The Bush “rate freeze” initiative in reality is about attempting to speed up the loan servicer process of evaluating whether borrowers would qualify for loan modification. The term for this is “fast track” loan modification.
The 5-year rate freeze is a very peripheral issue. The loan servicers could have already offered this to borrowers on a case-by-case basis if they chose to. The “rate freeze” was simply a devious lure used to bait the media and draw extensive coverage (to “hype” the plan). And the media fell for the bait.
A borrower qualifies for “fast track” assessment if they meet the following criteria:
1) They occupy the house involved
2) They must be current on their existing “teaser rate” mortgage payments
3) FICO credit score is less than 660 (”subprime”)
4) Payments would increase more than 10% after reset
5) Mortgage originated between Jan. 1, 2005 and July 31, 2007
The linchpin of this whole plan are new guidelines set down by the American Securitization Forum. This is widely overlooked in the media coverage on this issue. The White House omitted any mention of this very key fact in their announcement. There are legal ramifications here that I hadn’t been aware of before.
Here is what those new guidelines say:
The June 2007 Statement provides further interpretive guidance that in evaluating a loan modification, the servicer should compare the anticipated recovery under the loan modification with the anticipated recovery through foreclosure on a net present value basis, that whichever action maximizes recovery should be deemed in the best interests of investors, and also that the standard “in the best interests of” the investors should be interpreted by reference to the investors in that securitization in the aggregate.
For any securitized pool and set of fast track loan modifications, as to each loan in the group, the servicer will have determined individually that the borrower is not able to refinance, that the borrower is able to pay at the current rate, and that there is a reasonable basis for believing that the borrower will not be able to make payments under the loan as originally required after the upcoming reset date.
In light of current market conditions including home value trends, it appears that key elements of any net present value determination (such as default rates with or without a modification, and loss severities) cannot be accurately predicted based on historic data.
Nevertheless, we believe that a servicer can appropriately take the view that a group of loans modified under the fast track procedures for Segment 2 loans will in the aggregate result in a better recovery on a net present value basis, when comparing the reduction in interest payments that may result from the modifications with potential losses upon foreclosure that might have resulted absent the modifications.
Accordingly, we believe that the methodology for making fast track loan modifications under Segment 2 complies with this guidance, and will result in action that is in the best interests of investors.
When we break this down, what are these guidelines really saying?
They are saying that normally a loan servicer would make a decision between loan modification and foreclosure on the borrower by performing a net present value analysis of the cash flows received by the lender (MBS investors) under both scenarios. The scenario that yields the highest net present value provides the loan servicer with the legal basis for choosing that option. This protects the loan servicer from legal liability (lawsuits by MBS investors), should their decision be questioned in court. The loan servicer’s mandate is ultimately to serve the best interests of the lender.
This net present value analysis can only be done on a case-by-case basis, using specific and extensive information about each particular borrower. It is that process of gathering the information and performing the analysis that can really slow things down when it concerns applications for loan modifications.
When a large wave of mortgage delinquencies builds up (as has been happening over the past year), then this really creates a huge backlog for the loan servicers. It overtaxes their resources, particularly given that the loan service departments are looked at by head office management as a “cost centre” and therefore an expenditure that should be minimized (in order to maximize corporate profits). The more mortgage delinquencies that build up, the worse the backlog situation will get. The outlook for mortgage delinquencies at this point looks pretty grim, so you can see where this is going.
Hence the desire for a “fast track” process.
But a “fast track” process can only be put into place by virtue of disregarding the requirement for net present value analysis (which is the legal foundation for establishing that the interests of the MBS investors are being served).
The American Securitization Forum is trying to give loan servicers a “green light” to disregard the NPV analysis criteria that form the basis for providing loan modifications (such as an interest rate freeze).
The pretext they provide for disregarding NPV altogether is that “key elements of any NPV determination (default rates and loss severities) cannot be accurately predicted based on historic data.”
In other words:
Due to the nature of the current real estate downturn, we can’t predict default and loss severity rates—therefore we cannot perform NPV analysis.
Now this is where it gets very interesting. Now that they have stated that, look at what they then say:
Nevertheless, we believe that a servicer can appropriately take the view that a group of loans modified under the fast track procedures for Segment 2 loans will in the aggregate result in a better recovery on a net present value basis, when comparing the reduction in interest payments that may result from the modifications with potential losses upon foreclosure that might have resulted absent the modifications.
Translation: “We are not able to perform an NPV analysis (and provide a mathematical foundation for our judgement), but we “believe” that the loan modification option will result in a higher NPV than the foreclosure option.”
“We cannot perform the NPV analysis to compare the options, yet we nonetheless somehow “know” that the NPV for loan modification will be higher than the NPV for foreclosure.”
“Therefore, we recommend that the loan servicers should go with “fast track” loan modification instead of foreclosure, as we are confident they will be on solid legal ground (regarding serving the interests of the MBS investors).”
Interesting reasoning.
If I could just ask one little question here:
How do you “know” the NPV will be higher for the loan modification option when you can’t calculate the NPVs to begin with? How does that stand up in court exactly?
This seems legally very questionable to me. I’m not a lawyer, but perhaps this opens the door to potentially massive lawsuits. I’m not sure how MBS investors on the whole will react to all of this. The uncertainty in itself is certainly not market-friendly.
Is this good or bad for the MBS market?
That is really the ultimate criteria for evaluating this plan, because that is the driver of real estate prices nationwide.
Post a Comment