Study: Less Than 3% of Mortgage Mods Involve Principal Reductions

The ratings agency DBRS made mortgage principal reductions the focus of a research note released Monday.

The agency analyzed mortgage modification data from the first quarter of this year provided by the Office of the Comptroller of the Currency and the Office of Thrift Supervision.

DBRS found that capitalization and rate reduction modifications made up the majority of loan restructurings, while principal reduction modifications accounted for just 2.80 percent of the total mods performed during the January-to-March period.

That figure is up from 1.90 percent of principal-reducing mods over the same timeframe last year, but down sharply from the 5.70 percent reported in the third quarter of 2010.

DBRS says investor reactions to the use of debt forgiveness as a loss mitigation tool continues to be mixed among senior and subordinate bondholders.

The agency explained that in a traditional debt reduction scenario, the principal forgiven will be treated as security losses and be absorbed first by subordinate holders, many of whom bought securities based on their “interest-only” values and will see these bonds deplete faster than initially anticipated.

Senior investors, while losing some immediate credit enhancement, may benefit from such modifications as overall cumulative losses should lessen in the long run, according to DBRS.

Even within the senior bondholders’ class, super senior and senior mezzanine investors may disagree on debt forgiveness.