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In Pursuit of Loan Mods
by Neil Morse
MORTGAGE BANKING | February 2010
In retrospect, have frantic efforts to pursue loan modifications under the government's program really made a difference?
On the one hand, helping families hold onto their homes, full of prized possessions and treasured memories, seems only right. On the other hand, refusing to honor a legal commitment (a mortgage) and stiffing investors for their hard earned capital seems wrong.
So, what to do with all those loans (and borrowers) not performing as expected? The federal government's hope is the Rome Affordable Modification Program (RAMP), a modification initiative for borrowers with certain home loans such as those owned by Fannie Mae and Freddie Mac.
Under the program, eligible borrowers who are behind on payments or at risk of default can have their mortgage interest rate reduced (modified) to as low as 2 percent for five years. The Department of Housing and Urban Development (RUD) issued an announcement at the end of December 2009, noting that "several million homeowners are estimated to be eligible for the program and more than 1 million have already received modification offers." Yet through December, servicers had approved 112,521 permanent modifications under RAMP. The new terms become permanent after borrowers make three (monthly) payments on time and complete required paperwork, including proof of income and a letter documenting financial hardship.
But the industry didn't just start doing workouts with the RAMP program. When subprime loans first started to default, lenders responded with their own efforts. As a result, the industry worked out more than 2.6 million subprime loans in the period from July 2007 through Aug. 31, 2009, according to the Mortgage Bankers Association (MBA). More recently, RAMP has been struggling in its efforts because the problem has shifted from one caused by unaffordable mortgage products to one caused primarily by lost income.
So, despite high hopes, BAMP statistics indicate slow going so far, but not for lack of effort by servicers. Under BAMP, according to BUD, more than 850,000 homeowners have had a median payment reduction exceeding $500 thus far under trial conditions, but the challenge will be to lock those savings into permanently modified loans.
New rules went into effect at the end of 2009 requiring each BAMP servicer to report to the Treasury twice a day on its conversion of trial mods into permanent loans, with penalties to follow if those reports do not please the government. BUD said in a Jan. 5, 2010, press release, "Over the past month, administration representatives were on-site in servicer offices to ensure that servicers increased efforts to deliver decisions to borrowers in trial modifications who had submitted all of their documents, and to obtain any missing documents from borrowers."
No wonder, then, that these are tense times for earnest, long-time industry professionals like Mary Coffin, senior vice president of loan servicing and post closing for Wells Fargo Home Mortgage, Des Moines,
Iowa, which services one in six U.S. mortgages.
She told an audience attending a loan-modification conference last fall that residential servicers were attempting to meet current demands of the market by "hiring like crazy."
Wells Fargo has almost doubled its staff working on mortgage restructurings, adding close to 7,000 employees in 2009, according to Coffin. Coffin's colleagues at Charlotte, North Carolina-based Bank of America Corporation, New York-based Citigroup Inc. and New York-based JPMorgan Chase & Co. expected to collectively hire almost '7,000 people by year-end 2009 mostly to work with financially ailing homeowners, according to the companies.
It is a necessary strategy, according to Duwaine Thomas, director of servicing management at Fannie
Mae, who notes, "There are not enough mortgage professionals to fill [all the] call centers and get good results."
The sheer volume of desired loan modifications is still very much a new experience for most loan-servicing companies, which report people from a wide variety of backgrounds-from rental-car service representatives to former chief executives of small mortgage brokerages that went under-are applying for these servicing jobs.
Many of the new loan-modification staffers, however, "don't understand all the programs, so there is a lot of slippage in that area," Thomas says. Tacking toward the dramatic, he adds: "It's trench warfare out there. Even with pristine credit, you have to treat borrowers as if they are high-risk."
For new call-center staffers and their more seasoned teammates, it's a whole new ballgame, according to Coffin, who looks back at "the old way of doing business" and says that when the borrower first went delinquent,
"[we] would start with a repayment program." Now, though, "a different solution needs to be found," she told the loan-modification conference attendees.
"Today, we're underwriting the financial condition of the borrower in order to pick the right solution that is sustainable. That is the first big change that has happened for servicers," Coffin says.
Ramping up trial mod conversion rates
In an effort to step up conversion efforts, BUD directed staff in its 81 field offices to distribute outreach tools and encourage its 2,700 approved counseling organizations to distribute information to participating borrowers. In addition, BUD is pushing modifications by partnering with the National Governors Association (NGA), National League of Cities, National Association of Counties, Conference of State Bank Supervisors (CSBS), the American Association of Residential Mortgage Regulators (AARMR) and individual state regulators.
The stepped-up effort is in response to BUD's findings that even as the pace of modifications has accelerated, a "vast majority of loans modified through the program remain mired in the trial stage, lasting up to five months," according to HUD.
Laurie Anne Maggiano, director of policy, Office of Homeownership Preservation, Treasury Department, identified one reason for the delays. "We have a lot of borrowers in trial periods who are making all the payments, but because of documentation requirements [read: deficiencies] servicers cannot transition them to a permanent mod," she says, adding that "servicers came to us and said, 'We need help-the documentation requirements are too onerous, we're having trouble getting borrowers to return certain pieces of paper. Borrowers don't understand the documents we're using; you need to streamline the process '- so we have," Maggiano told attendees at the 2009 Mortgage Bankers Association (MBA) Annual Convention in San Diego.
"The new borrower evaluation process will delegate to servicers a significant amount of decision-making, in terms of what documents we will use and rely on for borrower verification," Maggiano explains.
Sounds good-but at least one expert observer doubts it will solve all the problems. Attorney Stephen F.J. Ornstein, a partner in Sonnenschein, Nath & Rosenthal LLP's Washington, D.C., office, believes "modifications are inherently difficult in a market like this where unemployment is so high." He adds, “It's one thing to modify loans, but if the borrower has lost a job they're not going to be able to pay the new modified loan."
As a result, Ornstein says, "There's a lot of frustration with [HAMP]."
Terry Cuoto, partner with Newbold Advisors, Clearwater, Florida, thinks loan modifications are "a great tool, but they don't help those without the desire to pay. There's no silver bullet," he declares-meaning "one solution that works for every borrower. HAMP is not for everybody."
He adds: "We're probably putting some people into loan mods that aren't best [suited] for them. If we could just reduce principal it would solve a lot of borrowers' problems, but there's a lot of moral hazard there."
Viewed from the servicer perspective, the difficulties with modifying so many loans often centers around a lack of borrower understanding and a continuing shift in government requirements.
"There is an artificially high expectation" among borrowers, says Dave Miller, senior vice president of business development at Cenlar FSB, Ewing, New Jersey, one of the nation's largest mortgage servicers.
"Customers become frustrated with the process as we start talking to them, because [the modification offer] doesn't meet their expectations [based upon] what they have heard," he says.
"Or, they decide the effort is not worth it," adds Michael Young, Cenlar's chairman of the board, who is also MBA's vice chairman. "The detail and complexity of documentation is much more extensive than most of the defaulted borrowers would ever imagine," he notes. The company's servicing portfolio includes about 40,000 mostly conforming loans with an unpaid principal balance totaling $90 billion. Its core clientele include community banks, credit unions and some mortgage banks.
According to Miller, Cenlar will add staff in 2010. "We'll continue to hire and build off on the default side. Loss mit remains critical for our clients," he says. Miller believes the market has "not really hit the bottom" of the current downward cycle, and delinquencies will continue to rise.
In defense of homeowners, Chris Sabbe, executive vice president of Sterling Horne Retention Services, Altamonte Springs, Florida, says, "Servicers are pushing a lot of blame onto borrowers when there needs to be a relationship change between them. We need to fundamentally change the conversation from 'We're here to collect the bill with late payments' to 'We're here to help you:" says Sabbe.
"A lot of borrowers don't realize they have options to stay in their homes," he says. The disconnect between borrowers and servicers over loan modifications may be traced to an insufficient amount of "hand-holding," suggests Dan Reiman, founding partner at Newbold Advisors.
"You need a person talking to another person on the line to determine their needs and issues and the right program for them, [because] 80 percent to 90 percent of [those borrowers] are not eligible for HAMP. There needs to be that 'dinner-table conversation: like the one they had with their loan originator:' recommends Reiman, who has more than 20 years' experience working in technology and business leadership capacities for companies such as GE Capital Mortgage, Fleet Mortgage, Fannie Mae and Fidelity Information Services (Alltel).
Reiman attributes a "lack of account ownership" in servicing shops for a resulting "handoff-after-handoff and backlog-after-backlog" on consumer outreach efforts. "You spend all this money getting a borrower on the line, and if they're not right for that one [modification] program you're going to let them off the hook?" he asks incredulously. "That's the craziest thing I've ever seen. Once you've got them on the line, find the right program for them," Reiman says.
Abandoning old approaches
Ron Morgan, chief executive officer of Sterling Horne Retention Services, says, "Servicers have to unwind their traditional methods. They can't apply to today's volumes what they've been doing the last 20 years." He insists: "They need to change their game." In 2010, Morgan expects all parties to "offer up some new solutions like write-downs to current property values so the [monthly mortgage] payment is right-sized."
Indeed, "each servicer-borrower interaction" is an opportunity "to create or destroy momentum/' maintains Greg Hebner, president of MOS Group Inc. in Irvine, California.
But "the numbers are staggering," says Nigel Brazier, president of Acqura Loan Services, Plano, Texas, who sees "a population of 10 million people you've got to talk to, to validate that they don't have [necessary income] or they've lost a job or have a permanent correction in cash flow. You need a lot of bodies to do this contact," insists Brazier, explaining that the challenge is "not going away soon."
And that does not even address methodology, which is a key point, according to Steve Horne, president of Wingspan Portfolio Advisors, Carroliton, Texas.
"Modifications are a powerful workout tool," Horne agrees, "but when used incorrectly they are one of the most destructive tools out there. Stories are legion where mods are failing by droves:' according to Horne, perhaps because "most borrowers who are in default are scared out of their freakin' brains with no idea of what's going on. They are totally intimidated by the entire process and deathly afraid of losing their house," he says.
Making things worse not better
Jon Daurio, chairman of Kondaur Capital Corporation, Orange, California, a distressed assets buyer-seller-servicer, is outspoken on the practical effects of the varied government attempts to modify mortgage terms.
A core problem, Daurio says, is determining the true impact of a modification. "The government's formula for determining the net present value [NPV] of a modified loan is critically flawed because it doesn't take into account the true risk that the loan will default, and the subsequent severity of that loss," he says. Current loan modification actions, he insists, "are making things worse, not better."
A preferred method of calculation for NPV, Daurio reckons, is "what a ready, willing and able buyer would pay for that loan on the day it is modified. The government started to get this right initially," he says, "but where it skidded off the road is in how they calculated the net present value of the modified loan." In a free market, he says, "the net present/fair market value is what a buyer will pay on the day a loan is modified."
Daurio would modify a loan "only when the net present value of that modified loan is reasonably close to, or greater than, any alternative solution"- which could be a refinance, foreclosure, deed-in-lieu transaction or short payoff (including a short sale).
That last option is gaining more favor, reports Anthony Segrich, general sales manager at Foreclosure.com, Boca Raton, Florida.
Short sales gaining appeal "End investors were not willing to explore short sales before," Segrich says, explaining that it had been too different a transaction from the more familiar real estate-owned (REO), and "disposal channels were not equipped to deal with short-sale processes."
But now, he says, "It is more financially viable for an institution to do that rather than foreclose," given the prospect of high legal costs in a foreclosure. He ticks off a list of other foreclosure-related expenses, including:
• tax implications after a property takeover;
• association dues;
• electrical bills;
• code violations;
• maintenance of a property; and
• theft and destruction.
The full cost of a foreclosure, estimates Sterling Home Retention Services' Morgan, is $80,000.
All this makes short sales "a much friendlier transaction," as Segrich puts it, and explains why servicers and banking institutions are now rolling out short-sale strategies.
Cenlar's Young cites as "one obstacle in the [loan-modification] process, the high frequency of change introduced by different investors," and he complains that it is "difficult to build a standardized [servicing] system" as a result. Consequently, he says, "every servicer has an issue in responding to [these] changes." Young asks rhetorically: "Do you start over-can you go forward? And what about re-engineering business you already have?"
Continuing government changes "impacts us negatively," Young adds. "It is difficult to train and develop systems [in response]. The burden it puts on staff to maintain a working knowledge with ever-changing requirements is difficult."
He sees a shift in the overall loan performance landscape. "In some ways, the nature of the problem has changed from ARM [adjustable-rate mortgage] resets, subprime and a crash in real estate values to a loss of income by borrowers-and that's a much more difficult problem to address."
Losing faith in loan mods
Mark Zandi, chief economist at Moody's Economy.com, West Chester, Pennsylvania, has all but forsaken the loan-mod approach, judging from his comments to The New York Times in early January. "I don't think there's any way for Treasury to tweak their plan, or to cajole, pressure or entice servicers to do more to address the crisis/' he said.
Zandi opines that "for some folks, [loan modifications are] doing more harm than good because, ultimately, at the end of the day they are going back into the foreclosure morass."
In the end, all the hand wringing over mortgage loan modification’s the many details about who, when, how much and how long-may prove unnecessary as a new trend spreads across the landscape.
Dubbed variously as "walkaways" and "strategic defaults," it's a problem that already has generated up to 26 percent of current foreclosure activity, according to one University of Chicago study. These instances of walkaways may include homeowners who can afford to pay but choose not to, and their aggregate number may exceed 1 million in 2009-more than four times the 2007 level, according to the credit firm Experian, Costa Mesa, California, and consulting firm Oliver Wyman Group, New York.
Further, First American CoreLogic, Santa Ana, California, reports that nearly 10.7 million households had negative equity in their homes in the third quarter of 2009, representing 23 percent of all homes nationwide.
As more mortgage balances far exceed home values, a growing number of families have done the simple math and made the jump from being homeowners to renters, in the process miniaturizing the idea of "moral hazard" into little more than an old and quaint notion. Such a trend, foreshadows a seismic shift for the housing finance market and, more ominously, a permanent change in the historic relationship between lenders and borrowers.
Neil j. Morse is an independent writer and mortgage industry consultant based in Newtown, Connecticut.
He can be reached at nmorse@morse communications.com.