Citigroup to Support Bankruptcy Loan Modifications

Cramdown legislation that would allow the bankruptcy court to make loan modifications on behalf of distressed borrowers is a hot topic on Capitol Hill. The saga took a surprising turn recently, when Citigroup broke away from its peers and said it would back the legislation.

The Banker on Deal or No Deal may be the most-recognized dealmaker these days, but his fame could soon be overshadowed by the U.S. Bankruptcy Court. The word is out that Citigroup intends to support legislation that would allow bankruptcy judges to modify distressed mortgage loans.

Lawmakers are drafting legislation that would allow bankruptcy court judges to make mortgage loan modifications. The intent of the legislation is to help borrowers keep their homes, even if it means forcing a loss on the lender through lower interest rates and longer repayment schedules. The financial industry has long been opposed to this so-called "cramdown" legislation, arguing that those forced losses will only be passed on to other mortgage borrowers in the form of higher costs.

Troubled trailblazer

In an unexpected move, Citigroup broke with its industry peers by indicating that it would support a cramdown law. The financial giant's chief executive said, "Citi shares this legislation's goal to help distressed borrowers stay in their homes, and believes it will serve as an additional tool to the extensive home retention programs currently in place to help at-risk borrowers."

Incidentally, Citigroup negotiated a massive bailout deal with the Feds last year involving a government guarantee on roughly $306 billion of troubled assets. The deal also included a $20 billion equity injection for Citi on top of the $25 billion infusion already provided through the Troubled Asset Relief Program.

More conservative stance

Citigroup's change of heart came after Senator Richard J. Durbin and Representative John Conyers, Jr. recommended altering the proposed bankruptcy legislation to include these stipulations:

1.    Bankruptcy modifications would only be allowed on mortgages that are currently funded; future mortgages wouldn't be eligible.

2.    Homeowners who didn't request a loan modification from their loan servicer before filing for bankruptcy will not be eligible; certification of that request will be required.

3.    Lenders can surrender their claims in a bankruptcy case where a serious breach of the Truth in Lending Act exists.

Even this toned-down version of the cramdown legislation has met with opposition. Industry participants are concerned that lenders will have to absorb more than their share of the pain associated with the weakening economy. Plus, adding losses to lenders' books will only restrict the credit markets even more. Financial executives are also worried that the cramdown legislation will make bankruptcy an attractive option for homeowners, rather than a last resort solution.

If Citi's support sways enough lawmakers, the rest of the financial services industry won't get to answer the famous Deal or No-Deal question. They'll just have to take the deal-and hope the consequences aren't as bad as they've predicted.