Fitch Comments on JPMorgan's and Wells' Reclassification of 2nd Liens

With their 2012 first quarter earnings, JPMorgan and Wells Fargo revealed the reclassification of $1.6 billion and $1.7 billion, respectively, in second lien mortgages as nonperforming loans even though they are not yet delinquent.

Fitch Ratings said it believes many U.S. banks are likely to follow suit, and that it does “not view this as a material shift in the performance of these loans.”

Both banks cited regulatory guidance as reasons for the reclassification.

The reclassified loans are second liens associated with delinquent first liens. In cases involving delinquent loans, second liens are written off before a first lien takes any losses.

According to a Bloomberg article, of JPMorgan’s $1.6 billion of second liens that were classified as nonperforming, $1.4 billion were still current as of March 31.

“However, increased regulatory scrutiny of second liens may continue to affect the way banks account for potential losses on these portfolios,” Fitch said.

The article from Fitch also noted the recent debate to have principal reductions applied to Fannie Mae and Freddie Mac loans, which Edward DeMarco, acting director of the Federal Housing Finance Agency (FHFA), has not allowed so far despite mounting pressure.

If principal reductions were allowed, eligible second liens on GSE loans would be written down proportionally, not written off.

According to a note from the Treasury Department, “under HAMP, where a first lien mortgage is modified, then the holder of an eligible second lien must modify that lien proportionately if they are a participant in the Second Lien Modification Program (2MP).”

Almost half, or about 47 percent, of all HAMP modifications during the 2011 fourth quarter were GSE loans, according to the Office of Comptroller of the Currency, and FHFA estimates that roughly half of all HAMP-eligible loans have a second lien associated with them.

“We would likely revisit our loss estimates on second lien loans if there is a sufficient increase in principal modification activity,” Fitch stated.

Fitch also said roughly half of the $850 billion in outstanding second liens are concentrated at the five largest banks, which includes Bank of America, who has one of the largest second lien portfolio in the U.S.

By: Esther Cho