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Banks May Reluctantly Back Bankruptcy Bill

Laurie Kulikowski

The banking industry is skeptical of lawmakers' efforts to allow bankruptcy courts to modify terms of residential mortgages, but some companies may join Citigroup (C Quote) in supporting a bill in an effort to help shape it.

Late Thursday, Senate Democrats announced a deal with Citigroup to support a bill that could alleviate housing foreclosures for consumers facing bankruptcy. Roughly 8.1 million homeowners, about 16% of all homeowners, are at risk of foreclosure, Sen. Richard Durbin (D., Ill.), Sen. Christopher Dodd (D., Conn.) and Sen. Charles Schumer (D., N.Y.), said in announcing Citi's support for the bill on Thursday.

Sen. Durbin had re-introduced the bill to the Senate on Tuesday. House Democrats also introduced a similar bill.

The senators hope Citi's support for the legislation, which mortgage lenders fiercely opposed last year leading up to the passage of the $700 billion financial bailout package Congress passed in October, will become a part of the economic recovery package being drafted on Capitol Hill. They also expect to win the support of other financial institutions on the issue, the senators said.

But some say that in light of the tumultuous housing environment banks have already been working to help borrowers through loan modifications. They say that more legislation is unnecessary.

"My personal view is we don't [need the legislation] because I think that it's in the lenders best interest -- and most of them are doing it -- to negotiate with borrowers," says Jean Everett, a partner at Hiscock & Barclay's financial institutions and lending practice.

"When you really look at it, probably not a lot is going to change," Everett says. Given today's housing environment, most banks are already modifying loans to stem the losses, she says.

"I don't see how a lender making a reasonable business decision wouldn't make the same decision that the bankruptcy court [would] on a borrower [with] a residential mortgage that went into bankruptcy," Everett says. "The economics are just not there today for foreclosures."

Richard Bove, an analyst at Ladenburg Thalmann, also questions whether the legislation is needed. The Federal Reserve's willingness to buy $3 billion to $4 billion in mortgage-backed paper a day and mortgage rates that have fallen to record lows are helping create "a mortgage refinance boom," he writes in a note.

Bove chalks up Citi's support of the legislation to the $45 billion preferred equity stake the government took in Citi late last year. The Treasury in November invested another $20 billion in the bank and guaranteed $306 billion in illiquid assets against further losses, after the stock plummeted amid a crisis of confidence. The aid came on top of a $25 billion Treasury had made through the Troubled Assets Relief Program in October.

"My view is that when the government buys $52 billion in preferreds and helps guarantee a bank against losses on approximately $300 billion in loans it is going to get something in return. It is going to get a compliant bank," he writes. "Hopefully, Citigroup is not going to drag the industry along on other bad pieces of legislation."

Sandeep Dahiya, an associate professor at Georgetown University, says that more banks may decide to support the bill because this way they can exert some influence as to how the measure is passed. "Instead of having it forced down their throats, they might as well be at the table while this thing is being drafted and try to get some features," he says.

While banks worry writing down loans will only encourage people who can -- and should -- pay back their loans to ask for concessions, the bottom line is someone has to take the loss, he says.

The American Bankers Association, a trade group representing national and community banks, opposed the legislation because "it will leave in place overly broad mortgage cramdown authority and other provisions that will harm thousands of banks across the country that have made, and continue to make, good loans," according to a statement issued Friday.

Democrats have been pushing to get more help to homeowners, especially those in dire situations. Some congressmen have criticized Treasury's $700 billion Troubled Assets Relief Program, saying it does not help consumers enough. The new legislation is one way that borrowers could get more relief if passed.

On Friday, Rep. Barney Frank (D., Mass.), chairman of the House of Financial Services, noted in a press conference that measures to reduce mortgage foreclosures were included in legislation he was introducing that is intended to amend facets of the TARP bill.

In a letter to lawmakers, Citi CEO Vikram Pandit said the change to bankruptcy law "will serve as an additional tool to the extensive home-retention programs already in place to help at-risk borrowers."

Citi has helped approximately 370,000 families avoid foreclosure since early 2007, it noted in the letter.

Other banking institutions including JPMorgan Chase (JPM Quote) and Bank of America (BAC Quote) have also initiated programs to help struggling borrowers, as have Fannie Mae (FNM Quote) and Freddie Mac (FRE Quote).

David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, says that the "incremental losses" from the legislation could be "capped" for Citi "due to the government's risk guarantee on these mortgages," he writes in a note.