Double Dip in Residential Mortgage Foreclosures

The Wall Street Journal had a front page article today predicting a double dip in residential mortgage foreclosures. This is not new news and is what we have been advising clients of for a while now. Not only that, we also see the second wave to be much larger in geographic distribution. It will not be confined to California, Nevada, Arizona, Florida and Michigan and will result in a flood of foreclosures and short sales and another decline in the prices for residential real estate.

There are two primary drivers that will result in an increase in foreclosures in the first to second quarter of 2010.

The first is that the continued increase in unemployment will continue to cause an increasing number of residential mortgages to fall into default. The "real" unemployment rate is already far above the official numbers with some estimates as high as 18% to 20%. The economy needs to add between 100,000 and 200,000 new jobs per month to maintain a steady unemployment rate. We are nowhere near that type of job growth today. As a result, expect the real unemployment rate to continue to climb, regardless of what the official numbers indicate.

The second driver is the Obama administration's hope for homeowners programs (e.g., FNMA Homeowner Affordable Modification Program or HAMP). These programs are acting as dams against the tide of foreclosures and loan servicers (and banks) are treating the programs as profit centers instead of bona fide loan workouts. As a result, they are putting virtually all delinquent homeowners on a HAMP trial modification, regardless of whether they meet the requirements and are waiting to verify income until near the end of the trial period.

A major issue and a fundamental reason why HAMP is not a true loan workout is that HAMP only considers mortgage debt-to-income ratios instead of a consumer's total debt-to-income ratio (including installment and revolving debt). So loan servicers are not re-underwriting the debt in order to determine the maximum amount that a borrower can actually afford.

The effect of this shortcoming is that HAMP will only be a temporary fix for most homeowners. The evidence of this is clear when you consider that one particularly large bank found that 60% of delinquent mortgagees did not qualify for HAMP because their mortgage DTI was already under the 31% limit set by Fannie Mae indicating that the mortgage debt was not the primary issue, instead it was all the other consumer debt. Yet, servicers continue to put homeowners on the trial plans.

So what this means is that many of the loans currently being modified on a trial basis will again fall into delinquency and ultimately will either have to be short sold or taken into foreclosure. The result will be another more broad based spike in foreclosures and another decline in residential real estate prices. And it will happen quickly. If you are still skeptical, just take some time to dig into the data and I am sure you will come to a similar conclusion.

Then take a look at what is currently happening in the commercial real estate market and the scenario becomes truly frightening.

BRIEF OVERVIEW OF FHA HAMP

FHA HAMP is a new and important part of the FHA’s overall loss mitigation waterfall.  Complying with all the requirements of the FHA loss mitigation waterfall is critical to be able to collect a claim in the event of a foreclosure and subsequent REO sale.  Servicers cannot initiate foreclosure until all loss mitigation options have been considered.

As a result, servicers should ensure that each step of the waterfall is effectively executed, documented and is in full compliance with FHA policy and procedures.

General Requirements:

FHA requires servicers to be very aggressive in resolving loans early in the delinquency process.  No later than when 3 full monthly installments are due and unpaid, lenders must evaluate each defaulted loan and consider all loss mitigation techniques to determine which, if any, are appropriate.  In order to comply with this 90-day evaluation requirement, lenders must already have contacted the borrower and gathered sufficient information about the borrower’s circumstances, intentions and financial condition in order to determine their eligibility for loss mitigation alternatives. Between 31 and 180 days, FHA expects the servicer to either resolve the loan or initiate foreclosure. 

In the event that the specified loss mitigation approaches do not resolve the loan, FHA expects the servicer to move immediately to foreclosure.  In any event, servicers must initiate foreclosure within six months of the loan entering default, subject to a 90-day extension if the servicer has begun but not completed a loss mitigation solution. 

The FHA requires action prior to the Loss Mitigation waterfall in the form of (a) informal forbearance plans (less than 3 months in duration) and (b) delinquent refinance where the borrowers equity can be used to pay off arrearages.  If neither of these is workable based on capacity information gathered, then the servicer moves to Loss Mitigation Waterfall.

Servicers are also encouraged to offer counseling to delinquent borrowers.  At minimum, they must provide HUD publication PA-426H by the 60th day.

Program Incentives:

The incentives for each of the Loss Mitigation and Disposition waterfall options is as follows:

Reinstatement Options
Special Forbearance                  $    100  ($200 for lenders with performance scores in the top 25%)
Loan Modification                  $    500
Partial Claim                                       $    250
FHA HAMP                                         $ 1,250
 
Disposition Options
Pre-Foreclosure Sale                $ 1,000
Deed-In-Lieu of Foreclosure            $    250

The incentive for FHA HAMP is $1,250.  It comprises $500 for the Partial Claim and $750 for the modification.  The servicer must report the insurance partial claim (30% balloon) within 60 days of the initiation of the trial period.  At that point, they receive $500.  After the trial period, when the modification becomes permanent, the servicer receives an additional $750. Also, $250 is available for title and recording expenses.  The servicer has discretion to decide to record but it must deliver marketable title.

Loss Mitigation Waterfall For Loans That Can Be Cured:

1)    Special forbearance

a)    4 months or longer

b)    Not more than 12 months of PITI

2)    Loan modification

a)    Permanent change to rate and term to bring loan to performing status

b)    Must result in a fixed rate loan

c)     Can offer performing loan modifications but no incentive payment

d)    Can also offer modification for unemployed borrowers (this is a recent development)

e)    No LTV restriction

f)     May capitalize arrearages but not late fees, foreclosure costs or administrative costs

3)    Partial Claim

a)    Used to forgive arrearages

b)    Cannot be combined with Loan Modification

c)     Borrower must have sufficient capacity to continue monthly mortgage payments

4)    FHA HAMP

a)    30% balloon calculated as principal net of arrearages and costs

b)    Capped at 31% front end with 55% back end requirement

c)     No NPV requirement but is last on the waterfall so de facto NPV

d)    Not generally an option for unemployed because of the 55% back end ratio limit

Please note that modifications cannot be combined with partial claims. In modifications, the arrearages would be capitalized so there is no need for a partial claim.

Calculation of Maximum Partial Claim Amount under FHA HAMP:

The maximum partial claim amount under FHA HAMP consists of the sum of (i) arrearages, (ii) legal fees and foreclosure costs related to a canceled foreclosure action and (iii) the principal reduction / deferment. 

·      Arrearages included in the partial claim cannot exceed 12 months of PITI

·      The maximum partial claim amount is 30 percent of the outstanding principal balance as of the date of default

·      The principal deferment on the modified mortgage is calculated by multiplying the outstanding principal balance by 30 percent and then reducing that amount by arrearages advanced to cure the default for up to 12 months PITI, and any foreclosure costs incurred to that point 

·      The principal deferment amount is limited to the amount that will bring the borrower(s) total monthly mortgage payment to 31 percent of gross monthly income

Example From HUD / FHA:

Borrower had a reduction of income and is delinquent 3 full mortgage payments.  The unpaid principal balance on the mortgage on the date of default is $150,000 and the monthly payment is $1,220 (consisting of P&I of $920 and escrows, including MIP, of $300). The financial analysis reveals that the borrower’s gross monthly income is $3,500 and the total monthly other recurring debt payments are $800. 

In order to fulfill the 31% front-end ratio requirement, the borrower(s) total monthly mortgage payment would have to be reduced to $1,085 ($3,500 x 31%).  Therefore, P&I would have to be reduced to $785 ($1,085 total monthly mortgage payment less $300 escrow and MIP).  Assuming that the loan modification will have an interest rate of 6% and a P&I of $785, the new mortgage amount would have to be $130,931, resulting in a principal reduction of $19,069 ($150,000 unpaid principal balance less $130,931).  In this example, the borrower’s back end ratio is 53.9% ($1,885/$3,500), which satisfies the 55% back end ratio limitation. 

In this example, the maximum principal deferment is $41,340 (30% of $150,000, less the $3,660 delinquency, or $45,000 - $3,660).  However, based on their gross income, borrower is eligible only for a principal deferment of $19,069 plus $3,660 arrearages (which would include any foreclosure costs incurred to that point) for the total partial claim of $22,729.

Waterfall For Loans That Cannot Be Cured:

1. Pre-foreclosure sale
2. Deed in Lieu
3. Foreclosure

The servicer cannot pursue a foreclosure action until all loss mitigation options have been exhausted.  It is therefore critical that the servicer pursue all loss mitigation options, including FHA HAMP, to be eligible to collect on a claim under a foreclosure action and subsequent REO sale.   

FDIC ASSET SALE ARTICLE FROM FinCri

Please see this excellent article from FinCri. Ermete Vestri and John Pumpelly are quoted.

http://fincriadvisor.com/2009-08-02/assetsalesvaluations

SERVICER CAPITALIZATION’S EFFECT ON LOAN MODIFICATION EFFORTS

Most servicers and bondholders tend to agree that modifying default and delinquent loans is preferable to foreclosure, especially in light of current real estate prices. However, some are executing on these plans more quickly than others.

The answer may lie in the underlying capitalization of the servicers more so than resource and near-term cost issues. Many servicers are more concerned with liquidity than earnings in this environment.

At the recent meeting on July 27 between Treasury and the major servicers, some servicers indicated that while the $1,000 incentive for servicers was admirable, the delay in resolution caused by the Government’s modification process and trial period put a great burden on the servicers to fund higher advances.

The government will pay servicers $1,000 for every loan modified, and another $1,000 a year for three years if the borrower stays current. However, these servicers indicated that this is outweighed by the cost of the advances on the delinquent payments.

The group has asked for help in funding these temporary advances that are fully reimbursed when a loan is modified or foreclosed through the Fed's Term Asset-Backed Securities Loan Facility (TALF,) which allows for the pooling of advances for sale to investors.

While there are other issues at play, including the rating of the TALF debt, the conclusion should be pretty clear. Those with sufficient advance funding facilities are able to finance the debt outside of the TALF and execute on Government and their own modification programs. Some examples appear to be the major banking players such as Wells Fargo and Chase and the better capitalized servicers such as Ocwen. Those that do not have adequate credit facilities in place are still trying to find a way to access the TALF at reasonable prices.

What they are saying is that they need working capital financing at reasonable prices to be able to accomplish this. Are they really positioning for bailout money in the form of low priced loans? This seems logical. One fact is clear. If the servicers run out of cash, the implications and complexities are mammoth.

NEXT UP: BEST PRACTICES FOR LOAN RESOLUTION AND MODIFICATION

Intriguing Thoughts on Loan Modifications

We have been monitoring progress regarding the administrations initiative established for modifying or refinancing over 9 million consumer mortgages, and have drawn specific observations and conclusions. We sincerely hope that you find them useful.
 
1.       There has been a tendency to apply generic strategies to circumstances that instead compel the applicable parties to identify more personalized solutions. This is not a “one size fits all” situation and cannot be remedied through the application of non-specific solutions.
 
Every consumer has a different set of reasons that is driving their existing challenge. There may be a loss of earnings or reduction in household income as one or multiple borrowers may be unemployed or under employed. It could be an interest rate adjustment that was not anticipated and the increase of payments exceeds existing capacity.
 
These and a host of other reasons are the origin for the delinquency, which demands that each circumstance be investigated and new details on lifestyle be vetted to identify alternatives to foreclosure. Each transaction must be investigated to determine the borrower’s capacity and willingness to pay. These details need to be incorporated to determine what the consumer’s household can manage monthly and then an evaluation needs to be performed to compare the various modification options that may exist against the least appealing alternative, foreclosure.
 
Employing Net Present Value assessment to these alternatives is the fiscally responsible approach but can only be effectively accomplished through the deployment of a highly sophisticated data acquisition effort.
 
2.       Both the banking and mortgage loan servicing industry are under-equipped to institute an “all-inclusive” tactic. Their existing staffing models and competencies were designed to manage “business as usual”. Unfortunately, our current environment is not at all “usual”.
 
To identify, recruit, employ, train and allocate the required resources is time consuming and incredibly cost ineffective. These issues have resulted in the application of more generic programs which, as mentioned previously, have proven to be unproductive.

A more practical method for distributing responsibility and competencies would be a partnership where deployment of a specialized workforce is focused specifically on delinquency resolutions, while their partners (the financial institutions) are concentrating on identifying and mitigating potential or future challenges. Cure yesterday’s problems while preventing tomorrows from occurring, simple logic, challenging execution.
 
3.       Some of the delays experienced in the introduction and implementation of modification programs have been due to the importance of ensuring a comprehensive understanding of the alternatives. Defining internal procedures, developing technological automation and integration, designing specific programs for execution and then implementing accordingly, are time consuming and arduous tasks.
 
Whether your strategy is to deploy the Home Affordable Modification Program exclusively, an internal customized technique, or a combination of both, until you can ensure that the resulting output complies with objectives, you cannot perform.
 
A more functional option would be to rely on what already exists and proven to be effective. Avoid the confusion and delay in execution by identifying industry accepted and demonstrated alternatives in combination with internal expertise and proficiencies.
 
The technology, human capital, processes, policies and functionality exists, though proper deployment and utilization is lacking; again delaying effective implementation of programs that will address and supply relief to this damaged marketplace. This situation needs to be tackled with emphasis on immediate implementation mandated to ensure these problems can be mitigated.  
 
4.       What are the ideal alternatives? A compelling question that requires an equally interesting and convincing answer. Any program, internal or according to administration policies, has to be designed so that the resulting output benefits all impacted parties.
 
The Bank or Servicer wants to ensure that the applicable option is fiscally responsible and the consumer has to have incentive to re-instate the obligation, which may not exclusively be an affordable payment.
 
The extent to which most consumers have experienced “home price depreciation” that has caused their mortgages to be in excess of 140% of the collateralized properties current market value, has produced an undeniable predicament. Principal forbearance was envisioned as a method to address these circumstances.
 
At “face value” that approach had merit and was well intended. But, it requires a consumer to believe that they will experience an equally rapid market appreciation as they had the reverse depreciation. That perception may be unrealistic as most experts agree the hope for a market turn around is unlikely to occur within the next 7 to 15 years.
 
As new policies are contemplated, the concept of Principal Forgiveness has to be a variable that receives consideration. Though difficult and less appealing to the banking and servicing community, a future strategy that includes a degree of re-imbursement for every dollar of principal forgiven, will in many circumstances have a considerably more impactful effect and could provide the foundation to achieving anticipated results.
 
5.       The banking and servicing community has a notable challenge to ensure they deploy methodologies that manage cash flows on loans that cure without intervention (Cure Risk) and establish fact-based alternatives to circumvent re-default (Re-Default Risk).
 
This concern requires that each transaction be handled individually and that solutions are determined as a result of close investigation and review of current realities.
 
Short-term consumer challenges, where absolute re-stabilization of household incomes is anticipated, must be met with short term solutions that provide for the applicable time relief required to allow the consumer to get back on their financial feet. Consumer circumstances that demand extended remedies must achieve expectations that they can be maintained over an extended period, avoiding the unforeseen or undesired potential for re-default.
 
6.       The existing tactics the market place has implemented appear to have either a technology or human capital approach or a unique combination of both. Some have opted to use automation as the method to identify alternatives. Others have decided to add human capital to deploy and attack the ever-growing problem. Others yet have introduced a combined approach, yet the human capital elected to participate often does not possess the required proficiencies to manage the issues complexity.  
 
Though each of these solutions is admirable, they do not appear to have had the envisioned impact. As future conversation and deliberation occur, emphasis on remediating the problem through tactical application of automation with the inclusion of human capital that is technically proficient and competent needs to be the focus.
 
In conclusion and given these realities, the US Government has an opportunity to influence future decisions made on behalf of the market places’ effort to resolve this looming and economically impactful predicament. The Government’s emphasis that the market support their chosen solution will create greater conformance and improve the probability the application will achieve its anticipated results. Additionally, the market will work in unison to evaluate outcome, and create an environment where modified procedures are shared throughout. As new information and knowledge is acquired, everyone benefits and it simplifies and provides assurances that the application of new procedures is introduced throughout the marketplace.  
 
The Government is trying desperately to play the lead role in getting the ball moving. This is the right approach and will result in (a) an increased number of home owners retaining their most prized possession and the American Dream (b) a stabilization of the underlying real estate market through a reduction in foreclosure activity, and (c) maximization of cash flows on loan portfolios over the long-term.   

NEXT UP:  SERVICER CAPITALIZATION’S EFFECT ON LOAN MODIFICATION EFFORTS