between 65% and 75% of modified subprime loans will become 60-days or more delinquent again within a year of the loan modification

TO BE NOTED:

• May 26, 2009, 3:04 PM ET

Do Loan Modifications Work?

Fitch Ratings has a report out today that looks at how well loan modifications work, as the WSJ notes Tuesday. The upshot: between 65% and 75% of modified subprime loans will become 60-days or more delinquent again within a year of the loan modification.

Modifications come in many stripes: Servicers may lower interest rates, extend the term of a loan, or change adjustable-rate loans to fixed-rate amounts. They even may increase the principal on a mortgage by adding delinquent amounts to the outstanding loan.

But reducing the mortgage principal may be the most effective way to get delinquent borrowers back on track: A monthly mortgage survey released Tuesday by LPS Applied Analytics finds that modifications that reduce principal have a 25% lower re-default rate within six months of a loan modification. Many housing analysts have championed more aggressive reductions that reduce loan principal. Likewise, Fitch finds that loans with principal reductions had a 40% to 50% chance of a re-default. Modifications, meanwhile, that increase the loan’s principal have higher default rates, of around 60%-70%.

Modifications have emerged as the loss mitigation tool of choice for most lenders, accounting for 56% of all loan workouts–these also include payment plans, short sales, or any other remedy to avoid foreclosure– in the last six months of 2008, compared to just 31% of all loan workouts in the last six months of 2007, Fitch reports. Short sales, where the lender allows the borrower to sell the home for less than the value of the mortgage have also jumped in popularity, growing to 11% of all workouts for the last half of 2008, up from around 4% for the previous six month periods."

loan modification analysis has a lot of moving parts

TO BE NOTED: From Shadow Bankers:

"U.S. Government Foreclosure Mitigation Policies: Too Little, Too Late? (Part 2) Jump to Comments

By John Kiff

In the first post in this series, I gave a very broad brush overview of the three government foreclosure mitigation programs that have been introduced since 2007. In this post, I’m going to dive a bit deeper into the details of the Home Affordable Modification Program (HMP), the more recent of the government’s two active foreclosure mitigation plans. I’ll get into the Hope for Homeowners (H4H) program in the next post.

The point of both programs is to get the borrower’s payment-to-income (PTI) ratio down to 31 percent. The PTI is calculated by dividing all mortgage-related payments (including insurance and property taxes, but excluding mortgage insurance premia) by the homeowner’s gross income. HMP does it by offering to subsidize the cost to the lenders of temporarily reducing monthly payments to the 31 percent PTI ratio.

HMP gives lenders a subsidy of up to one-half the difference between the monthly payments at the 31 percent PTI ratio, and what the payment would have been at a 38 percent ratio, for up to five years. In addition, they get $1,500 for every current loan modified to encourage the offering of early intervention (rather than waiting until the borrower is seriously delinquent). Studies have shown that early intervention results in lower redefault rates (see “loan modifications and redefault risk”).

Servicers also get $1,000 for each modification, plus another $500 if the borrower was still current and $1,000 each year (for up to three years) that the borrower stays current (“pay for success”). One of the reasons cited for the H4H’s poor results has been that servicers are unincentivized and under resourced.

HMP also subsidizes lender costs of extinguishing junior liens (up to 12 percent of the unpaid balance), or subsidize junior lien holder costs of temporarily reducing interest rates to as low as one percent. Junior lien servicers who opt to reduce the interest rate will receive $500 upfront and $250 per year for up to five years. For more information see the April 28 update.

In order to make this all more concrete, I’m going to run some numbers on a hypothetical seriously delinquent $200,000 10 percent 30-year mortgage on a property that was worth $250,000 at origination (an 80 percent LTV). The monthly payment is $2,380, including $625 of insurance and property taxes. The borrower’s gross annual income is assumed to be $57,120, to imply a current PTI of 50 percent.

In order to get the PTI down to 31 percent the interest rate must be reduced from 10 to 3.125 percent (see table). Lender subsidies will amount to $326 every month that the modified loan stays current (half the difference between payments at the 38 and 31 percent DTI levels) for up to five years. Since the rate is below the current Freddie Mac Weekly Primary Mortgage Market Survey (PMMS) rate, after five years, the rate increases by one percent every year until it reaches the PMMS rate. I assume that the PMMS Rate is five percent.

The result of all of this, in net present value (NPV) terms using a 7.50 percent discount rate, is an effective write down from $200,000 to $122,530 plus $8,143 if the modified loan stays current for five years. However, before racing ahead into this modification, the servicer will compare this potential $130,673 NPV to the liquidation value in foreclosure.

The table below estimates these liquidation values in three home price depreciation (HPD) scenarios. For example, at zero, the lender will net about $148,750, making foreclosure a better alternative to an HMP modification. At 25 percent the net is $106,563, making it a close call between modification and foreclosure. At 50 percent HPD the $64,375 recovery value makes modification a possibly better choice.

The table below shows the outcomes for the HMP modifications under the three HPD scenarios, compared to the outcomes if the servicer just rides out the loans (“status quo”). The dollar numbers are the NPVs, and the assumed probabilities are in the parentheses (more about those later). It suggests that HMP modifications aren’t likely work out so well in the zero and 25 percent HPD scenarios for this particular example, because their expected NPVs are less than those in the status quo scenarios (see below for more detail). However, in the deep depreciation scenario (HPD = 50 percent), the HMP modifications have a have higher expected NPVs.

In general, the ultimate success of the HMD modifications will depend on whether the modified loan stays current (“cures”) or redefaults. The decision as to whether to modify will also depend on the likelihood of the unmodified loan becoming or staying current. The Treasury is making available to servicers an NPV calculator which embeds their suggested assumptions for the two key default probabilities, and large servicers (with books exceeding $40 billion) “may” use their own. I’m not a servicer, so for now, all I have to go on are the HMP NPV guidelines which remain vague on many key details and parameters.

In the above table I assume that the default probability on the unmodified seriously delinquent loan is 85 percent and 30 percent if it is modified. The expected NPV on the modified loan is $147,493 or less (depending on the amount of post-modification HPD), and $164,090 on the unmodified loan. In all but the 50 percent HPD scenario, for this specific example, it looks like it would be better not to modify.

Of course, as we discussed in the last post, default rates on modified loans are likely to vary according to the type of modification and the degree to which the loan balance exceeds the value of the underlying property (“negative equity”). Hence, a more sophisticated analysis would vary the probabilities according to the negative equity, which might even swing the evaluation towards the status quo in the 50 percent HPD scenario.

However, we’re not quite done yet! The hypothetical loan we just worked over was seriously delinquent. What about current borrowers? Recall that HMP is going to pay lenders $1,000 and servicers $500 for every current loan that they modify under HMP. However, although proactive modifications can be a good thing, they can backfire if borrowers who would have otherwise stayed current come forward for modifications. HMP controls this “moral hazard” risk by requiring that the borrower give proof of a significant change in income or expenses, to the point that the current mortgage payment is no longer affordable. However, keep in mind that, despite all the nasty headlines, there are still lots of nonprime loans that are not delinquent, so this risk could be significant.

Anyways, one of the key take aways from this post should be that loan modification analysis has a lot of moving parts, many of which I’m leaving out of this example (e.g., delinquency and prepayment timing, the evaluation horizon, and discount rate). Also, there are numerous other combinations and permutations of DTIs, LTVs and HPDs. In the next post in this series, I’ll go through a similar analysis of the H4H program, and show how it fits with the HMP under different DTI/LTV/HPD scenarios.

——————————————————–

* John Kiff is a Senior Financial Sector Expert at the IMF. These are his personal views, and should not be attributed to the IMF, its Executive Board, or its management."

Investors say this would allow servicers to prioritise the banks that own them, and whose risky mortgages are supposed to take losses first

TO BE NOTED: From the FT:

"Investors move against mortgage securities bill

By Aline van Duyn and Saskia Scholtes in New York

Published: April 23 2009 22:35 | Last updated: April 23 2009 22:35

Bond investors are lobbying hard to change federal policies aimed at reducing foreclosures in the US, saying the measures discriminate against holders of top-rated securities backed by mortgages.

The investors are set to meet senators next week. The next step could be legal action against the US government if the law is passed, on the basis that it could violate the Fifth Amendment, which blocks abuses of state interference in legal procedures.

“Serious investors are committing significant resources to this issue,” said Eric Brenner, partner at Boies Schiller and Flexner, which is advising investors that hold mortgage-backed securities. “They are really troubled that government action could prevent enforcement of their contracts and are considering the potential for legal action to protect their property rights.”

The plans, introduced by Barack Obama, US president, last month to try to stem the surge in foreclosures, could go before Congress next month.

The difficulty in changing terms on mortgages – particularly those that have been repackaged into securities and sliced into tranches owned by investors around the world – has angered advocates for homeowners. High levels of foreclosures and forced sales are a factor in depressing house prices.

Investors owning securities backed by people’s main mortgages say banks owning riskier mortgages – so-called second lien – could use the legislation to avoid billions of dollars of losses.

These second-lien loans are mostly owned by banks, which also own the mortgage servicers. A “servicer safe harbour” in the legislation would shield servicers from legal action if they changed the terms on people’s mortgages, many of which back securities.

Investors say this would allow servicers to prioritise the banks that own them, and whose risky mortgages are supposed to take losses first.

This could help banks avoid billions of dollars of losses that would instead be suffered by investors.

The proposals have the backing of large banks, such as Bank of America, JPMorgan Chase and Wells Fargo.

The fight by investors potentially pits some of the biggest buyers of bonds against banks and the government.

JPMorgan declined to comment. BofA and Wells Fargo were unavailable for comment."

"It's a relationship rife with the possibility of conflicts of interest"

ChumpChanger with an interesting post about foreclosures:

"I mentioned in the story that two big players, REDC and Hudson & Marshall, have essentially locked up the business of auctioning off the houses that mortgage issuers are foreclosing on.

The question is how these two players have managed to split the market so efficiently. One thing to look at is their relationships with the banks that serve as preferred lenders for their auctions. These lenders seem to be largely the very same ones that financed the houses that are now being foreclosed on in the first place (I wrote about Countrywide's relationship with REDC earlier this year in Slate). It's a relationship rife with the possibility of conflicts of interest. If a mortgage company actually owns the underlying mortgage, it has a great deal of incentive to finance a buyer that will get it out of foreclosure, even if the loan is likely to go bad later. If, one the other hand, it's the servicer for a mortgage that's been packaged into a bond and sold to investors, the big incentive for the company auctioning off the house isn't to get maximum value, but to make sure it gets to finance it (hey, there's not much mortgage business these days). It's a small corner of the real estate market, but it's one that's worth looking into. Though the whole mortgage crisis is feeling a little like yesterday's news with everything else going on, isn't it? "

Not to me. This is one of those issues that needs to be investigated because it could be a continuation of earlier practices which also involved conflict of interest. We cannot leave collusion uninvestigated.

"So let's assume that fraud gets a free pass. "

Arnold Kling picks up a point made by John Paulson in his congressional testimony that I agreed with. First, here's Paulson:

"The Institute, launched with a $15 million grant from investment management firm Paulson &
Co. Inc., will provide funding and training to organizations that help homeowners negotiate
alternatives to foreclosure. The majority of the funds will be grants to support direct legal
assistance to borrowers in 10 or more states to fight foreclosure, predatory lenders and abusive
loan servicers. It will do this primarily by providing money to top non-profit legal-aid groups and
law school clinics."

Here's my comment:

"Since this is mainly legal help, and the loans are called abusive, maybe we should be doing what I say, which is examine the legality of these loans."

Here's the Kling post:

"Thomas Cooley writes,

The most important role for public policy is to provide incentives for servicers to restructure and modify loans, to make certain that shared appreciation contracts are part of the policy mix, and to address the legal barriers to modifying securitized loans.

Pointer from Greg Mankiw.

My wife says that I became too angry and agitated at the hearing when Ed Pinto suggested that we need a major effort at loan modifications. I do become angry and agitated every time one of these suggestions gets made.

What are the standards that you are going to use to determine eligibility for loan modification?

Many (most?) of the loans that you would be modifying involve fraud. Sometimes, it was the borrower who deliberately committed fraud. But most of the time, it was the mortgage broker. We won't be able to sort that out. So let's assume that fraud gets a free pass."

See, I don't make that assumption. However, it's becoming obvious that my idea, and Paulson's it seems, to legally challenge these mortgages is going nowhere. I suppose people will claim that it will take too long, but I actually believe that people simply don't want to deal with this legal mess. Now, it's possible that people might begin taking Fraud, Negligence, Fiduciary Mismanagement, and Collusion seriously, given this Madoff mess among others, but I'm not holding my breath.

"What we need is an honest housing market, with legitimate owners, legitimate renters and prices that balance supply and demand. Loan modifications undermine the honesty of the market. They delay the necessary adjustments. With foreclosures, it might take two years for the housing market to find a bottom. With loan mods, it will take at least ten years.

Why is loan restructuring so popular? I think it's because people are in denial. They want to think that there is some feel-good way to avoid severe adjustments in housing. But loan restructuring will worsen the pain, not relieve it."

I don't know what the correct adjustment is, and I doubt that anybody does, even experts. I don't mind a few marginal attempts to ease this fall, or try and feel out a bottom, but, as of now, I still believe that we should let housing prices fall, for reasons I've already given. Namely, I believe that it would be better for the buyers. I agree with Kling that the most generous explanation of this Flight From Fraud is yet more Wishful Thinking, a desire to get this mess over as quickly as possible, whether or not the plans offered for renegotiating mortgages would in fact do that. One big problem I have is that I believe that servicers and lenders, and, in some cases, borrowers, realize that there is this Flight To A Quick Solution Through Government Action, and have been holding out or dragging their feet in hopes of provoking such action.

As I've said with TARP, the only real solution would be for the government to go in and impose a settlement, but, in this aspect of our crisis, the legal problems are, in my mind, insurmountable. They would result in unconstitutional seizures of property, at the very least. The solution, to the extent that there is one, is going to be a number of attempts to help this situation which will, in the best possible case, marginally ease the problem. God forbid we make matters worse, but that's a real possibility.

Again, I believe that Massive Fraud is being left unexamined and unprosecuted. Stick that up your Moral Hazard Pipe and smoke it.

"the problem is not the fact that so many subprime mortgages are trapped in securitization pools."

Joe Nocera in the NY Times on the problem of bunched mortgages, and how to renegotiate them:

"The F.D.I.C., however, begs to differ. As you’ll recall, the agency took over the California bank, IndyMac, which had, as Ms. Bair put it, “a pretty impaired portfolio.” It has since instituted a broad mortgage modification effort that also serves as a laboratory for what can and cannot be done. What the agency has discovered, said Mr. Krimminger, is that the contracts are rarely as constricting as investors and servicers have been portraying them. They do not allow principal reduction, for sure, but they almost never disallow interest rate reduction — or delaying principal payments for a short time. What’s more, Mr. Krimminger said, the servicer agreement simply says that the servicer’s job is to maximize the investment — which often means avoiding foreclosure."

Here's my comment:

“Nothing to prevent mass foreclosures of these loans will be effective unless Congress acts affirmatively to remove liability and provide financial incentives for refinancing. Jawboning bondholders and fiduciaries has not and will not work.”

From last week. Today:

“They do not allow principal reduction, for sure, but they almost never disallow interest rate reduction — or delaying principal payments for a short time.”

Not allowing principal reduction would seem to be a big problem. All the lowering interest rates would do it seems is lower the payments, but it might not be enough. And the legal problems do seem to apply.

I think you’re right back where you started. If it were a clear financial gain to renegotiate these mortgages, it would be done. You still need incentives for the servicers and lenders, and obviously they want a better deal. I thought that you showed why last week. Namely, as an earlier poster said, they want the government to intervene in some way, incentives, subsidies, tax breaks, legislation, to sweeten the deal for them.

For one thing, if servicers get legislation that allows them more room to cut better deals for themselves in the future, that would be a win. How about we just call some of these people and ask them what’s up?

— Don the libertarian Democrat

"Of course, there's a fundamental problem with modifying those loans:"

Joe Nocera in the NY Times asks the big question about solving the mortgage problem:

"You see, all of these programs deal only with “whole loans” — that is loans on the books of the institutions, unencumbered by securitizations. So far, the attitude of all involved when it comes to securitized mortgages is to throw up their hands and say — “it’s too hard to deal with!” And it may well be: mortgages that were sold to Wall Street and wound up in mortgage-backed securities have been sliced and diced and sold and resold to investors with varying risk tolerances. They are serviced by people who owe a fiduciary duty to all these investors, no matter what their place on the risk continuum.

James Grosfeld, the former chief executive of Pulte Homes, summed up the problem in a recent e-mail message:

There are well over $1,000,000,000,000-$1,500,000,000,000 of mortgages trapped within mortgage-backed securities. These are the most risky mortgages ever issued — mortgages poorly underwritten and often with unaffordable payment shock at the end of teaser rate periods. Pool losses will be unprecedented.

However, there has been no successful effort on a broad scale to reform these mortgages because of contractual obligations of trustees and servicers to bondholders. Simply put these fiduciaries are scared of being sued by bondholders if they modify loans into affordable new mortgages. Every effort to jawbone trustees/servicers to reform these mortgages quickly and on a mass basis has failed and will fail. These fiduciaries fear financial liability, and servicers are overworked and have no meaningful financial incentive to provide this desperately needed refinancing.

Recently, certain hedge funds have threatened to sue fiduciaries of these securitizations if they refinance loans. Congressional hearings are taking place with respect to these threats. Nothing to prevent mass foreclosures of these loans will be effective unless Congress acts affirmatively to remove liability and provide financial incentives for refinancing. Jawboning bondholders and fiduciaries has not and will not work.

The situations borders on the absurd. Investors will not allow mortgage modifications that would hurt them more than some other investors — thereby insuring that everyone gets hurt even more as foreclosures continue. And as foreclosures continue, the financial crisis continues to deepen because foreclosures on Main Street mean billion-dollar write-offs on Wall Street. And struggling homeowners can only pray that their mortgage is still held by the bank and not sold to Wall Street — in which case they are out of luck. It is like flipping a coin to see if you can hold onto your home."

Here's my comment:

“Every effort to jawbone trustees/servicers to reform these mortgages quickly and on a mass basis has failed and will fail. These fiduciaries fear financial liability, and servicers are overworked and have no meaningful financial incentive to provide this desperately needed refinancing.

Recently, certain hedge funds have threatened to sue fiduciaries of these securitizations if they refinance loans. Congressional hearings are taking place with respect to these threats. Nothing to prevent mass foreclosures of these loans will be effective unless Congress acts affirmatively to remove liability and provide financial incentives for refinancing.”

This sounds like moral hazard blackmail. Other people have been bailed out, and we’re willing to risk a blowup against the better odds and terms of getting bailed out.

I see only two choices:
1) Free market: Let them blowup.
2) Government intervention: Force terms upon everyone involved.

The in-between route is just too bitter a pill to swallow in my opinion.

So, it's a big problem.

Here's Barbara Kiviat's take:

"While Justin has had his eye on Hank Paulson, I've been listening to the House hearing on how well investors, servicers and lenders are going along with mortgage modifications.

Barney Frank had nice things to say about the efforts of Frannie, JP Morgan Chase and Bank of America (never mind that B of A got sued into changing the terms of its Countrywide loans), but then he took servicers to task for not more aggressively modifying mortgages held in securitizations.

Of course, there's a fundamental problem with modifying those loans: for each securitization trust, there can easily be hundreds of bondholders with legal rights, and good luck coordinating all of their interests and wishes.

As Frank pointed out, Treasury's original plan to buy toxic assets off bank balance sheets would have made the U.S. government the sole owner of many of these securitized trusts. And once the feds owned the paper, they could have done whatever they wanted, including telling servicers to cut interest rates or reduce principal balances across the board. Well, Frank didn't go into that level of detail, but that's the logical extension.

Now, because of the TARP-and-switch, we're still talking about how we can get investors and the servicers of their investments to eagerly adopt loan modifications. Frank talked about having to "restructure the servicing mechanism," but it wasn't clear to me if that would be retroactive or going forward. He seemed pretty serious about it, though, saying, "You should not have a legal form where the authority to make important decisions is so spread out that no one can make them." (I know someone who would agree.)"

Here's my comment:

donthelibertariandemocrat Says:

1. Wednesday, November 12, 2008 at 4:09 pm

   "The solution, free-marketeers will be glad to know, isn't less ownership but better ways to aggregate it. Consider the patent pool created in 1917 that let airplanemakers swap technology and share profits without threat of litigation. For property use, Heller imagines something like a co-op board for landowners. Suddenly, there's someone in charge to talk to--and maybe that airport gets its runway."

   I think that you're right here, but not about these bundled mortgages. The problem is that the servicers have no incentive to do this, and the holders are betting on a government subsidy as of right now. They have learned from TARP. But then, I find that many people who appear perplexed by the complexity are quite aware about they're doing.

So, here I disagree with Barbara. It's not the complexity of these investments, but the interests of the people holding them that's the problem.

"ultimate results would be better and less risky than the losses now being incurred."

Peter Bernstein, who knows a lot more than me, on renegotiating mortgage terms in the NY Times:

"Treasury Secretary Henry M. Paulson Jr. proposed a federal government purchase of this so-called toxic paper from financial institutions, which had the attraction of setting a price on these obligations and rendering some liquidity to them. But the mortgages would still be outstanding, and the names of the homeowners who took out those mortgages would still be there. Hence, the ownership of the mortgages might change, but the debtor would still be the same family or individual owing the same amount of money. The main concern now is to help the lender and the homeowner simultaneously.

A solution to these dilemmas would greatly improve the chances of reaching the primary goal: stabilization of home prices. To achieve it, we must alter the terms of these mortgages to contain the foreclosure process and, in time, bring it to an end. Only then can we shrink the number of houses under forced sale conditions and stop the downward pressure on prices.

A compulsory change in mortgage terms would initially appear to damage the lender in order to protect the borrower. But lenders are in as much trouble as borrowers because they cannot collect the money owed them and have little chance of selling a home at a price that would enable them to come out whole. Lenders and borrowers are in this crisis together.

The best solution proposed so far has been from Sheila C. Bair, the chairwoman of the Federal Deposit Insurance Corporation. Under this proposal, servicers of mortgages would rewrite outstanding mortgages to a more affordable level for the homeowner by lowering the principal amount owed, by reducing the interest rate, by extending the maturity — which would reduce monthly payments — or by combining these steps. In addition, the government would share a portion of the losses in these mortgages if they went into default.

WHILE this arrangement would mean a lower return than the lender originally expected, the ultimate results would be better and less risky than the losses now being incurred.

Others will come up with improvements to this plan or offer different models, but the main point is to intervene promptly, directly and powerfully to counter the home price debacle."

I included this because it lends support to the plan I put forward earlier. Two points:

1) "In particular, many mortgages were packaged as collateral for newly created fixed-income paper now owned by investors and institutions all around the world."

2)"WHILE this arrangement would mean a lower return than the lender originally expected, the ultimate results would be better and less risky than the losses now being incurred."

My point was to have terms in place that could be used, in a ladder like approach, to renegotiate loans in the future, especially where the lender is complicated to deal with. My proposal would not rule out foreclosure, nor be mandatory, merely a set of rules that could be entered into when a borrower gets in trouble, and I was suggesting we could get government information on this process in this current solution, whatever it is.