Friday, February 26, 2010

FDIC to test principal reduction for underwater borrowers

Original posted in the Washington Post by Renae Merle:

The Federal Deposit Insurance Corp. is developing a program to test whether cutting the mortgage balances of distressed borrowers who owe significantly more than their homes are worth is an effective method for saving homeowners from foreclosure.

The program would be aimed at a growing population of homeowners who are underwater on their loans, estimated at more than 20 percent of borrowers, or 11 million homeowners. Economists consider these borrowers among the most vulnerable to foreclosure, and some industry officials worry that more of them will simply walk away from their mortgages, or "strategically default," rather than spend a decade or more trying to regain positive equity.

Under the FDIC program, borrowers would be eligible for a reduction in their mortgage balances if they kept up their payments on the mortgage over a long period. The performance of those borrowers would be compared with borrowers given more traditional mortgage relief packages, such as those that cut the interest rate on loans.

"We're thinking about it in terms of earned principal forgiveness. If you stay current on your mortgage, you would earn a principal reduction. It would only be for loans significantly underwater," said FDIC Chairman Sheila C. Bair.

The program would have a small reach and apply only to loans acquired from a failed bank seized by the FDIC. That would be less than 1 percent of mortgages currently outstanding. The initiative could be launched later this year, FDIC officials said, but a date has not been set.

The effort adds to the growing debate about whether principal reductions should become a larger part of mortgage-relief efforts. Another government program, known as Hope for Homeowners, sought to reduce mortgage balances of underwater borrowers but has floundered since its launch, and legislation to allow bankruptcy judges to cut the principal on a borrower's loan failed in the Senate last year.

Treasury officials have said they are considering proposals to address negative equity but have not offered any specifics. Under the federal foreclosure relief program known as Making Home Affordable, borrowers can receive up to $5,000 to lower their loan balance if they keep up their payments. But that amount would make only a small dent in the problem facing millions of homeowners, housing advocates said. During the fourth quarter of last year, the average underwater borrower owed $70,700 more than the value of their home, according to First American CoreLogic data released this week.

"Whether homeowners have equity in their home is a key predictor of whether they will default on their mortgage or redefault on a loan modification," said Julia Gordon, policy director of the Center for Responsible Lending. "That's why any serious plan to prevent foreclosures has to include principal reduction for those who owe more than their home is worth."

Lenders have been reluctant to cut the principal balance owed by distressed borrowers, arguing that it would encourage homeowners to become delinquent even if they can afford their mortgage. Instead, the industry has focused on providing mortgage relief by lowering a borrower's interest rate or extending the terms of a mortgage to 40 years. In some cases, a portion of the principal balance is put into a second mortgage that does not have to be paid off until the borrower sells the home or refinances.

Yet, some in the industry have started to relent. During the third quarter of 2009, 13 percent of loan modifications included a reduction in the borrower's principal, according to a report by the Office of the Comptroller of the Currency. That was up from about 10 percent during the second quarter.

Wells Fargo, for example, has increasingly used principal reductions for homeowners with a risky mortgage, known as "option" ARMs. These loans, also called "pick-a-pay" mortgages, allow borrowers to choose how much to pay each month. Many of these borrowers pay less than the amount of interest due, and the unpaid interest is tacked on to the balance. These loans also tend to be concentrated in places where home prices soared and then plunged precipitously, leaving many homeowners significantly underwater.

Wells Fargo, which acquired many of these loans as part of its 2008 purchase of Wachovia, says it forgave $2.6 billion in borrowers' principal balances for these types of mortgages last year. But even when principal reduction is offered, it will not necessarily be enough to bring a borrower back to full equity, company officials said.

"It needs to be done on a case-by-case basis, either in certain geography types, or with certain customer types," said Mike Heid, co-president of Wells Fargo Home Mortgage. "I do not believe that you can do a programmatic-wide or country-wide principal forgiveness [program]. You end up with many problems if you try to do this across the board."

Thursday, February 25, 2010

Chase and Other Servicers Leave Many in Loan Mod Limbo; Treasury Threatens Penalties

Original posted on ProPublica by Paul Kiel:

About 97,000 homeowners in the government’s mortgage modification program have been stuck in a trial period for over six months. Most of them, about 60,000, have their mortgages with a single mortgage servicer, JPMorgan Chase.

Trial periods are designed to last only three months, after which mortgage servicers are supposed to either give homeowners a permanent modification or drop them from the program. According to a ProPublica analysis, about 475,000 homeowners [1] have been in a trial modification for longer than three months.

While the Treasury Department has so far allowed servicers to stretch the trials without repercussions, the government issued little-noticed guidelines in late December, warning that lenience will end at the end of this month. Servicers will have to clear out their backlogs, and those that don’t abide by the guidelines could face “financial penalties,” said a Treasury spokeswoman. But Treasury has been vague [2] on how big those penalties will be.

Although homeowners in the trial modifications have had the benefit of seeing their monthly payments drop (by an average of $522), there are adverse consequences [3] when a trial drags on. A homeowner’s credit score can take a hit. Because a homeowner is not making a full payment, the balance of the mortgage grows during the trial period, putting someone who was behind when the trial began even further behind if it fails. The homeowner can be in worse shape if the modification fails since she’s been making the trial payments instead of saving for the possibility of foreclosure. And last but certainly not least, those homeowners suffer the stress and fear of not knowing whether they’ll be able to keep their homes.

Some homeowners have been in limbo for as long as 10 months – since the launch of the program. Recently, we at ProPublica asked readers [4] to help us find who’d been in a trial period for the longest time. We heard from hundreds of frustrated homeowners, many who’d begun trials last summer. Among them were two — Marlene Colon of Tinton Falls, N.J., and Deb Franklin of Airville, Pa. – who had begun trials last May and were still waiting. Chase Home Finance, a subsidiary of JPMorgan Chase, serviced both their mortgages.

Click to  see our interactive chart tracking the performance of servicers in the  government's loan mod program
Click to see our interactive chart tracking the performance of servicers in the government's loan mod program
[1] Since the first servicers signed up last April, about 1 million homeowners have been put into trial loan mods. Only 116,297 [5] have emerged with a lasting modification. That number will undoubtedly go up next month, though given the scale of the foreclosure crisis [6], it will remain disappointingly low. However, if the servicers succeed in reducing their backlogs, an even larger number of homeowners might find themselves dropped from the program and facing the possibility of foreclosure.

Colon, the New Jersey homeowner, and her fiancé sought a modification from Chase last spring after she lost her job and ongoing health issues prevented her from working elsewhere. Although she was glad to see her payment drop from about $1,600 per month to $965, she said it has been a struggle to get any answers since then. “I think they do it to wear us down so we throw our hands up in the air and say we give up,” she said.

She and her fiancé were current on their payments when the trial began and had a high credit score, she said, but they’ve since seen their credit card limits cut. Treasury instructed servicers to report the trial payments as a reduced payment plan to the credit reporting agencies, which can result in a significant lowering of credit scores.

It’s unclear when she’ll get a final answer. Recently, Chase asked for updated copies of her fiancé’s pay stubs, she said, which she says she promptly sent in.

Christine Holevas, a spokeswoman with Chase, said in a statement that Colon’s case was “under review,” but did not give more detail.

As for the tens of thousands of other homeowners in limbo, Holevas said that Chase is “working through its inventory according to U.S. Treasury Department guidelines” and “trying to help struggling borrowers stay in their homes whenever we can.”

She emphasized that “we need the homeowners to get us all the required documents.” As ProPublica has reported, servicers (not just Chase) have a poor track record of handling documents [7]. Homeowners in the program routinely complain [3] about servicers losing paperwork and asking again and again for the same documents.

Colon says her problem has always been getting information from Chase, not the other way around. “I can’t imagine that someone who’s in a bind wouldn’t comply,” she said. “We’ve done everything that they’ve asked of us.”

No other servicer has near as many homeowners in limbo as Chase. A smaller servicer, Saxon Mortgage Services, a subsidiary of Morgan Stanley, has a similar proportion of lingering trial mods – about one-third of its homeowners in trials have been in one for more than six months. But it services relatively few mortgages over all, and has only about 13,000 mortgages in trial modifications. A spokeswoman said that Saxon had “launched a number of proactive programs to work with borrowers to collect all of the documentation required.” Bank of America, by far the largest servicer, has about 12,000 homeowners in a similar position. A spokesman said that the bank was gaining “momentum” in providing permanent modifications. (You can see how all the servicers match up in our interactive chart. [1])

A Surge in Denials?

Banks and servicers have not only been slow to approve homeowners for permanent modifications, there have also been surprisingly few homeowners dropped from the program – only about 61,481 as of January. Borrowers can be dropped for missing payments, failing to send in documents or simply proving ineligible.

Part of the reason for the trial backlog are the Treasury guidelines. In late December, Treasury initiated a “review period” [8] during which servicers were prohibited from dropping homeowners from the program if they were still in the home. Servicers were supposed to take the opportunity to let homeowners know this was their last chance to send in missing documents or payments. The grace period extended through January.

Click  to see our interactive chart tracking the performance of servicers in  the government's loan mod program
Click to see our interactive chart tracking the performance of servicers in the government's loan mod program
[1] That means the number of denials should surge this month, which is why many observers, like the blog Calculated Risk [9], think February’s numbers will be particularly revealing of the modification program’s success.

About two-thirds of homeowners in trials are current on their payments, according to Treasury. That means that roughly 275,000 homeowners are not. However, that doesn’t necessarily mean they will all be dropped from the program – homeowners who stopped making the trial payments after the expiration of the three-month trial period are still eligible [10] for a permanent modification.

Treasury is also pressuring the servicers to make final decisions about homeowners in cases where no documents or payments are said to be missing. About the same time that Treasury launched the review period, it also instructed servicers [10] that they must make a determination about such homeowners by the end of February.

“We have been working very closely with servicers and are confident that they will meet the February deadline for making determinations on borrowers in the trial phase,” said a Treasury spokeswoman.

Estimated Trials Lasting Longer Than Six Months: Top Four Servicers

ServicersEst. Trials Exceeding 6 months% of All Trials Begun That Exceed 6 Months
JPMorgan Chase subsidiaries60,17835%
Saxon Mortgage Services12,85135%
Bank of America (incl. Countrywide)11,6345%

Source: Treasury data, ProPublica analysis

Tuesday, February 23, 2010

Financial Services Committee to Consider the Future of Housing Finance

Washington, DC - Financial Services Committee Chairman Barney Frank (D-MA) announced today the committee will hold a hearing on March 2 to begin the process of considering the future of housing finance. The hearing will focus on all the private and public entities that support the mortgage market, which include the Federal Housing Administration, Ginnie Mae, Fannie Mae, Freddie Mac, Federal Home Loan Banks, and private lenders and securitizers. It is the first step in a legislative process to determine the future of housing finance and the federal government’s role in responsible homeownership and the supply of affordable rental housing. Chairman Frank has invited Treasury Secretary Timothy Geithner and Housing and Urban Development Secretary Shaun Donovan to present the Administration’s perspective, as well as representatives of the advocacy community, academia, and industry to present their ideas on the future of housing finance. Witnesses will be announced at a later date.

You will be made aware of HAMP but it still sucks

Original posted on FT Alphaville by Tracy Alloway:

Barry Ritholtz has got his hands on something interesting – what looks to be the equivalent of Hamp on steroids.

Readers of FT Alphaville may remember that the US Treasury’s Home Affordable Modification Program, which aims to keep borrowers in their houses by reducing interest payments, has not really lived up to the government’s expectations. The Treasury is now looking for ways to modify the modification programme, such as by introducing principal forgiveness instead of just forbearance.

According to this draft presentation, which seems to have been obtained by Ritholtz as well as some news outlets like the Wall Street Journal, it looks like the Treasury is — so far — focused on simply fine-tuning its existing programme.

Some of the bullet points from the document:

Supplemental Directive 10-02 — Foreclosure & Bankruptcy Changes

  • Prohibits referral to foreclosure until borrower is evaluated and found ineligible for HAMP or reasonable contact efforts have failed
  • Requires servicers to stop all foreclosure action once borrower is in a trial period plan
  • Requires written certification that a borrower is not HAMP eligible before an attorney or trustee can conduct a foreclosure sale
  • Requires servicers to consider borrowers in bankruptcy for HAMP and removes other bankruptcy barriers
  • Clarifies investor solicitation/identification requirements.

In addition to tweaking some of the paperwork requirements, it looks like the Treasury wants to change Hamp’s solicitation policy — that is, the process by which delinquent US borrowers are offered trial Hamp mortgage modifications.

Under the current policy it’s merely implied that Hamp-eligible borrowers should be offered trial mods. Under the proposed policy, eligible borrowers must be offered the Hamp option. Furthermore, “reasonable solicitation” is defined as at least four telephone calls over at least a 30-day timeframe, and two written notices including one sent by “certified mail return receipt”.

The message from the US Treasury: You will be made aware of Hamp.

Whether you want it or not.

US housing market hit by ‘walkaways’

Original posted in the Financial Times by Aline van Duyn :

Wayne B, a 62-year-old executive who works at an airport, and his wife Orapin, a dental assistant, are about to do something odd. The couple, with a pristine credit history, have decided to default on their $500,000 (£325,000, €370,000) mortgage on a townhouse in Livermore, a respectable city in California’s San Francisco Bay area.

It is not that they are unable to afford the $4,600 monthly mortgage outgoings: they have never missed a payment. But the house they bought for $582,000 in May 2006 – at the peak of the US housing boom – is now not likely to be worth more than $315,000.

“The process towards a default has started,” says Wayne, whose lender does not yet know it will soon be left nursing losses on yet another foreclosed house – and one whose owner, among the top-rated in terms of creditworthiness, is an implausible-sounding default risk. “We plan to retire in four years and will not be able to afford the mortgage payments then,” he explains. “The loss if we sell will be so large that, after doing a lot of research, we have made a business decision to walk away.”

The high level of foreclosures in the US – the handing over of homes to banks that lent people money to buy them – has been a huge burden on the economy, has kept house prices on a downward spiral and has resulted in misery and anxiety for millions of people. In some areas so many homes have been abandoned that the entire community has fallen apart as schools close, public services are cut and homes are ransacked for fittings or taken over by criminals. That has also sent property values plunging for those people still in their homes and paying mortgages.

Stemming foreclosures is a key policy objective of President Barack Obama’s administration. Various programmes are being worked on to modify people’s mortgages in an attempt to reduce payments so that the mortgages are not defaulted on, but so far with only limited success.

The US housing crisis and the foreclosure wave have also been the fuel behind hundreds of billions of dollars in losses for banks and investors around the world – owners either of the defaulted mortgages themselves or of securities linked to their value. Famously, the biggest source of losses came from subprime mortgages – loans given in cavalier fashion to people with poor credit histories. When those borrowers began to default, it triggered the most widespread collapse of housing prices across the US seen since the 1930s.

Prices are still falling. So the extent of losses banks and investors will have to take on mortgages that are still being paid every month, but may not be for longer, hangs large over the US economy. Without a recovery in house prices, consumer spending and confidence in the US is expected to remain muted, reducing the potential for economic growth.

US housing charts

Further losses on mortgages could result in more pain for banks, too, reducing the amount of new credit that they can make available to consumers and businesses. This, in turn, would have knock-on effects for the global economic outlook, as the US remains one of the biggest drivers of international trade and commerce.

The behaviour of people like Wayne could therefore be crucial. With a growing number of Americans facing negative equity – where the mortgage exceeds a property’s current market value – and becoming ever more pessimistic about the prospects of house prices recovering to make up that difference, they are surrendering to foreclosure even though they can still meet the repayments.

The trend is clear in recent rates of non-payment, or delinquency, on mortgages. In January, delinquencies on outstanding “jumbo” mortgages – big loans granted to people with good credit histories – rose to 9.6 per cent, according to Fitch Ratings. Many of these problem loans, which have gone unserviced for 60 days or more, were taken out after 2005. And non-payment is increasing not just in hard-hit states such as California: in New York, Florida, Virginia and New Jersey they are all on the rise too.

“These are all states where many of the mortgage holders are educated people and it is easy to connect the dots and conclude that these people are deciding it is no longer worth paying a mortgage if they are under water,” says Ivy Zelman, a housing market analyst.

How to get out of debt

In many US states, if a home loan goes sour, mortgage lenders are entitled to claim only the property on which they provided the funds. Lenders generally have limited or no recourse to the other assets or future income of a borrower if there is a loss on the loan. Borrowers are not liable for any debts except those covered by the value of the home.

This feature of the US mortgage market is a main reason people can “walk away” from properties. In many other countries, including Britain, that is not so easy to do. Borrowers can still be liable for the difference between the size of their mortgage and the value of a home, even if house prices fall and people enter negative equity.

She expects US house prices could fall another 10 per cent under the combined weight of the build-up of unsold foreclosed houses, cash-strapped people unable to keep paying mortgages and people facing negative equity deciding simply to hand over their home to their banks.

Aclose look at mortgage payment trouble spots shows that the higher the negative equity, the higher the rate of non-payments. Fitch has found that for all the mortgages provided in the private market, householders with no equity have a delinquency rate of nearly 40 per cent, double that of homeowners who have a stake in their property.

For those with mortgages worth 50 per cent more than their homes, the delinquency figures are over 50 per cent, and these fall as the ratios fall.

Particular concern surrounds defaults by people who merely face negative equity rather than monthly funding problems. These “strategic defaults” may be accelerating as more people shrug aside societal pressure to meet debts if they can.

In previous housing downturns, the vast majority made every effort to pay their mortgage, which tended to be the last debt that was defaulted on. Now, as mortgages have become a more impersonal transaction (long-term relationships are rarely built up with mortgage brokers, and many homeowners knew their loans would have been repackaged into bonds and sold to investors around the globe), patterns have changed. As more people move around to find work or better living circumstances, they have less of a “home for life” approach to their houses – and mortgages no longer have so special a status.

Nevertheless, giving up on such a debt is still something that often causes emotional turmoil. Shasta Gaughen, a 39-year-old PhD graduate in anthropology who works with a Native American tribe in California, a few weeks ago stopped paying her mortgage. The one-bedroom condominium she bought for $196,000 in October 2005 is now worth just $60,000 and she has decided to default, “after two years of agonising”.

“The biggest problem is trying to convince myself it is not morally wrong to walk away,” she says. “I’m approaching my home as an investment that went bad. I’m not stealing anything, the bank will get the property. But my parents raised me to be responsible.” She has decided the “responsible” thing for her to do is get out of the flat and rent somewhere else for less than the $1,200 monthly mortgage payments.

A mortgage default could make renting a little more expensive but landlords already have signs out saying “bad credit accepted”.

The problems with negative equity are known, but so far there is no government strategy for tackling it. One concern is that giving some homeowners a reduction on their loans (a loss the banks would have to take on the chin) could evoke resentment among others who did not qualify and might themselves stop payments. Ideas to limit this “moral hazard” include requiring homeowners to give the mortgage lender a stake in the house if a loan is refinanced, meaning that any future price gains would be shared between homeowner and lender.

“Negative equity is a big challenge. It contributes to higher delinquency and redefault rates,” Seth Wheeler, senior adviser at the US Treasury, told a conference this month. “We will continue to study the reduction of principal where appropriate,” he adds, though the form it would take has not yet been determined.

Many mortgage investors and housing experts believe it has to be dealt with. “The housing problems run very deep, but so far policies have just kicked the can down the road,” says Laurie Goodman, analyst at Amherst Securities, a broker that specialises in mortgage investments. “To get an economic recovery you need to fix the housing problem. And to fix the housing problem, you need to fix the negative equity problem.”

As well as banks, investors owning the mortgages that were repackaged in the last decade are also concerned that there will be further losses on many of these bonds that have already fallen in value. With foreclosure patterns difficult to predict as even people with excellent credit histories and high incomes choose to default, it becomes harder to determine which securities will keep paying and which will not. Foreclosures eventually feed through to reduced interest payments on the securities.

This matters, not least because the private financing of mortgages in the US is at a virtual standstill. The market is all but entirely financed by the US government through Fannie Mae and Freddie Mac, the country’s twin federally backed mortgage agencies.

Nancy Mueller Handal, managing director at Metlife, a large insurance company, says nearly one-quarter of the group’s assets are invested in mortgage-backed securities. However, she says Metlife will not buy new securities until it knows what will happen to the current ones – and whether investors will have to absorb the resulting losses. The lack of clarity on foreclosures and house prices means she is still not sure whether the value of the securities will fall further.

In the meantime, Ms Gaughen is waiting to hear from her bank, Bank of America. She has hired You Walk Away, a company that offers legal advice, tracks the documentation process and lets people know how close they are to eviction.

You Walk Away estimates that she can live in the apartment without paying the mortgage for 12-16 months, leaving her with a nest-egg of cash at the end. Jon Maddux, chief executive, says the time people can stay has been steadily growing. His company, which charges a flat fee of around $1,000 for its services, started just over two years ago. At that time, most of his clients were extremely agitated and phone calls were often peppered with tears, Mr Maddux says.

Now, most customers are much less emotional about the information they are seeking. He estimates that 80 per cent of people signing up for advice are – like Wayne B in Livermore – paying their mortgages but opting to default anyway. “It is now a business decision that more and more people are choosing to make.”

Friday, February 19, 2010

How Home Equity Loans Keep Big Banks From Modifying Mortgages

Original posted on the Business Insider by Vince Veneziani:

There's a fine line in the sand drawn between two parties in the world of loan servicers: those who will reduce principal and those who absolutely will not.

In the latest edition of Asset Backed Alert, an article details how smaller servicers such as American Home Mortgage and Litton Loan Servicing are using good judgment and are helping homeowners reduce principal owed and the like on their mortgages.

The reason why these companies are working with homeowners is due to the fact that they are small and independently run, unlike servicers owned by big banks. ABA explains:

In some cases, the bank-owned players are reluctant to forgive or delay principal because their parent companies also extended home-equity loans to the borrowers. With many homeowners already under water, cutting principal from the first-lien mortgages in those cases would also necessitate reductions for the home-equity credits. Depending on the loan terms, the banks might be forced to wipe out home-equity balances altogether.

Either way, the issue is hot with investors right now and needs to be resolved in a timely manner, before the write downs overburden their associated firms.

Monday, February 15, 2010

Produce the (Bogus?) Paper

Original posted on Credit Slips by Katie Porter:

In 2007, I wrote an article showing that notes and mortgages were often missing from bankruptcy mortgage claims, despite a clear rule that they should be attached. That finding did not establish that companies do not have such documentation. At that time (a long-ago era of blind faith in commercial entities), some people suggested to me perhaps creditors simply do not wish to be bothered with the time and expense to comply but that all transfers were valid. In the intervening years, story after story has emerged about mortgage servicers who brought foreclosure cases without being able to show their clients had a right to foreclose. Homeowners, desperate to stave off foreclosure while negotiating for a loan modification or waiting for HAMP to become operational, are increasingly demanding that lenders "produce the paper." In legal terms, this means the servicer should show that it is the authorized agent of a trust or other entity that is the holder of the note and the assignee of the mortgage.

Upon challenge, many companies have been unable to show they had the paperwork, leading to their cases being dismissed (see here, here and here for some examples). The hard part has been to figure out the longer term consequences of lacking a proper chain of negotiation and assignment. What is the effect of an assignment of a mortgage in "blank"? Is this an incomplete real estate instrument that has no valid effect, similar to a deed without a grantee? Can parties go back after the fact and create assignments today to correct problems in transfers from years ago (and if so, what about when the chain of title involves a now defunct lender or bank? what about corrections to chains of title made after the debtor files bankruptcy and the automatic stay is in place?)

Lenders and their agents seem to busy churning out assignments to repair defects and create a paper trail. Of course, with all this paperwork creation, there are bound to be some slips-ups. Follow this link and click on "view image" to see the public recordation of an assignment "for good and valuable consideration" of a mortgage to "Bogus Assignee for Intervening Asmts, whose address is XXXXXX." If this works to assign a mortgage, what is the purpose of requiring assignments at all?

Home > Servicing/Default > HAMP Failures May Reverse Recent Upticks in Pricing: Moody’s RSS Twitter HAMP Failures May Reverse Recent Upticks in Prici

Original posted on the Housing Wire by Jon Prior:

Home prices will likely decline another 8% from Q409 to the end of 2010, reversing recent gains in the market, for a 34% peak-to-trough drop, according to a Moody’s report which faults the “underwhelming” success of the government’s Home Affordable Modification Program (HAMP) as the key driver for the assumption.

To be sure, the updated outlook on the extent of pricing collapses are an improvement from last month, when the analysts predicted prices to fall 37% to a bottom in Q310.

Additionally, the S&P/Case-Shiller US house price index showed a 7% growth in home prices in the second and third quarters of 2009. The National Association of Realtors (NAR) also reports that median existing house price losses narrowed 4.1% in Q409 to $172,900, the smallest decline in more than two years. Moody’s analysts, in fact, anticipate house price increases will prevail in the final quarter of 2009, though they expect the growth to end there, dropping 8% through Q410.

Coupled with the first-time homebuyer tax credit, declining sales of distressed property – including foreclosures, deed-in-lieu and short sales – fueled the recent price growth. The Home Affordable Modification Program (HAMP) kept some of these foreclosures off of the market, as the US Treasury Department continues to push servicers to permanently modify more loans on the verge of foreclosure. But HAMP will only help so many, according to Moody’s.

Servicers participating in HAMP modified roughly 66,000 mortgages through December 2009, far from the Obama Administration goal of 3-to-4m. Moody’s analysts see the program modifying 400,000 to 1m loans. Recently, the House Committee on Government and Oversight Reform launched an investigation into the effectiveness of HAMP.

“The assumption that the program’s success will remain underwhelming underpins our unchanged expectations that house prices will further decline,” according to the report. “Many of the loans in the program will fail to convert to a permanent modification and will eventually end up on the market as heavily discounted distress sales.”

Determining the actual amounts and timing of distressed sales, however, is hard to pin down due to sparse data, according to the analysts. There is no authoritative source of data for real estate owned (REO) sales to third parties, which muddies the crystal ball for pricing forecasters. The loans that fail to convert to a permanent modification from the three-month trial period will hit the market at different times, given different moratoriums and clogged foreclosure courts.

Despite HAMP shortcomings, the success of private modification programs from lenders could be underestimated. But analysts still see another drop in prices before the market fully bottoms.

Friday, February 12, 2010

How long will you be underwater?, II: Modifications

Original posted on Rortybomb:

So let’s assume that there’s an option value in being above water in your mortgage, if only because you can sell it without having to go into your pocket for additional payments. You’d have to do that for the massive transaction and closing costs in the exercise we are about to do, so we’ll assume that’s even.

I’m curious as to your thoughts, what are some other things that could influence the value of that option?

Mortgage Modification

So…mortgage modification. Through HAMP, the government subsidizes mortgage modifications that get the mortgage payment down to 31% of income. The formula for a fixed-rate mortgage payment is:

c = (r / (1 − (1 + r) N))P0

You can lower “c”, the payment, by reducing the interest rate, increasing the number of years on the loan, and decreasing the principal. And that’s the order of the modification waterfall: taxpayers subsidize lowering the interest to as low as 2%. In order to get the payment down to 31%, the servicers can also increase the terms of the loan out to 40 years, and they can also put principal into forebearance (so you’ll have a balloon payment) or reduce it outright.

From Treasury’s December report, we see that permanent modifications by waterfall steps have 100% interest rate reduction, 43% term extension, and 26% principal forbearance.

So, there’s this family. They are are underwater on their mortgage. They are also stuck in the two-income trap: their current mortgage payment is 40% of their household income, and one of the two equal wage earners loses their job. They can only find new work at half the wage, so their household income is now 75% of what it was a month ago. Their mortgage now goes to 53% of the household budget, and they can’t make ends meet.

Good and Bad Modifications

So they apply for a modification. There’s two ways this can go to get the mortgage payment down to around 31% of your income. The first is to simply reduce the interest rate to 2%. That looks like this:

Not bad. It decreases the time underwater.

But there’s another way to do the modification. Let’s say the servicer simply reduces the interest rate to 3%. They also add 5% to the principal through fees, taxes, etc. Then, in order to make the mortgage payment fit your budget, they add 8 years to the term of the mortgage, putting you from 27 out of 30 years to 35 out of 35 years. (I think that is how it is done with term extensions, from the Treasury documents I’ve seen).

Your mortgage payment is still the same as in the first example. But that looks like this in this model:

So we know that a shocking 70% of mortgages that are modified have their balances increased. That pushes the curve up in and of itself. I’m currently trying to get numbers on how much it is increased, and how much the terms are increased on average (and interest rate reduced).

Given the nature of servicers in these circumstances, and their current profit incentives, and the clumsiness of regulators and government officials in monitoring their performance, do you think these modifications would go in the good or bad graph? Like that X-Files poster, “I want to believe.” But I’m not seeing anything to convince me. This is a bad way to try and handle this situation.

You know what is good at handling these situations? Bankruptcy courts. Can we get mortgage cramdown already? We can create a special modified bankruptcy rule for mortgage principals if we are worried it would distort all the other consumer spending. You know what else is good at handling these situations? Blunt government dollars. Why don’t we take all the money we are wasting nudging servicers, and just buy the mortgages themselves?

Everything I see here makes me think the government should be going nuts trying to find a solution – this is a serious problem effecting unemployment and the general recovery – and I see little to think HAMP hasn’t been a failure and won’t continue to be.

How long will you be underwater?, I: Some Numbers

Original posted on Rortybomb:

Matt Frost noted that there were “strange reproductive politics implicit in the comments” on the foreclosure email post. This is fascinating, from a commenter: “I finally lost my sympathy when they decided to have a baby without their financial situation being resolved.”

You know who else was born at a moment where the parents didn’t have access to stable housing? Jesus. But I’ll stick to the maths.

I suppose that comment hinges on what you mean by financial situation being resolved. If it means waiting to have a baby until, say, all your student loans are paid off, sorry to tell you but on behalf on my generation the piping will probably have gone dry by the time the last of those are paid off. I assume it means that life, moving to new jobs, starting new careers, etc. should be put on hold until underwater mortgages start to clear. How long is that going to take?

Let’s assume that there’s an option value in being above water in your mortgage, if only because you can sell it without having to go into your pocket for additional payments. You’d have to do that for the massive transaction and closing costs in the exercise we are about to do, so we’ll assume that’s even.

I’m also fascinated by this post at calculated risk. They reproduce this graph:

Noting: “Strategic default on the part of the owner occupier becomes more likely at such high levels of negative equity….The default rate increases sharply for homeowners with more than 20% negative equity.”

This got me thinking: what does the payment schedule look like for someone who is 20% negative equity? How long will you be underwater, given reasonable market conditions?

Let’s take a reasonable suggestion of market conditions. This, as everything that is at the rortybomb blog, is not to be taken as financial advice. Let’s say inflation is 2% in the near future. According to Shiller’s data, the real gain to housing is .26% compounded annually. (Huge thanks to Richard Serlin for thoughtful help with me thinking through these examples.) So let’s say the nominal value of your home increasing year to year is 2.26%.

Let’s also say your mortgage is 30 years, and that the interest rate on it is 6%. As a reminder, LTV means Loan-To-Value, or the ratio with the mortgage amount divided by the property amount. Many people bought at the top of the bubble that when prices crashed, so their mortgage turned out to be a lot higher than what the property is worth.

One key to remember is that, as always with mortgages, the first mortgage payment you make is almost all interest, and the last mortgage payment you make is almost all principal. I am going to assume that this mortgage is three years into the payment cycle when we calculate the LTV.

Example One: Average

Here’s a chart that takes this example and graphs the LTV versus the years it takes for a mortgage to become above water, to have the principal of the mortgage equal the house value through growth of the value of the property and paying off the principal (R code available if interested):

So if you are 10% underwater, it will take around 29 months, or around 2 and a half years, until you own a small piece of your home. If you are 30%, it will take around 76 months, or around 6 and a half years. For those with an LTV of 120, they have 54 months – they will pay for the first small piece of their home around August 2014.

Example Two: Interval

Now that’s an average case scenario. Let’s plot it again with a good case and a bad case, to give us an interval. How best to do it? I’m going to assume a 4% yearly nominal growth for the good case scenario – split that between inflation and property value growth however you’d like. For the worst case, I am going to assume the nominal value of the house decreases 2% for 2 years, and then goes back to increasing 2.25% year after year. Here is that graph:

The higher line is the bad case scenario – keeping LTV the same, it means more time until you are above water. Here the range is 20 to 54 months for an LTV of 110 and 55 to 97 months for an LTV of 130. For an LTV of 120, where the defaults accelerate, looking out you’d see an interval of 39 to 77 months, or a timeframe between April, 2013 and June, 2016, when you can be above water. How’s that for uncertainty?

As you can see, the marginal effect of principal increases never really decreases – it’s always equally bad to add more principal, and equally good to remove some, in terms of getting above water. This is why mortgage modifications that add principal are terrible, which I’ll discuss in the next post.

Mortgage assistance relief services targeted in FTC rulemaking

Original posted on Lexology by Jonathan Pompan and Kristalyn Loson:

On February 4, 2010, the Federal Trade Commission (“FTC” or “Commission”) issued a Notice of Proposed Rulemaking (“NPRM”), seeking comment on a proposed Rule that would regulate loan modification, foreclosure rescue, and other mortgage assistance relief (“MARS”) providers.

The proposed Rule would ban MARS providers from collecting fees prior to delivering these services, prohibit misrepresentations in the marketing of these services, and require certain affirmative disclosures about the nature and terms of the service. Significantly, the proposed Rules also would extend liability for violations to persons or companies who provide assistance or support to MARS providers that violate the proposed Rule.

The Commission invites comment from entities that would be covered under the proposed Rule as well as those with an interest in the rulemaking. The NPRM lists general questions to which the Commission seeks responses from the public, such as “what changes should be made to the proposed Rule to increase benefits to consumers and competition” and “how would the proposed Rule affect small business entities,” as well as questions about specific proposed provisions, some of which are enumerated below. Of particular note are comments requested on a jurisdictionally-based exemption for bona fide nonprofits (including bona fide nonprofit housing counselors) and a limited exemption for attorneys.

Comments are due on or before March 29, 2010.


The 2009 Omnibus Appropriations Act(1), as clarified by the Credit Card Accountability and Disclosure Act(2) (“Credit CARD Act”), gives the FTC specific rulemaking authority to prevent unfairness or deception in practices involving loan modification and foreclosure rescue services. This NPRM follows up on the Commission’s June 1, 2009 Advanced Notice of Proposed Rulemaking addressing MARS.(3)

The Commission has continued an aggressive approach in protecting consumers against the alleged deceptive practices of MARS providers. In the past two years, the Commission has filed over 28 lawsuits against entities in the industry and the proposed Rule would provide an additional basis for enforcement. States also are active in the regulation of MARS providers and state Attorneys General have investigated over 450 MARS providers, resulting in hundreds of enforcement actions.

On the same day that the NPRM was issued – February 4, 2010 – FTC Chairman Jon Leibowitz testified before the U.S. Senate Committee on Commerce Science and Transportation about the Commission’s enhanced efforts to protect consumers during the economic downturn, including initiating hundreds of cases against mortgage relief scams.

Who Is Covered by the Proposed Rule?

The proposed Rule is directed toward MARS providers and is intended to apply to “every solution that may be marketed by covered providers to financially distressed consumers as a means to avoid foreclosure or save their homes.” The proposed Rule defines “mortgage assistance relief service” to include “any service, plan or program, offered or provided in exchange for consideration on behalf of the consumer, that is represented, expressly or by implication, to assist or attempt to assist the consumer” in negotiating a modification of any term of a loan or obtain other types of relief to avoid delinquency or foreclosure.

The Commission intends the definition to include mortgage brokers to the extent that they market MARS but would generally exclude loan holders, servicers, and agents of such holders and servicers. However, the Commission does not intend the proposed Rule to apply to “bona fide loan origination or refinancing services.” In addition, the proposed Rule generally exempts loan holders and servicers and their agents. The Commission seeks comment on the scope of this exemption, including whether services have engaged in covered conduct that warrants encompassing them in the proposed Rule.

The proposed Rule would only apply to entities under FTC’s jurisdiction. Accordingly, the proposed Rule generally exempts from the definition of MARS providers any nonprofit excluded from the FTC’s jurisdiction.(4) The proposed Rule states, “The Commission intends for this exemption to include bona fide nonprofit housing counselors presently offering mortgage assistance services.” Note there is no similar express statement of exclusion for nonprofit credit counseling agencies in the FTC’s proposed Rule to amend the Telemarketing Sales Rule (“TSR”) to cover debt relief services. It should also be noted, however, that the FTC has a long history of enforcement against entities it deems to be “sham nonprofits.”

For similar reasons as the bona fide nonprofit exclusion, the reach of the proposed Rule would not cover banks, thrifts and federal credit unions, as the FTC Act places these entities outside the FTC’s jurisdiction. Although the exclusion of nonprofits (and banking entities) is a jurisdictional issue, the Commission seeks responses on the effect of these exclusions, such as whether the proposed Rule creates an incentive for forprofit entities to become nonprofits.

In addition to jurisdictional exclusions, the proposed provides a limited exemption for attorneys engaged in MARS. The NPRM states, “[t]here is no general exemption for attorneys from the requirements of the proposed Rule. The Commission, however, proposes a limited exemption for licensed attorneys’ conduct in connection with a bankruptcy case or other court proceeding to prevent foreclosure, where that conduct complies with state law, including rules regulating the practice of law.” The Commission explains that attorneys who provide such representation in bankruptcy or court proceedings would be exempt from prohibitions on advance fees, and also would be permitted to advise consumers to cease contact with their lenders. Attorneys would still be subject to the proposed Rule’s ban on misrepresentations, disclosure requirements, prohibitions on known substantial assistance, and recordkeeping requirements. The NPRM notes that these rules are designed to balance the potential value of a legal review to consumers who are trying to save their homes with the unfortunate fact that growing number of attorneys are allegedly involved in deceptive and unfair MARS activities, including serving as a front for organizations seeking to avail themselves of the attorney exemptions under various state MARS laws. In justifying the delicate balance the limited attorney exemption strives to achieve, the NPRM asks for comment on different ways the exemption could be tailored, and whether the exemption should apply to any other groups.

Key Areas

The proposed Rule focuses on five key areas: (1) Prohibited Representations; (2) Ban on Collection of Advance Fees; (3) Required Disclosures; (4) Liability for Substantial Assistance; and (5) Recordkeeping/ Compliance.

1. Prohibited Representations

  • The proposed Rule prohibits several specific representations as deceptive or unfair, including:
  • Instructing consumers to stop communications with their lenders or servicers,
  • Misrepresentation of likelihood of time necessary to obtain results,
  • Wrongful suggestions of affiliation with government, nonprofit housing counselors, or program, lenders or loan servicers,
  • Implication of relief of payment and obligations under the existing mortgage, and
  • Misrepresentation of refund and cancellation policies of the MARS provider.

2. Ban on Collection of Advance Fees

Under the proposed Rule, MARS providers would be prohibited from charging or collecting any payment from consumers until they provide a documented offer from the mortgage lender or service provider to modify mortgage terms or deliver on a similarly-promised service. This proposal takes aim at what the Treasury Secretary Timothy Geithner characterizes as “bad actors who promised to loan modifications but never delivered,” and would essentially prohibit the charging of any up-front fees or piecemeal payments. The NPRM states that typical up-front fees can be in the thousands of dollars. The results that MARS providers must achieve before requesting or collecting payment are those results which their claims cause consumers to expect or that consumers reasonably expect given the type of service sold. The NPRM specifically requests data on the costs to MARS providers if they are prohibited from charging advance fees and also seeks comments on alternatives to the advance fee prohibition.

3. Required Disclosures

Prominent and clear disclosures are required by the proposed Rule in a variety of media formats, including written, audio and video disclosures, as well as disclosures in interactive media. Specific requirements such as size, text and duration of display of the disclosures are addressed.

The subjects of the disclosures mirror the prohibited representations and include, among others, that: (1) the provider is a for-profit business and is not endorsed by either the government nor the consumer's lender; (2) the total fee the consumer will have to pay to purchase, receive and use the service; and (3) that even if the consumer purchases the service, the consumer’s lender may not agree to change their loan.

Required disclosures under the proposed Rule are to be provided in all commercial communications. The Commission admits that it does not have any empirical research on whether the proposed disclosures are an effective means of conveying the status, cost and limitations of MARS providers and seeks comment in this area. The FTC also inquires whether other disclosure requirements should be added to the proposed Rule, such as requiring MARS providers to disclose their historical performance.

4. Liability for Assisting and Facilitating

The proposed Rule includes provisions extending liability to entities that work with MARS providers engaged in deceptive or unfair practices if they “know or consciously avoid knowing that the provider is engaged in any act or practice that violates the Rule.” This “substantial assistance” provision is modeled after a similar provision in the FTC’s Telemarketing Sales Rule and what has, in recent years, become the FTC’s general enforcement position. The NPRM lists the provision of advertising services, telemarketing, marketing support, payment processing, and lead generation as activities that might constitute substantial assistance. On the other hand, the proposed Rule specifically excludes from liability entities that provide basic support and services but have no reasonable way of knowing the providers are engaged in violation of the rule. Both the FTC and state law enforcement officials are able to obtain monetary and injunctive relief against those who “substantially assist” culpable MARS providers.

5. Recordkeeping

The proposed Rule requires MARS providers to retain several different types of records for a period of 24 months. The failure to do so is a violation of the proposed Rule. The recordkeeping requirement is modeled after similar requirements in TSR and requires the following to be kept:

  • All contracts between the provider and any consumer for mortgage assistance relief services;
  • Copies of any written communications between the provider and the consumer occurring before the consumer enters into a contract or agreement for mortgage assistance relief;
  • Copies of documents or telephone recordings created in compliance with requirements to monitor employees’ and independent contractors’ compliance with proposed Rule;
  • All consumer files containing the names, telephone numbers, dollar amounts paid, and quantity of items or services purchased if such information is kept in the ordinary course of business;
  • Copies of materially-different sales scripts, training materials, commercial communications, and other marketing materials; and
  • Copies of documentation required to be given to the consumer.

In addition to preservation of required records, the proposed Rule also requires that MARS providers take enumerated steps to monitor compliance of their employees and independent contractors, and to investigate “promptly and fully” any consumer complaints. Documentation of such monitoring is requested under the proposed Rule.


The proposed Rule would provide that “[a]ny attempt by any person to obtain a waiver from any consumer of any protection provided by or any right of the consumer under this rule constitutes a violation of the rule.”


The Commission has authority to investigate and enforce the proposed Rule, and can impose monetary penalties up to $16,000 per violation, including against those who substantially assist entities in violation. States also can bring civil actions in federal district court to seek civil penalties and other relief.

To view all formatting for this article (eg, tables, footnotes), please access the original here.

Thursday, February 11, 2010

Citi Ups Incentives for Borrowers to Give Back Homes, Nicely

Original posted in the Wall Street Journal by James R. Hagerty:

Mortgage lenders are trying to arrange smoother departures for distressed homeowners who can’t be saved by loan modifications — and discourage them from trashing the homes on their way out.

CitiMortgage, a unit of Citgroup Inc., announced Wednesday a pilot project that will let some delinquent borrowers remain in their homes without making mortgage payments for six months if they voluntarily transfer ownership to the bank.

Over the past two years, millions of foreclosures have been delayed by state and federal programs requiring lenders to try to keep borrowers in their homes by easing their monthly payments. But the moment of truth is approaching for hundreds of thousands of households that sought help under the Obama administration’s Home Affordable Modification Program, or HAMP, launched a year ago, as well as borrowers who have sought help through other programs.

As of Dec. 31, about 900,000 borrowers had been given trial modifications under HAMP. Many have been unable to document that they have enough income to qualify for that program, however. Some soon will run out of options for keeping their homes.

The CitiMortgage pilot program provides incentives for more borrowers to use a procedure known as a “deed in lieu of foreclosure,” in which the borrower voluntarily transfers ownership of the home to the lender, which then cancels the mortgage debt. Aside from letting such people stay in the homes for six months, CitiMortgage says it will give them at least $1,000 to cover relocation costs, an incentive sometimes dubbed “cash for keys.”

The pilot program is available for certain people whose mortgages are owned by CitiMortgage in Texas, Florida, Illinois, Michigan, New Jersey and Ohio. The bank should benefit by avoiding legal costs and reducing the time homes are left vacant and exposed to vandalism. Participants will be required to “maintain the property in its current condition,” the bank said. It plans to expand the program if the pilot is successful.

“Something formally needs to be done in addition to the modifications,” said Sanjiv Das, chief executive of CitiMortgage. “We are in a different stage of the housing cycle. Restructuring mortgage payments was part one of the cycle, making sure that foreclosure glut doesn’t hit the industry is part two of the cycle. Citi is trying to stay ahead of it.”

The program also reflects a realization that some people have the wrong house, rather than the wrong mortgage, and want to get out, Mr. Das said.

Another alternative to foreclosure is a short sale, in which lenders agree to allow a distressed borrower to sell the home for less than the loan balance due. Though the lender takes a loss, it is often much smaller than the hit that would arise from foreclosing and then maintaining the house while waiting for it to be sold. The Greater Las Vegas Association of Realtors says about 21% of home resales in January were short sales, up from 19% a month earlier.

Potential buyers of homes in short-sale situations have long complained that banks often take months to respond to offers. But banks, prodded by the U.S. Treasury, have been trying to streamline the short-sale process. CitiMortgage last year set up a dedicated team charged with responding faster. J.P. Morgan Chase & Co. also has beefed up its short-sale team.

Bank of America Corp. said it has a pilot program that streamlines short sales. The bank said it would be able to approve sales within two weeks of receiving offers under that program. For homeowners who don’t find a buyer within 120 days, Bank of America will offer a deed in lieu. Bank of America said borrowers will have cash incentives for completing this program.

In addition, the government-backed mortgage investors Fannie Mae and Freddie Mac both have programs that allow people who give up ownership of their homes to remain in them as renters.

One big problem is that many borrowers no longer have equity in their homes and thus may be tempted to abandon them. At the end of 2009, 21% of households with mortgages on single-family homes owed more than the current value of their homes, a predicament known as being under water, according to a new estimate from

Laurie Goodman, a senior managing director at mortgage-bond trader Amherst Securities Group LP, estimates 7.1 million of the 7.9 million households behind on their mortgage payments will lose their homes to foreclosure if nothing is done to improve current loan-modification programs. She believes banks should put much more emphasis on loan modifications that reduce the principal for people who are deeply under water.

Buying out the mortgage market

Mortgage finance twinned with accounting rarely makes compelling reading, but bear with us.

Wednesday’s announcement that the two US Government Sponsored Enterprises (GSEs) will start buying out certain loans, has interesting repercussions for the mortgage market as a whole, as well as the Federal Reserve’s exit programme.

Freddie plans to buy “substantially all” mortgages delinquent by at least 120 days from its fixed-rate and adjustable rate securities. Fannie, meanwhile, will start repurchasing loans for mortgage-backed securities (MBS) trusts that are delinquent by four or more consecutive months.

From Linda Lowell at Housing Wire:

Loan buyouts from Ginnie and GSE pools have been a focus of MBS investor and analyst attention for months now. And it’s a concern that should trickle down to anyone interested in the capacity of the secondary market to foster affordable mortgage rates in the primary market.

Why? Because a buyout is a prepayment. That means the entire remaining principal balance on the loan returns to the investor at par. Unfortunately, most MBS pools are currently priced at a premium to par. Roughly 95% of 30-year fixed rate securities (the heart of the market) are priced over par, at an average price above 104 points (source UBS). That means any investor who carries their MBS positions at market value (and that’s the vast majority) will take an loss on ever dollar that prepays, one that averages to about 4%. Ouch.

Translation: Investors get semi-stuffed in buyouts since they get the whole of their principal back before all their expected interest-payments. If Fannie and Freddie didn’t repurchase the mortgages, they would have to pay missed interest payments to the investors.

Fannie and Freddie have had the ability to buy out loans delinquent by more than 120 days for a while now, but they’ve historically been reluctant to do so. This is where the accounting aspect comes in — until recently both GSEs had to write down bought-out loans to market value, which meant they had to hold additional (expensive) capital against them.

That all changed on January 1 when a new accounting standard — FAS 166/167 — came into effect.

The rule is aimed at bringing things like SIVs and QSPEs back onto balance sheets, but it also has the effect of releasing the GSEs from some of those capital constraints. Under FAS 166/167 the loans are held on balance sheet, so don’t have to be written-down to market value once their bought out.

The new buy-out plans mean higher prepayment speeds at both Fannie and Freddie.The only thing that will constrain them will be the GSEs’ own portfolios. According to some analyst estimates, Freddie has a bit more leeway here than Fannie. But expect some impact on the banks:

Back to Lowell:

Prepayments are the thorn on the rose of government-guaranteed and government-sponsored MBS. Removing credit risk just takes one hurdle out of the investment decision. The problem of anticipating prepayments and adjusting portfolios as needed remains. Only sophisticated institutional investors, with tons of technology in the back office and on their traders’ and PMs’ desks, participate in the MBS market. In the good old days, prepayments could be modeled fairly effectively as a function of interest rates – the impact of mortgage rates on refinancing activity and home sales. Those simple assumptions were swept aside by the housing bubble, weird loan vehicles and bad underwriting. Now, investors have to consider the impact of default on prepayments . . . Uncertainty always carried a cost in the MBS market, so it will be interesting to follow price action and trader color over the next days and weeks.

The market will be even more uncertain given that the Federal Reserve is scheduled to end its $1.25 trillion MBS-purchasing programme in March. Many commentators have expressed worry the private market won’t be able to step in to replace it, resulting in lower or more volatile MBS values.

On that note, we noticed a bit of positive commentary from Laurie Goodman at Amherst Securities:

There will be a lot of cash coming back [because of the Fannie/Freddie buyouts]: approximately $166 billion, $111 billion from Fannie, $55 billion from Freddie, beginning on March 15 and continuing for a few months. This cash will not be matched with additional supply. If this cash is to be reinvested in mortgages, it could have a tightening effect. This will help cushion the effect of the end of the Fed purchase program.

Wednesday, February 10, 2010

Freddie Mac Will Buy Out 120-Day Delinquent Mortgages

Original posted on the Housing Wire by Diana Golobay:

Government-sponsored mortgage securitizer Freddie Mac (FRE: 1.17 -2.50%) said today it will buy “substantially all” mortgages delinquent by at least 120 days from the company’s related fixed-rate and adjustable-rate mortgage (FRM and ARM) Participation Certificate (PC) securities.

Freddie said the loan purchases will show up in the PC factor report published after March 4, 2010. The corresponding principal payments on affected PCs will pass through to FRM and ARM PC holders on March 15 and April 15, respectively.

“[T]he cost of guarantee payments to security holders, including advances of interest at the security coupon rate, exceeds the cost of holding the nonperforming loans in the company’s mortgage-related investments portfolio as a result of the required adoption of new accounting standards and changing economics,” Freddie said in the announcement today.

New Financial Accounting Standards (FAS) 166 and 167 affected the transfer of financial assets and the consolidation of variable interest entities. Essentially, the standards require financial firms to bring securitized assets onto balance sheets.

Because of the standards, it would be more expensive to maintain guarantee payments to security holders than simply purchasing most delinquent loans out of PCs and holding them in portfolio, Freddie said.

The company said it expects to report the number of loans 90+ days delinquent in related 15- and 30-year FRM PCs and in ARM PCs in the monthly volume summary by April 2010.

A Freddie Mac spokesperson did not return calls seeking comment on the dollar volume of delinquent loans affected by the announcement.

The US Treasury Department on December 24th announced it was raising GSE portfolio caps. The potential for voluntary buyouts of delinquent loans by GSEs also rose since the Treasury’s announcement, according to global financial services firm Credit Suisse. The firm said in early January a swift buyout of the entire delinquent pipeline was possibly in the works. Since then, the industry has kept its eyes and ears open for a surge in delinquent buyouts.

The Federal Reserve is wrapping up $1.25trn of mortgage-backed securities (MBS) purchases from Freddie, Fannie Mae (FNM: 0.9781 -0.19%) and Ginnie Mae. Analysts have suggested private capital will not fill in for the Fed’s demand soon.

The Fed has considered extending and expanding asset-purchase programs, including the MBS program, if its exit this quarter is not replaced with private investor demand, causing MBS spreads to treasuries to blow out again.

Tuesday, February 9, 2010

Canada: Clarifying The Status Of Islamic Home Finance In Canada

Original posted on Mondaq by Gar Knutson and Jeffrey S. Graham:

This week the Canada Mortgage and Housing Corporation released a research report entitled "Islamic Housing Finance in Canada". The report analyses Islamic housing finance in a sampling of countries throughout the world, including common law and civil law jurisdictions, in order to draw parallels with the Canadian legal system. The report then examines the development of Islamic finance in Canada and the potential legal and regulatory obstacles that arise.

The report first surveys the principles of Islamic finance and compares how Islamic finance compares with conventional finance. Next, the report considers the application of Shariah to mortgage lending internationally, noting that it is more state centric and less internationalized than other forms of Islamic finance and investment. It is noted that in recent years a number of companies have begun offering Shariah compliant home financing options in Canada and that the Canadian experience is not unique and that the experience of other countries applying Shariah principles to mortgage lending are illustrative of how the product develops. The report finds that in certain jurisdictions such as the UK and New Zealand governments have passed laws to facilitate Islamic housing financing while in others, notably the US, Australia and France, these finance instruments are being offered without significant legislative changes. Further it is noted that there are no significant differences among states with English common law systems, including the UK, the US and Australia, and states with civil law based legal systems, including France, Turkey and Lebanon.

The state of Islamic housing finance in Canada is surveyed. It is noted that the Shariah complaint mortgages were first offered in Canada by housing cooperative organizations. More recently, the market has been serviced by specialized lending institutions that have obtained funding from third parties such as conventional financial institutions and on-lent those funds by way of Islamic mortgages. It is noted that the interface of Shariah law with the Canadian legal system does not, in and of itself, create any particular issues and that Canadian real property law would continue to apply to the property that was the object of the transaction. Further, it is noted that there are no contract or other requirements that cannot be met using conventionally drafted legal instruments that are fully enforceable under the laws governing the contract, if such law is the law of a Canadian province. Depending on the structure, landlord-tenant laws may be implicated and certain of the rights of the parties determined in accordance with the requirements of that legal regime. In addition, the report discusses briefly the application of land transfer, commodity and capital gains taxation in the context of Islamic mortgages.

The report also considers the ability of banking organizations in Canada to provide Islamic housing finance. It concludes that most product offerings in the realm of housing finance would not be prohibited within the existing regulatory regime for Canadian chartered banks and other federally regulated financial institutions.

It is fair to say that there is growing interest in the topic of Islamic finance in Canada. With a prominent and growing Canadian Muslim community and strong and innovative financial sector, there is every reason to believe that Islamic finance will continue to grow in relative terms in Canada. Among the developments that can be anticipated, it should be noted that an Islamic Finance Working Group (IFWG) has been established by the Toronto Financial Services Alliance, a unique public-private partnership with a mandate to enhance and promote the competitiveness of Toronto as a premier international financial centre. The IFWG is considering the opportunities and challenges in helping to promote the development of Islamic finance in Canada. The report of the IFWG is expected to be released in the coming weeks.

Pay Borrowers to Pay Their Mortgage?

Posted in the Wall Street Journal by Nick Timiraos:

How do you get borrowers to avoid walking away from homes that are deeply underwater without encouraging more to follow by writing down principal balances? One idea: Pay them to keep paying their mortgage.

The novel approach is being touted by Loan Value Group LLC, a firm selling their idea—and ready-made application—to mortgage investors nervous about the risk of strategic default, where borrowers walk away from their homes even though they can afford to pay their mortgages. The firm says it’s signed up an undisclosed mortgage investor to test a pilot program with a few hundred borrowers.

Here’s how the program works: The mortgage investor (possibly joining with other risk holders, such as mortgage insurers or second-mortgage holders) offers a cash reward to borrowers if they agree to keep paying their mortgage. The incentive amount varies by borrower depending on income, negative equity, geography and other risk factors—those who are more likely to cause steep losses receive a bigger carrot. The “responsible homeowner reward” grows for up to five years as the borrower makes monthly mortgage payments.

The borrower can’t collect that cash payment until the mortgage is paid off (though investors could allow the reward to be used towards paying off the mortgage in a sale or refinancing if the reward amount is enough to close the transaction).

The main goal of the program is to avoid the moral hazard and upfront costs to the investor associated with writing down borrowers loans. “When you make it so a borrower doesn’t have to do anything negative to get the reward, you remove moral hazard,” says Frank Pallotta, a founder of Loan Value Group who previously led mortgage banking teams at Morgan Stanley and Credit Suisse.

The size of the reward isn’t going to make up for the borrower’s entire negative equity whole, but Mr. Pallotta says the incentive payments are designed to present enough of a “shock-and-awe number upfront” to change the borrower’s psychology. Instead of thinking about how much debt they’re getting out of by walking away, maybe some borrowers will think about the cash bonus they’ll get if they stay current and are able to recover their equity if home prices stabilize and recover.

At the same time, investors don’t have to consider writing down the principal of the loan, which can often require the investor to mark-to-market the restructured loan and recognize an immediate loss.

The program isn’t designed to help borrowers who can’t afford their mortgage, though mortgage-holders certainly could offer the program to at-risk borrowers who’ve already received a modification in their monthly payments through the government’s Home Affordable Modification Program.

To be sure, the program raises plenty of questions: will investors want to put up cash for borrowers who might pay anyway? Mr. Pallotta says the program is liable to pay for itself if it only convinces a small fraction of borrowers to avoid walking away, given the significantly higher costs of foreclosure. If strategic defaults are as serious a problem as some housing analysts and studies show, it will certainly be worth watching to see if such a program catches on with other investors.

Silent Second Lien Risk to RMBS Getting Louder

Original posted on the Housing Wire by Diana Golobay:

Second liens, commonly made in the form of home equity lines of credit (HELOCs), are so far a silent hazard to first lien bond holders in residential mortgage-backed securities (RMBS), as many of these investors may not even know if a second lien is tied to their collateral investment.

And as the press continues to focus on subprime fall-out, strategic default and option ARM resets, experts warn that these “silent second” HELOCs may become a much louder problem, according to converging data from a consumer credit agency and securities research team.

They say that investor claims on the underlying assets are potentially compromised by federally-subsidized modifications of first liens. In the short term, investors of RMBS may see reduced cash flow as the borrower’s second lien debt is piled onto the underwater property, further constricting household finance. Along a longer timeline, the risk of default rises as negative equity increases.

HELOCs were common in 2002 in cases where homeowners put 20% or 25% down, according to HousingWire sources. Homeowners often opened home lines of credit to access the equity in their homes – even as early as the closing table. Getting closer to 2007, less and less money was being put down on homes, though the rate of HELOC origination did not necessarily slow.

Once house prices began to fall, the presence of second liens became a major issue to first lien holders. Not only were borrowers increasingly trapped in negative equity positions on first liens, but additional debt from second liens placed all the more financial pressure on performance. Additionally, some RMBS analysts say first lien holders also lacked clarity regarding which first lien assets are also secured by second liens. First lien RMBS investors were not automatically notified when second liens were made on the underlying property.

Amherst Securities Group back in March 2009 warned the administration’s Home Affordable Modification Program (HAMP) would be detrimental first lien holders in private-label RMBS.

Holders of second liens are not forced to participate in HAMP, and “acute” conflicts of interest arise between servicers and investors, especially when the servicer of the first lien also services the second lien. HAMP also “violates the time-honored” cash flow priority where second liens are written off before cash flow on the first lien suffers, Amherst said.

The plan for federal modifications “in combination with the servicer safe harbor [that protects servicers from legal backlash for complying with the Truth in Lending Act], leaves the current first lien holders with no protection,” said Laurie Goodman and Roger Ashworth from the Amherst team. “It is the equivalent of having the fox guard the hen house, with the fox in possession of the only set of keys.”

Goodman and Ashworth added: “And it potentially corrupts the integrity of the securitization market. In any structured security, the prioritization of claims is integral to valuation. Once the precedent is set to violate this hierarchy, by making the first liens holders incur losses without touching the second lien cash flows, the integrity is breached.”

Nearly a year later in January 2010, the Amherst MBS strategy group was still warning of the prevalence of second liens by product type (illustrated below) – which will become a much louder issue if federal modifications begin to focus on principal reduction.

“Lien priority dictates that the first mortgage cannot be written down until the second is extinguished,” Amherst said. “And second liens are not an inconsequential factor; they appear disproportionately on the books of the largest banks, so extinguishment would impact the capital position of these institutions.”

The Amherst team used the First American CoreLogic LoanPerformance Securities and and LoanPerformance TrueLTV databases to determine that more than 50% of first liens in private-label securitzations have second or higher liens behind them. The presence of this second lien raises the combined loan to value (CLTV) by more than 20 points and takes a “significant adverse impact” on the performance of first liens.

Amherst also found simultaneous second liens are more prevalent for 2006-2007 vintages, while subsequent seconds were more common within earlier vintages from 2002-2005. Default frequency is worse on simultaneous seconds than on subsequent seconds.

And as defaults rise overall in RMBS, borrowers’ use of revolving credit has also increased.

Consumer credit bureau Equifax adds that not only are CLTV ratios on current loans not widely understood, but the entire issue is under-reported in the press, in a report provided to HousingWire. In that report, 25% of borrowers with current Alt-A loans had closed-end seconds in July 2009, up from just 10% in July 2005. Equifax also indicated 23% of prime borrowers getting high use (80%) of revolving credit lines in July 2009, from 17% four years earlier. Similarly, 22% of Alt-A borrowers now have high use of revolving lines, compared with 10% in July 2005. 20% of subprime borrowers are now getting high use out of their revolving credit, compared with 10% in July 2005.