1 What Banks and Mortgage Lenders Need to Know About the Federal Government s Comprehensive Loan Modification Program March 2009 BACKGROUND On February 18, 2009, President Obama announced the Homeowner Affordability and Stability Plan to help up to 7 to 9 million families restructure or refinance their mortgages to avoid foreclosure. As part of this plan, the Treasury Department ( Treasury ) announced a national modification program ( Program ) aimed at helping 3 to 4 million at-risk homeowners both those who are in default and those who are at imminent risk of default by reducing monthly payments to sustainable levels. The loan modification part of the Plan is backed by $75 billion from the Treasury. On March 4, 2009, the Treasury issued uniform guidance for loan modifications across the mortgage industry under the Home Affordable Modification Program ( HMP ). Fannie Mae issued on efanniemae.com its HMP guidelines, Ann : Introduction to the Home Affordable Modification Program, HomeSaver Forbearance, and New Workout Hierarchy, on March 4, 2009 (the Fannie Mae Guidelines ). Fannie Mae and Freddie Mac also issued guidance on the Home Affordable Refinance Program for GSE loans, which is a separate program designed to provide refinancing to borrowers owning underwater valued homes. Treasury stated that all banks that accept Financial Stability (f/k/a TARP) funds in the future will be required to implement the HMP. Thus, any institution intending to accept or even considering the acceptance of Financial Stability funds in the future should understand the burdens and benefits of mandatory HMP participation. In addition, federal banking regulators wholeheartedly support the HMP and will encourage depository institutions that did not or will not accept TARP or Financial Stability funds to adopt the same procedures and guidelines. 1 The Treasury established a dedicated website, to keep borrowers and industry participants apprised of the HMP and related developments. Importantly, any bank or non-bank mortgage lender that is an approved Fannie Mae or Freddie Mac seller-servicer will be required to modify eligible loans sold to the GSE s that were originated prior to January 1, That is, Fannie Mae or Freddie Mac portfolio mortgages or MBS pool mortgages guaranteed by Fannie Mae or Freddie Mac are to be reworked under the HMP if such mortgages meet general and specific HMP criteria (discussed below). The HMP replaces GSE streamlined modification programs (SMP s). 2 1 In general, banks that sold residential mortgage loans serviced by third-party mortgage servicers are not directly responsible for implementing HMP. The burdens and benefits of the Program will fall on the mortgage servicer. 2 Effective March 4, 2009, servicers can no longer offer SMP to borrowers. However, a borrower who defaults on an SMP is eligible for an HMP. There are set procedures for dealing with borrowers who are in the SMP trial period. In any event, Fannie Mae s HMP guidelines borrow numerous SMP features.
2 INITIAL CONSIDERATIONS Treasury designed the Program to encourage and incentivize lenders and servicers to participate in HMP voluntarily. This is through payment from Treasury of a one-time modification fee, Treasury s loss-sharing mechanism and reward payments for borrowers and servicers for successful modifications. So, lenders and servicers who effectively are not required to participate in HMP may elect to do so. Treasury now is working on a subscription package that will include the lender/servicer application and agreement, further Program guidelines and form documents. At this time, lenders and servicers considering participation in the Program should analyze their portfolios, identify potential HMP eligible loans (at the baseline, owner-occupied first mortgage loans in default, including loans in foreclosure, but also including ARM s subject to reset in the near future), establish the additional cost of participating in the Program and run the numbers that Treasury is offering through the Program. Another consideration for lenders considering the Program is Treasury s net present value approach, which is intended to assure that HMP modifications are at least economically neutral when compared with foreclosure and post-foreclosure property disposition. Finally, the outcome of Congress s consideration of bankruptcy cramdown legislation (discussed below) may turn out to be an important factor in any lender s or servicer s consideration of voluntary participation. An important point that is not explained verbatim in the Treasury s HMP guidelines: Treasury views HMP as an all or nothing undertaking. A lender agreeing to the Program will not be permitted to cherrypick among loans that it owns. Treasury has not said whether the same is true for third party mortgage servicers that also own and service their own loans. Treasury has made it clear, though, that servicers will not be required to modify loans on terms not permitted by securitization documents. Treasury does not intend to abrogate contracts between servicers and securitization vehicles, but Treasury nonetheless believes that few loans will be rendered incapable of HMP modification by virtue of securitization documents. To that end, Treasury will expect servicers to work with investors to overcome legal impediments of securitization structures and Treasury will require actual servicing limitations to be documented in a loan servicer s application to participate in the Program. 3 Larger financial institutions employ internal mortgage servicing divisions that service residential mortgage loans sold to the GSE s or kept in portfolio. These institutions over the past year or more have geared up to implement and process loan modification and other foreclosure-avoidance transactions on a large scale. Unfortunately, disproportionate compliance, operational and resource burdens likely will fall on community banks, regional banks and other smaller institutions that retain residential mortgage loans in portfolio or retain servicing rights in loans sold to the GSE s. Given the fact that HMP becomes effective immediately, financial institutions large and small already are fielding questions from customers who are in distress or who simply want more information on their options. For example, many borrowers have heard that HMP modifications should result in interest rates of 2% with cost savings of hundreds of dollars a month. The Treasury imposed an additional HMP-related burden on FHA approved lenders. As discussed below, lenders or servicers of non-gse loans who are FHA approved to offer the Hope for Homeowners program will be required to consider each HMP-eligible borrower for a Hope for Homeowners refinance. It appears that Treasury expects such lenders or servicers to run the Hope for Homeowners application and underwriting process at the same time as the 3 H.R. 1106, a/k/a the cramdown bill, includes safe harbor provisions for servicers engaging in mortgage loan modifications, particularly the Program. It remains to be seen whether the bill, as approved by the House, will become law.
3 intaking and underwriting of an HMP modification. Congress now is attempting to streamline the Hope for Homeowners program such that Treasury s requirement of parallel consideration would be beneficial to borrowers. Another important consideration is the growing number of state laws that directly or indirectly require or encourage loan holders and servicers to have systematic loan modification programs in place now. It may be in the best interest of a lender or servicer doing business in one or more of these states (and additional states, for that matter, that currently are considering similar legislation or regulation) to put HMP in place in order to respond to the mandates or incentives in these state laws. Examples include: North Carolina State Home Foreclosure Prevention Project, which in effect requires servicers or holders of subprime mortgages to have systematic loan modification programs in place. California s foreclosure moratorium enactment, which permits lenders or servicers to move forward with foreclosure if loan modification options are made available to defaulting borrowers. 4 New York s comprehensive 2008 mortgage servicing and consumer protection law. New Jersey s recent Mortgage Stabilization and Relief Act. Finally, the cramdown bill passed by the House of Representatives on March 5, 2009, H.R. 1106, now before the U.S. Senate, specifically references the HMP. In effect, a debtor s right to cramdown of a first mortgage loan is conditioned on the debtor s certification that he or she contacted the loan holder or servicer 30 days prior to filing, provided the loan holder or servicer with written information about the debtor s income, expenses and debt, and considered any [HMP] loan modification offered to the debtor by the loan holder or servicer. This latter requirement is intended to impel lenders and servicers to have the HMP in place and offer it to any borrower who inquires, under risk of the subject loan being crammed" by a U.S. Bankruptcy Judge. Under the House bill, lenders would find additional motivation to offer and complete HMP modifications, because under Chapter 13 bankruptcy, a borrower could get a better deal that would include principal writedown (the essence of cramdown in bankruptcy). SCOPE AND THRESHOLD QUESTIONS Which loans are covered by the Program? First-lien residential mortgage loans made prior to January 1, 2009 that carry an unpaid principal balance (UPB), prior to capitalization of arrearages, less than or equal to the expanded FHFA conforming loan limits, which begin at $729,750 or less for single unit properties. This includes loans that exceeded previous conforming loan limits when made. There is no distinction between subprime, Alt-A or conforming loans, such that even creditworthy borrowers who obtained conforming prime loans are eligible for the Program, provided that the hardship-related and other underwriting criteria and net present value test can be met today. 4 Both Fannie Mae and Freddie Mac put in place foreclosure moratoria as to borrowers who may be eligible for HMP. It is likely that Treasury, in connection with more detailed Program guidelines expected soon, will impose the same requirement. Thus, any lender or servicer considering voluntary participation in the HMP for non-gse loans likely should be prepared for such an outcome. According to the Treasury, the servicer or lender must suspend foreclosure during any HMP trial period (discussed below).
4 The remaining general eligibility criteria, which are designed to provide relief to a broadly-targeted group of homeowners, are: The mortgage loan is delinquent or default is reasonably foreseeable; loans currently in foreclosure are eligible. The mortgage loan is secured by a one- to four-unit property, one unit of which is the borrower s principal residence (owner occupied). The home must not be investor owned. Cooperative share mortgages and mortgage loans secured by one-unit condominiums and manufactured homes are eligible for the HMP. The property securing the mortgage loan must not be vacant or condemned. The borrower documents a financial hardship by completing a Home Affordable Modification Program Hardship Affidavit (Form 1021) or Treasury equivalent for non-gse loans and provides the required income documentation. The documentation supporting income may not be more than 90 days old (as of the date the servicer is determining HMP eligibility). A borrower in active litigation regarding the mortgage loan is eligible for the HMP. The servicer or loan holder may not require a borrower to waive legal rights as a condition of the HMP. A borrower actively involved in a bankruptcy proceeding is eligible for the HMP at the servicer s discretion. Borrowers who have received a Chapter 7 bankruptcy discharge in a case involving the first lien mortgage who did not reaffirm the mortgage debt under applicable law may be eligible for alternative GSE modification plans under revised HMP documents. The borrower agrees to set up an escrow for taxes and insurance prior to the beginning of the loan modification trial period. Under the HMP, servicers and lenders will use a uniform loan modification process to provide eligible borrowers with sustainable monthly payments. The HMP will expire on December 31, VA, FHA and rural housing loans are not part of HMP and are addressed in separate program guidelines, including Hope for Homeowners. Loans may be modified only once through HMP. HMP carries no particular loan-to-value LTV requirement but instead focuses on adjusted debt-to-income (DTI) figures of particular borrowers and a net present value (NPV) determination that compares the expected return on the modified loan and the expected loss on foreclosure of the home. This makes HMP quite similar to the Federal Deposit Insurance Corp. ( FDIC ) mod-in-a-box program. In fact, banks that already are familiar with mod-in-a-box will find it much easier to navigate the HMP. Servicers (including holders servicing their own loans) may elect to put HMP into place for non-gse loans, including loans held by lenders in their own portfolios or loans that are serviced by third-party servicers. As to non-gse loans, lenders and servicers will participate in the Program by executing a servicer participation agreement and related documents with Fannie Mae as the Financial Agent for the Treasury. For non-gse loans, Treasury intends to make policies and procedures and form documents available in the near future. It is expected that Treasury will adopt
5 guidelines and procedures similar to the GSE guidelines that already are available. Under this assumption, the discussion below is based on the detailed Fannie Mae Guidelines that have been issued already. For the GSE s, HMP documents will be available on efanniemae.com and freddiemac.com. Documents are to include the HMP Workout Plan, the HMP Modification Agreement (the HMP Agreement ) and the HMP Hardship Affidavit (Form 1021). The HMP Workout Plan Cover letter and the HMP Agreement Cover Letter will also be available. Treasury is expected to provide its non-gse forms in the coming weeks, which are expected to be similar if not practically identical to the GSE forms. INCENTIVES FOR BORROWERS AND LENDERS Treasury is providing a host of financial incentives for lenders, servicers and borrowers to participate in HMP. These payments are loan-specific and Treasury will not be making payments or providing reimbursement for overhead or other expenses. These payments include: Share payments to servicers or loan holders consisting of the cost of reducing payments from 38 percent to 31 percent of the borrower's monthly income. Pay for Success payments to servicers or lenders of $1,000 for each modification and continuing annual fees of $1,000 for each modified loan that remains current. Borrowers who stay current on their payments will be eligible for annual principal reductions of up to $1,000 per year for five years. For loans that are identified by servicers or lenders to be at risk of imminent default, additional onetime bonuses of $1,500 for loan holders and $500 for servicers will be paid for HMP modified loans that remain current. In addition, Treasury is to announce additional incentives for second-lien holders to extinguish their liens in order to permit first-lien modifications. The Treasury stated that comparable incentives will be available to encourage loan refinancing. Treasury also is to announce the details of home price depreciation payments and payments to facilitate short sales and deeds-in-lieu. BORROWER COMMUNICATIONS AND INTAKE Because the HMP is effective immediately and has been widely publicized, lenders and servicers must be ready now for borrower inquiries. Lenders who do not have in place procedures for accepting an increased volume of customer communications will quickly need to establish and implement call-intake and initial screening procedures, even if the lender is not participating in the HMP. Lenders will be challenged to provide a special type of customer service to borrowers who inquire about HMP or other loan modification or foreclosure avoidance plans, because often these customers are distraught and afraid of losing their homes. Smaller financial institutions that have originated a significant volume of Fannie or Freddie loans may be resource-challenged to immediately implement a new, labor-intensive program. Nonetheless, Fannie Mae stated in its HMP Guidelines:
6 The Treasury similarly stated: Fannie Mae expects servicers to have adequate resources and facilities for receiving and processing the HMP documents and any requested information that is submitted by borrowers. Servicers must have procedures and systems in place to be able to respond to inquiries and complaints about the HMP. Servicers should ensure that such inquiries and complaints are provided fair consideration, and timely and appropriate responses and resolution. Servicers should have procedures and systems in place to be able to respond to inquires and complaints related to loan modifications. Servicers should ensure that such inquiries and complaints are provided fair consideration, and timely and appropriate responses and resolution. The Fannie Mae Guidelines provide that at the outset, the servicer should work with such borrowers to obtain the borrower s financial and hardship information and to determine if the HMP is appropriate. According to the GSE s, servicers may only solicit a borrower for the HMP if the borrower is currently two or more payments past due. Treasury puts it another way, that is, participating lenders or servicers have an affirmative duty to reach out to all potentially eligible borrowers who are or become delinquent. 5 Under the Fannie Mae Guidelines, lenders are not expected to solicit or reach out to non-past-due borrowers. However, according to the Treasury, every potentially eligible borrower who contacts his or her participating lender or servicer must be initially screened for hardship. For non-defaulted borrower facing a financial hardship is considered unable to make his or her mortgage payment in the immediate future and at risk of imminent default. These borrowers must be offered the opportunity of an HMP modification, using the same procedures and standards that apply to defaulted borrowers. The initial risk of imminent default hardship determination is to be based on a change in the borrower s financial circumstances or whether the borrower facing a recent or imminent increase in payment ( payment shock ) on the loan. If the borrower reports a material change in his or her circumstances, the lender or servicer must ask about the borrower s current income and assets, current expenses and other specific circumstances related to the claimed financial hardship. The lender or servicer is required to verify these assertions through documentation. The GSE s are developing Affidavit forms to support this process and Treasury is expected do the same. 5 Treasury does not appear poised to require lenders or servicers to scrub their portfolios, looking for borrowers who may be at risk of imminent default. Such an exercise would be difficult to conduct under the HMP, because the lender or servicer must at a minimum obtain evidence of hardship from each potentially eligible borrower as part of the risk of imminent default determination and would have to have current income information in order to determine Front-End DTI. However, in informal comments to industry representatives, a Treasury official suggested that it should be possible for lenders or servicers to conduct a net present value comparison for all non-defaulted at risk loans and use this analysis as a basis for contacting possibly eligible borrowers. This appears to pose a Catch 22 for participating lenders and servicers, at least as to non-gse loans.
7 According to the Fannie Mae Guidelines, when discussing the HMP, the servicer should provide the borrower with information designed to help them understand the modification terms that are being offered and the modification process. Such communication should be designed to help minimize potential borrower confusion, foster good customer relations, and reduce legal compliance and other risks in connection with HMP transactions. According to Fannie Mae, a servicer also must provide a borrower with clear and understandable written information about the material terms, costs, and risks of the modified mortgage loan in a timely manner to enable borrowers to make informed decisions. For any borrower who is two or more payments past due: A servicer may make a firm offer solicitation to borrowers for whom the servicer has recent financial information (provided within 90 days of the date the servicer is determining HMP eligibility) indicating that the borrower may qualify for the HMP. The servicer must make an offer to the borrower utilizing Fannie Mae s form Workout Plan Cover Letter, enclosing the HMP Workout Plan and a HMP Hardship Affidavit. If a servicer does not have delinquent borrower s recent financial information, the servicer may send a letter instructing eligible borrowers to call the servicer to discuss the details of their individual circumstances. Fannie Mae has prepared a sample Solicitation Letter (which includes Fannie Mae s logo) for servicer use. LOAN MODIFICATION VERIFICATIONS AND UNDERWRITING The Program requires significant underwriting for loans that meet general eligibility criteria. Once the lender or servicer determines that the loan may be eligible, the lender or servicer must then determine whether the borrower is eligible for the loan modification under the HMP terms. It is recognized that there will be fallout at various stages and that not every borrower who is in financial distress will be able to obtain a favorable HMP transaction. As it stands now, the offramp for ineligible borrowers would appear to be Chapter 13, if the House bill becomes law. Proponents of the cramdown bill claim that it would help up to one million borrowers. If the Obama Administration s estimate of 3 to 4 million borrowers benefiting from the HMP is correct, it follows that between one-quarter and one-third of borrowers who attempt to get HMP relief may wind up in Chapter 13 bankruptcy. Default and Reasonably Foreseeable (Imminent) Default The first eligibility screen is whether the loan is in default (at least sixty days delinquent) or at risk of imminent default. As to the latter, lenders and servicers may offer an HMP modification without a missed payment if the borrower has suffered a valid hardship and a payment default is imminent. According to Fannie Mae, a payment default is imminent if it is likely to occur in the near future, generally within 90 days from the initial discussion with the borrower. The Fannie Mae Guidelines list the types of borrower hardships that tend to demonstrate imminent default. Fannie Mae requires hardship of the borrower or co-borrower to be documented on the HMP hardship Affidavit. The servicer s determination of whether default is imminent must also include evaluation of the borrower s financial condition and the condition of the property securing the loan. In addition, the servicer must adapt and document its internal systems and processes to demonstrate the basis for finding imminent default. At this time, under the Fannie Mae Guidelines, consistent with
8 ordinary loan servicing practices, servicers are prohibited from soliciting borrowers who are not in default for participation in the HMP. Verifying Borrower Income and Occupancy Status and Property Value Servicers may use recent verbal financial information (provided 90 days or less from the date the servicer is determining HMP eligibility) from the borrower (the term borrower includes any co-borrower) to calculate the targeted monthly mortgage payment. The targeted monthly mortgage payment includes the monthly payment of principal, interest, property taxes, hazard insurance, flood insurance, condominium association fees and homeowner s association fees, as applicable. Mortgage insurance is not included in the calculation of targeted monthly mortgage payment ratio. Treasury refers to this ratio as the Front-End DTI. Treasury (and Fannie Mae) defines monthly mortgage payment ratio as the ratio of the borrower s monthly mortgage payment to the borrower s monthly gross income (or the borrowers combined monthly gross income in the case of co-borrowers). Subordinate lien payments are not included. Under the Fannie Mae Guidelines, when the borrower returns the HMP Workout Plan and related documents to the servicer, the servicer must review the documentation to verify the borrower s income and determine the monthly mortgage payment ratio. A borrower will qualify for the HMP if the verified income documentation confirms that the monthly mortgage payment ratio (Front-End Ratio) is greater than or equal to 31%. 6 The servicer may not charge modification or other upfront fees nor require a borrower to make an upfront cash contribution (other than the first trial period payment) in order for a borrower to be considered for the HMP. The servicer is to seek reimbursement from the investor for out-of-pocket expenses such as notary fees, property valuation, recording costs and government fees. The servicer is required to bear the expense of any credit report. Lenders are expected to bear these costs for their own loans. In any event, unpaid late fees must be waived and cannot be imposed during the trial period. Borrower income verification documentation is to include the borrower s most recent two paystubs, a signed copy of the borrower s most recently filed federal income tax return and a signed IRS Form 4506-T (Request for Transcript of Tax Return). The Fannie Mae Guidelines provide for additional income verification requirements for borrowers with additional income, self-employed borrowers and borrowers who wish to rely on child support or alimony to qualify. According to The Fannie Mae Guidelines, a servicer must confirm that the mortgaged property is the borrower s primary residence from the borrower s federal income tax return, credit report or other documents such as utility bills. 6 A borrower must be reunderwritten for the HMP if the initial income information used by the servicer to solicit the borrower and the verified income evidenced by the borrower s documentation received varies by more than plus or minus ten percent. All parties whose income was used to qualify for the original mortgage note must submit income documentation which must not be more than 90 days old from the date HMP eligibility is determined.
9 For purposes of the net present value calculation (see below), the lender or servicer is not required to obtain a full-blown appraisal to determine property valuation. The lender or servicer may use either one of the GSE automated valuation models (AVM s) (provided that it renders a reliable confidence score) or a broker price opinion (BPO). If the lender or servicer is subject to supervision by a federal regulatory agency and the agency has reviewed its AVM or AVM validation, then the lender or servicer may use its own AVM, provided that the AVM renders a reliable confidence score. If the latter is not the case for a GSE or internally-generated AVM, then a full-blown appraisal or BPO ordinarily will be required. A servicer is not required to modify a mortgage loan if there is reasonable evidence indicating the borrower submitted false or misleading information or otherwise engaged in fraud in connection with the modification. Treasury is expected to issue additional guidance on fraud protection. It is not clear whether this guidance will include diligence related to borrower fraud that may have occurred at the time of loan origination, as is the case under FHA Hope for Homeowners guidelines. Applying the Waterfall Treasury requires the lender or servicer to apply familiar loan modification techniques in order to arrive at a modification that a borrower can afford and can be expected to perform. Treasury requires validation of the positive worth of the loan modification transaction to the lender or servicer through the application of a net present value test to the modification transaction arrived at through the waterfall procedure. Here, Treasury s approach is similar to the original procedures established by the FDIC for IndyMac bank loan modifications and later promulgated in the FDIC s mod-in-a-box program. Again, servicers and lenders that already are familiar with FDIC mod-in-a-box procedures will recognize the waterfall procedures and the NPV determination. The waterfall means that servicers or lenders must apply proposed modification terms in a set order of succession until the borrower s monthly mortgage payment is reduced to a target 31% DTI payment ratio. This should mean that the lender or servicer will not be required to offer a borrower an HMP modification that is any more advantageous to the borrower than what is demonstrated by the borrower s ability to make monthly payments going forward. The successive steps in the waterfall are: Step 1: Capitalize arrearages, which include accrued interest, out-of-pocket escrow advances to third parties and any required escrow advances to third parties required during the trial period and other servicing advances. Step 2: Adjust the interest rate to achieve a target an assumed Front-End DTI of 31%. Then, reduce the interest rate on the note in increments of.125 to get as close as possible to the Target Front-End DTI (31%), with an interest rate floor of 2%. Next, establish an interest rate cap of the lesser of the fully indexed and fully amortizing original note rate or the Freddie Mac Primary Mortgage Market Survey Rate. If the modified rate is at or above the interest rate cap, apply it to the remaining term of the loan; if not, then the modified rate is applied for the next 5 years, with an increase thereafter of 1% per year or until the interest rate cap is reached. Step 3: If the Front-End DTI of 31% cannot be reached in Step 2, extend the term and reamortize the mortgage loan by up to 40 years from the modification effective date (i.e., the first day of the month following the end of the trial period) to achieve the 31 percent payment ratio. (Negative amortization following the effective date of the modification is prohibited.)
10 Step 4: If the Front-End DTI of 31% cannot be reached in Step 3, that is, after capitalization of arrearages, reduction of the interest rate to the 2.0 percent floor and extension of the amortization period to up to 40 years, the servicer must provide for principal forbearance to reduce the Front-End DTI to 31%. The principal forbearance amount will not bear interest and will result in a balloon payment fully due and payable upon the earliest of the borrower s sale of the property or payoff or maturity of the mortgage loan. A principal write-down or principal forgiveness is prohibited on Fannie Mae loans, but permitted for non-gse loans. According to Treasury, principal forgiveness may be used at any stage of the waterfall to achieve the target Front-End DTI, but the amount of forgiveness is not considered for Treasury s cost share payment. Treasury will match any reductions in monthly payments from reductions in monthly payments below an assumed Front- End DTI of 38% down to a Front-End DTI of 31% (as determined by the waterfall ). Lenders or servicers are required to escrow for real estate taxes and insurance and mortgage insurance premiums immediately if they have the capability of processing escrow payments or are using third-party vendors for the purpose. Lenders or servicers who do not have this capability are required to implement the process within 6 months of entering into the Program with Treasury. As a practical matter, this requirement will apply to lenders holding or servicers servicing non-gse loans, because the GSE s already require such capabilities for GSE-approved seller-servicers. THE NPV CALCULATION A lender or servicer will be required to complete an HMP modification transaction if the Treasury s NPV Test shows that the net present value of the HMP modification cash flows is greater than the net present value of default, foreclosure and post-foreclosure disposition cash flows. Treasury s NPV Test applies to the standard waterfall and does not take into account principal forgiveness. On the other hand, a lender or servicer may elect to proceed with an HMP modification even if the NPV test is not satisfied. (This could become commonplace if the bankruptcy cramdown bill is enacted by Congress in the form voted on by the House of Representatives.) Treasury will issue detailed NPV Test guidelines in the near future. Treasury s NPV Model Parameters provide a general view of the procedure. For now, Treasury s parameters appear to be derived from the FDIC s mod-in-a-box program. There are two sides of the equation, one being the net present value of the modified loan s assumed cash flow and the net present value of foreclosure and disposition. The former relies on data that is more certain than the figures that must be assumed for the latter. Treasury will permit relative flexibility in determining the applicable cap rate, particularly for non-gse loans. For the default/foreclosure side of the equation, Treasury s NPV parameters include mention of applicable cure rates and redefault rates related to foreclosures, and remaining parameters on home price forecast, home price depreciation, foreclosure timelines and costs and so-called REO stigma, which are to be derived from Federal Housing Finance Agency (FHFA) data. BACK-END RATIO AND HOMEOWNERSHIP COUNSELING The borrower s total monthly debt ratio ( Back-End DTI ) is the ratio of the borrower s total monthly debt (housing payments, including payments on subordinate debt and mortgage insurance plus all recurring monthly debt payments) divided by the borrower s monthly gross income. Servicers will be required to send a letter to borrowers with a post-
11 HMP modification Back-End Ratio greater than or equal to 55% that states the borrower must work with a HUD-approved housing counselor on a plan to reduce their total indebtedness below 55%. To comply with the Fannie Mae Guidelines, the letter must describe the availability and advantages of counseling and provide a few local HUD-approved housing counseling agencies and direct the borrower to the appropriate HUD website where such information is located. The borrower must acknowledge in writing that (s)he will obtain such counseling. 7 Determination of the Back-End DTI requires the servicer to verify the borrower s monthly obligations. A servicer may consider information concerning monthly obligations obtained from the borrower either orally or in writing, but must obtain a credit report for each borrower or a joint report for a married couple to validate installment debt and other liens. The monthly gross expense is to be based on the sum of a host of monthly borrower expenses, and the method for summing up borrower charges or expenses is set forth in detail in the Fannie Mae Guidelines. THE TRIAL PERIOD Similar to the GSE s SMP, FDIC s mod-in-a-box program and other common loan modification programs, HMP requires the borrower to complete a successful trial period before the HMP modification will become effective. So, no HMP modification will become effective unless the Trial Period is successful. An HMP modification becomes effective the first calendar month following the successful completion of the Trial Period, meaning that the Borrower must be current at the end of the Trial Period. As is the case with similar loan modification programs, the Trial Period mechanism is intended to weed out modifications that do not work from the start and to decrease the ultimate redefault rate of HMP modifications. The Trial Period lasts 90 days (three payments at modified terms), fours months (according to Fannie Mae) for risk-ofimminent default loans or longer if necessary to comply with investor contractual obligations. Perhaps the most significant feature of the Trial Period is how Treasury payments to participating lenders and servicers are keyed to successful completion. For example, the Current Borrower One-Time Incentive of $1,500 will not be available unless the Trial Period is completed and the HMP modification becomes effective. Likewise, Treasury will not make lender/investor monthly payments during the Trial Period and will commence only if the Trial Period is successful and the HMP modification becomes effective. According to the Fannie Mae Guidelines, the servicer must evaluate the borrower who failed to complete the Trial Period for one of Fannie Mae s other foreclosure prevention alternatives prior to commencing or resuming foreclosure proceedings. The servicer may decide to allow the borrower to cure his or her default under the modified loan through a repayment plan, HomeSaver Advance or other means, for example. However, once a borrower ceases to be in good standing under the HMP, the borrower will not be restored to good standing under the HMP even if the borrower cures his or her default. A borrower who defaults under an HMP modification is not eligible for a subsequent HMP. 7 The servicer must retain in its mortgage files evidence of borrower notification. The servicer should advance the cost of the HUD counseling, which will be reimbursed by HUD. Details of the reimbursement process will be provided in subsequent announcements from the GSE s and Treasury.
12 Treasury says that lenders and servicers will be required to consider refinancing borrowers into FHA s Hope for Homeowners program ( H4H ) when feasible. It may be said today that H4H has not proven to be feasible at all. The House or Representatives is attempting to address H4H shortcomings in H.R. 1106, presumably, among other things, to help make H4H refinances more feasible under HMP directives. According to Treasury, servicer incentive payments will be paid for Home for Homeowners refinancing. If the underwriting process for an H4H refinance would delay eligible borrowers from receiving an HMP modification offer, lenders or servicers nonetheless must begin the HMP process with at least the trial period. During the trial period, servicers should work to complete the H4H refinancing. According to Treasury, any completed HMP modification under which the borrower redefaults must be terminated from the Program, resulting in the servicer, lender and borrower receiving no additional Program payments. However, redefaulting loans should be considered for other loss mitigation programs before being referred to foreclosure. THE MODIFICATION PROCESS Treasury has not issued detailed guidance yet on how the nuts and bolts of the HMP documentation process is to work or how lenders or servicers should deal with interested third parties such as securitization trusts or mortgage insurers. The Fannie Mae Guidelines are much more detailed than Treasury s initial issuance, and again Treasury can be expected to follow Fannie Mae s lead with respect to Program mechanics. Mortgage Insurer Approval Fannie Mae is seeking to obtain blanket delegations of authority from each mortgage insurer so that servicers can more efficiently process HMP modifications without having to obtain mortgage insurer approval on individual loans. Until Fannie Mae obtains a delegated authority agreement from a mortgage insurer on behalf of all servicers, a servicer must obtain mortgage insurer approval on a case-by-case basis. It appears that this blanket delegated authority will only extend to GSE loans, such that non-gse loans may be subject to case-by-case approval. Executing the HMP Documents According to Fannie Mae, servicers must use a two-step process that first provides a document outlining the terms of the forbearance (the HMP Workout Plan), and a separate document (the HMP Agreement), outlining the terms of the modification. At the beginning of the HMP process, Fannie Mae expects each borrower to sign an HMP Workout Plan and promptly (within 14 days) return it to the servicer. The borrower must return the HMP Workout Plan to the servicer along with the completed HMP Hardship Affidavit, verification of income and the first trial period payment. Then, the servicer must determine whether the borrower meets the underwriting and eligibility criteria, and has submitted good funds for the first month s trial payment. If so, the servicer should return an executed copy of the HMP Workout Plan to the borrower. If not, the servicer must promptly communicate in writing that determination to the borrower and consider the borrower for another foreclosure prevention alternative using Fannie Mae s new workout hierarchy. This New Workout Hierarchy is detailed in the Fannie Mae Guidelines for additional information).
13 Fannie Mae encourages servicers to send the HMP Modification Agreement Cover Letter and the HMP Agreement for execution by the borrower after receipt of the second payment under the trial period (or third payment for loans facing imminent default which require a four month trial period). It appears that servicers are not required to send out the final HMP documents until the trial period is completed and the HMP modification is shown to be successful. Fannie Mae strongly encourages servicers to use its standard HMP documents. The servicer must obtain prior written approval from Fannie Mae if the servicer desires to use its own HMP documents or to make material changes to the Fannie Mae approved forms. The Fannie Mae Guidelines list the types of modifications (keyed in part to diligence items such as title insurance) that are permitted without approval. The Fannie Mae Guidelines refer to MERS assignments and how MERS must be involved in the HMP modification documents. The Fannie Mae Guidelines require servicers to ensure that the modified mortgage loan retains its first lien position and is fully enforceable. The Fannie Mae Guidelines, for example, cover when the HMP Agreement must be in recordable form, including if state or local law require it (as in New York or Cuyahoga County, Ohio) or when the amount capitalized is greater than $20,000. The Fannie Mae Guidelines also list additional requirements on servicers to retain the first lien position, including current taxes and assessments and condo dues, title endorsement and junior lien subordination for HMP modifications carrying capitalized amounts greater than $20,000 and recordation of the HMP Agreement when required by state law and otherwise as set forth in the recordable-form requirements. REPORTING AND COMPLIANCE Both Treasury and the GSE s require or will require detailed loan-level reporting of HMP consideration, underwriting and performance. Fannie Mae reporting requirements are more or less consistent with current seller-servicer reporting requirements, but lenders and servicers of non-gse loans may be challenged to create data fields, input data points and transmit data to Treasury. Treasury is expected to publish additional guidance on data collection and reporting. 8 Treasury expects lenders and servicers to create and maintain detailed file-level documentation and data points demonstrating compliance with HMP modification requirements for verification and compliance reviews. In this regard, the Fannie Mae Guidelines state that every servicer must create an HMP internal control program designed to ensure effectiveness of HMP execution and compliance with the Program. This program must include monitoring, testing and validation. Fannie Mae states that Treasury will be appointing a third-party Compliance Agent, with the power to conduct audits, testing and security reviews, either on-site or offsite and with or without prior notice. The Compliance Agent s powers will be similar to those granted to federal banking agencies to conduct examinations. Servicers are expected to take corrective action designated by the Compliance Agent or Fannie Mae arising from such reviews, testing or audits. Treasury reminds all HMP participants of the importance of compliance, including attention to fair lending and disclosure laws. The Fannie Mae Guidelines flesh out these requirements. The Compliance Agent s reviews are to cover legal and regulatory compliance. Lenders and servicers are reminded that they should not discriminate against any protected class borrowers in the process of HMP modifications. 8 H.R. 1106, Section 125, seeks to impose data collection and reporting requirements on federal banking regulators.
14 ADDITIONAL REQUIREMENTS FANNIE MAE The Fannie Mae Guidelines establish additional requirements or procedures related to suspense accounts, reclassification or removal of MBS loans that are HMP imminent-default loans or HMP payment-in-default loans, servicer compensation, monthly statements, expanded servicer delegation, monthly investor reporting (LAR), mortgage insurer reporting, transfers of servicing, credit bureau reporting and the relationship of the Program to other Fannie Mae foreclosureavoidance programs. Donald C. Lampe, head of the Firm s Regulatory Compliance and Consumer Credit Practice Team, prepared this client alert. Womble Carlyle client alerts are intended to provide general information about significant legal developments and should not be construed as legal advice regarding any specific facts and circumstances, nor should they be construed as advertisements for legal services. IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).
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