S. homeowners and RMBS investors" said Somerville. Therefore, Fitch will confirm the current ratings when proposed changes in the deal documents incorporate broader abilities to make loan modifications. To meet industry servicing standards, the total collections on the loans (on a net present value basis) will need to be higher than the recoveries from immediate foreclosures. Modifications should also be designed to ensure that they identify sustainable payments for borrowers who are therefore less likely to re-default post-modification. Therefore, it is imperative that the qualification of the to-be-modified loan is done within well thought-out guidelines and procedures; Fitch has already seen how previous lax underwriting impacts loan performance.