Foreclosure and Loan Modification Wars

The Federal Deposit Insurance Corp has been pressing banks and lenders as well as other government agencies to do more to help homeowners who have fallen behind on their monthly payments.  The FDIC believes more help should come by means of foreclosure and loan modification programs.  The housing crisis is the fundamental force behind the credit mess.  Deflating home values and delinquent loans have caused bank capital problems, lending curtailments in housing, a drop off of lending activity in all sectors of lending with the possible exception of the most credit worthy borrowers and caused increased stress on consumer discretionary spending.  In the FDIC’s press release they state that it is imperative to provide incentives to achieve a sufficient scale in loan modifications to stem the reductions in housing prices and rising foreclosures.

Sheila Bair, chairperson of the FDIC, has been one of the strongest strong activist in the government regarding the need for more aggressive action to try and stop foreclosures and help bring and end to the underlying force the keeps the credit crisis alive.  For the most part the cries of the FDIC have gone without response or reaction.  The FDIC has now announced a plan of action to expedite loan modifications with the assistance of government funds.  In a nut shell, the FDIC plan would help mortgage servicers to modify millions of delinquent mortgages with the government rewarding participating lenders by sharing the cost of engaging in the modifications and the defaults on the restructured loans.

The FDIC laid out a fact sheet on the proposal.  The highlights of the proposal include the following:

This proposal is designed to promote wider adoption of such a systematic loan modification program: by paying servicers $1,000 to cover expenses for each loan modified according to the required standards; and sharing up to 50% of losses incurred if a modified loan should subsequently re-default

We envision that the program can be applied to the estimated 1.4 million non-GSE mortgage loans that were 60 days or more past due as of June 2008, plus an additional 3 million non-GSE loans that are projected to become delinquent by year-end 2009.  Of this total of approximately 4.4 million problem loans, we expect that about half can be modified, resulting in some 2.2 million loan modifications under the plan.

Details on Program Design

Eligible Borrowers:  The program will be limited to loans secured by owner-occupied properties.

Exclusion for Early Payment Default:  To promote sustainable mortgages, government loss sharing would be available only after the borrower has made six payments on the modified mortgage.

Standard NPV Test:  In order to promote consistency and simplicity in implementation and audit, a standard test comparing the expected net present value (NPV) of modifying past due loans compared to the strategy of foreclosing on them will be applied.  Under this NPV test, standard assumptions will be used to ensure that a consistent standard for affordability is provided based on a 31% borrower mortgage debt-to-income ratio.

Systematic Loan Review by Participating Servicers:  Participating servicers would be required to undertake a systematic review of all of the loans under their management, to subject each loan to a standard NPV test to determine whether it is a suitable candidate for modification, and to modify all loans that pass this test.  The penalty for failing to undertake such a systematic review and to carry out modifications where they are justified would be disqualification from further participation in the program until such a systematic program was introduced.

Reduced Loss Share Percentage for “Underwater Loans”:  For LTVs above 100%, the government loss share will be progressively reduced from 50% to 20% as the current LTV rises.  If the LTV for the first lien exceeds 150%, no loss sharing would be provided.

Simplified Loss Share Calculation:  In order to ensure the administrative efficiency of this program, the calculation of loss share basis would be as simple as possible.  In general terms, the calculation would be based on the difference between the net present value of the modified loan and the amount of recoveries obtained in a disposition by refinancing, short sale or REO sale, net of disposal costs as estimated according to industry standards. Interim modifications would be allowed.

De minimis Test:  To lower administrative costs, a de minimis test excludes from loss sharing any modification that did not lower the monthly payment at least 10 percent.

Eight-year Limit on Loss Sharing Payments:  The loss sharing guarantee ends eight years of the modification.

To summarize, we expect that about half of the projected 4.4 million problem loans between now and year-end 2009 can be modified.  Assuming a redefault rate of 33 percent, this plan could reduce the number of foreclosures during this period by some 1.5 million at a projected program cost of $24.4 billion.

This entry was posted on Sunday, November 16th, 2008 at 11:19 am and is filed under Money Rates. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.