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National Foreclosure Mitigation Solutions

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Invest In America

  1. 1. 11493543815<br />228600040005<br />Invest in America <br /> A Comprehensive Guide to a Loan Modification Solution<br />Discussion Document for Comments<br />By: <br />Dr. Robert Mark<br />Richard Greenwood<br />Mitchell Grooms<br />Ranga Rangarajan<br />104648053975<br /> <br />3478 Buskirk Avenue<br />Pleasant Hill, CA 94523<br />(925) 746-7186<br /><br /><br /><br /><br />TABLE OF CONTENTS<br /> TOC o "1-3" h z u <br />1.0Introduction to a Mortgage Loan Modification “Solution Structure” PAGEREF _Toc276633435 h 3<br />1.1 Rules and Regulations PAGEREF _Toc276633436 h 5<br />1.2 Managing the Risk PAGEREF _Toc276633437 h 6<br />2.0Local Government Role PAGEREF _Toc276633440 h 11<br />3.0Borrower applications PAGEREF _Toc276633441 h 11<br />4.0Lenders and Investors (“Holders”) benchmark targets PAGEREF _Toc276633442 h 12<br />5.0Second lien holder PAGEREF _Toc276633443 h 13<br />6.0Other lien holders PAGEREF _Toc276633444 h 13<br />7.0Matching borrower ability and holder criteria PAGEREF _Toc276633445 h 14<br />8.0Borrower requirements and conditions PAGEREF _Toc276633446 h 14<br />9.0Holder note and title documents PAGEREF _Toc276633447 h 15<br />10.0Fund Investment PAGEREF _Toc276633448 h 15<br />11.0How it works PAGEREF _Toc276633451 h 16<br />12.0 Next Steps PAGEREF _Toc276633454 h 19<br />48641011302900<br />242189013207900Figure 1 – Risk is Multidimensional 7 <br />395224013271500Figure 2 – Second Liens as a Percentage of Tier 1 Capital 13 <br />456819014224000Figure 3 – Second Liens as a Percentage of Tier 1 Common Equity 13<br />135509013144500Figure 4 – RAROC 16<br />184531013080900Box 1 – Solution Variables 9<br />225298013208000Box 2 – Crisis Management Plan 10<br />242189014097000Table 1 – Example Mortgage Loan 17<br />325818514033500Table 2 – Illustrative Loan Modification Solution 17<br />121348511938000About the Authors 21<br />89154016001900Bibliography 23<br />77089014033500End Notes 27<br />1.0 A New Mortgage Loan Modification “Solution Structure”<br /><ul><li>The goal of our paper is to describe a framework for setting up a Government Investment Enterprise (“GIE”) for the sole purpose of creating a national foreclosure mitigation program. Loss mitigation is considered an alternative to foreclosure and includes activities such as repayment plans, short sales and deeds in lieu of foreclosures. Loss mitigation is always a negotiated process and therefore is labor intensive and expensive. Mortgage insurers and junior lien holders must be agreeable to any loss mitigation solution. There have been very few opportunities for automation or economies of scale because each negotiation was historically separate. Labor expenses are also considered overhead, which are all non-reimbursable expenses to servicers. If the loss mitigation is in the form of a loan modification then re-defaults and self-cure risk are ongoing risk management considerations. If the housing market is strong then transaction processing dominates the mortgage servicing business. If the housing market is weak then default management and loss mitigation become more important.
  2. 2. We urge the Administration and Congress to establish a GIE to hold as well as attract equity investments made in qualified Single Family Residences (“SFR’s”). The initial investor in the GIE would be the Federal government. The goal would be to restore the mortgage market back to health. Currently, the mortgage market depends on government-sponsored or government entities, because investors have lost so much faith in the private origination and securitization of loans.The current environment mandates a total rethinking of how this problem is approached.
  3. 3. We believe the solution suggested in this paper does not call for new funds other than that which is already set aside under the current TARP (Troubled Asset Relief Program) programs as well as the exposure Government Sponsored Enterprises (“GSE”) already have through various guarantee programs. Many of the problems now plaguing current Federal foreclosure mitigation programs are inherent in their designs and cannot be resolved at this late date. Absent a dramatic and unexpected increase in enrollment in Federal foreclosure mitigation programs, many billions of dollars set aside for foreclosure mitigation may well be left unused. As a result, an untold number of borrowers may go without help, all because there was a failure to acknowledge the shortcomings of foreclosure mitigation programs in time.
  4. 4. In October 2008 under the direction of former President Bush the US Congress enacted the Emergency Economic Stabilization Act (EESA). In addition to creating TARP, EESA included the legal authorization and proscribed design elements for the US Treasury to implement a national foreclosure mitigation program. On March 4, 2009, newly elected President Obama and his new Treasurer (Timothy Geithner) announced the formation of the “Making Homes Affordable” program which contained a subprogram called the Home Affordable Modification Program (HAMP). HAMP specifically was created to address the mandates established by Congress in EESA for a national foreclosure mitigation program. HAMP was established to reach out to 3-4 million US homeowners and assist them in preserving their homes. HAMP was funded by Treasury with $75B in TARP funds; $ 25B dedicated to Borrowers with Fannie and Freddie home loans and $ 50B was set aside specifically for Borrowers with private label mortgages. As of December 2010, Treasury has spent less than $ 1B of the $ 50B set aside to assist Borrowers with private label mortgages and the GAO estimates that Treasury will only spend about $ 4B on HAMP over the life of the program.
  5. 5. The current environment in HAMP is neither efficient nor effective since homeowners, servicers and investors are faced with the protracted struggle of finding a solution. Current program solutions tend to be negative for at least one party and positive for another party (a zero sum game). The struggle over who has the stronger hand is, by default, where all the energy is going. These conundrums became even clearer as programs like HAMP and the Second Lien Modification Program (2MP) were introduced to address the crisis. Modifications were at best struggles to remain whole on the part of the servicer and investor in order to avoid the write down and resulting capital reduction. Borrowers prefer solutions that let them off the hook from the mess they feel they had got themselves into…like a short sale.
  6. 6. The “HUD Loan Counselors” put in place (under federal, state and private sector programs) have not been given effective tools to determine the real economic neutral point between the holder of the mortgage and the borrower. As a result, in the majority of cases, even those modifications that are crafted have been short lived and the borrower is in default again within three to six months. Our approach strives to find an optimal solution where we match as closely as possible the points of preference for each participant. The health and recovery of the USA economy is at stake and our focus must be on stability and the return of confidence as opposed to finding someone to blame or realize windfall gains (on either side of the issue). The solution being suggested in this paper offers opportunity and economic gain to many potential participants in the longer term. Nevertheless, in the near term, the foreclosure crisis needs to be fixed and the market made stable once again.
  7. 7. The time to process a foreclosure continues to extend every day due to the current impasse which adds to an already extended timeline required to process all of the steps required in a foreclosure. The foreclosure process varies from state to state. Whether the state follows a judicial or non-judicial remedy path the basic milestones of a) delinquency, b) default, and c) sale in each case come with stipulated time allowances. The borrower is allowed time to cure the default and participate in various forbearance programs in between and after each of those milestones. In many states, there is ultimately a redemption period once a foreclosure sale has taken place. These phases are each important and valid steps to ensure the borrower has sufficient opportunity to cure their predicament the consequences are clear. The number of participants, the volume of paperwork, the growing complexity along with the mistrust and confusion is overwhelming all the participants. Currently, there is an ongoing investigation conducted by a joint task force of Federal and State banking Agencies of major servicers.
  8. 8. The Federal Reserve and the Office of the Comptroller of the Currency are spearheading the efforts in coordination with an executive task force representing all fifty State Attorneys General. The current mortgage servicing system was not designed for the complexity of the loss mitigation tasks it is being asked to perform and it is certainly not equipped to perform such tasks at anywhere near the scope and scale of the current foreclosure crisis. In testimony by the banking agencies from the supervisory review at the Senate Committee on Banking, Housing and Urban Affairs, it was reported that there are significant weaknesses in risk management, quality control, audit and compliance practices. These as underlying factors contributed to the problems associated with mortgage servicing and foreclosure documentation. The agencies also found shortcomings in staff training, coordination among loan modification and foreclosure staff and management and oversight of third-party service providers (including legal services). The cost to lenders, servicers, borrowers, local governments and the economy as whole is continuing to grow and deepen the impact on the economy as whole.</li></ul>1.1 Rules and Regulations <br />Our program calls for investing in residential homes. Our program does not bail out lenders and investors. Our program does not forgive debt to borrowers who for whatever reason got in over their heads. The investment in these homes initially needs to be kept away from current GSEs and private entities for the near term, until the risks are reduced and the market stabilizes so options for the assets can be individually determined. The program would use funds to pay down existing first and second mortgages, modify terms to promote sustainability and change the risk attributes of the loan overall:<br /><ul><li>To the investor/holder of the first or second mortgage it would be similar to a pre-payment and enhanced risk protection.
  9. 9. To the borrower it would be sharing in the investment in their home and ultimately sharing in any value appreciation experienced over time.
  10. 10. To the government it would be to place/invest funds that it already has exposure on from existing programs but with a built in recovery mechanism that minimizes the taxpayer exposure while stimulating economic activity and fostering stability.
  11. 11. The program design should support homeowner wealth building as opposed to allowing easy access to funds for discretionary spending. Further, cash should not be removed except for controlled circumstance such as “value added” home improvements, education or health related events.
  12. 12. The proposed solution would also offer an opportunity to correct a number of troublesome issues raised in Congressional oversight committee testimonies regarding the legality and compliance difficulty of the current program. </li></ul>1.2 Managing the Risk<br /><ul><li>If we can improve the quality of risk management and completeness of the risk solution then it will help us solve the current foreclosure crisis. The current approach to risk management should be upgraded at all levels. These include originating, packaging and servicing mortgages. There was not enough focus during the boom period on the impact that mismanaging one form of risk (e.g. credit risk) had on other forms of risk (e.g. operational risk). Transferring risk seemed to be where the effort stopped.
  13. 13. The GIE would be responsible for tracking and managing the portfolio in order to protect investments in the GIE. The GIE would provide regular information updates for compliance as well as report on all the multidimensional risks that drive regulatory capital and economic capital in banks as shown in Figure 1. The GIE would structure documents and supporting information to ensure an initial and ongoing timely access to the information in order to monitor the completeness and integrity of the operating and risk information provided.
  14. 14. The residential mortgage business initially started pooling and securitizing mortgages to manage some of these risks (e.g. liquidity risk, interest rate risk, and credit risk). Out of this came the realization that an organization could maintain capital adequacy under growing mandates from regulators and still maintain market share and access to the related revenue pool needed to meet earnings pressure from investors. However, as the industry grew and used ever increasingly sophisticated tools, risk transference took the place of risk management. Those creating risk and pricing risk were compensated and incented on volume and conversely were not motivated to maintain risk at tolerable levels. Those keeping tabs of activity were not equipped to handle the churning of assets that developed and those receiving the risk relied on actuarial behavior and ratings that only worked if there were not any problems.</li></ul>Figure 1 - Risk is Multidimensional<br /> <br /><ul><li>The financial risks (i.e. credit risk and market risk) and operational risk (e.g. integrity of documentation) associated with mortgages needs to be tightly controlled. Operational risk has proven to be difficult to manage. The root of today’s operational risks goes back to the boom years when home prices were soaring. Banks and other originators pursued profit while paying less attention to the business of mortgage underwriting and servicing activities (such as collecting and processing monthly payments from homeowners and keeping track of documents and data). Many of these critical operations languished with inadequate staffing and outdated technology after the housing bubble began to burst (despite warning signs to the contrary and concern being voiced from industry observers). Our framework needs to ensure that all operational risks (including legal risk) are properly dealt with. These assurances would be addressed at the inception of all GIE investments. Establishing and maintaining awareness of the borrower’s ability to service the mortgage and confirm the chain of title would be among the first steps in our suggested program.
  15. 15. Borrowers began to default in droves which resulted in a never-ending game of catch-up. Independent mortgage servicers and bank owned servicers alike were unable to devote enough manpower to modify, or ease the terms of loans to millions of customers on the verge of losing their homes. Mortgage servicers have shown that they are ill-equipped to deal with the operational risk arising from the foreclosure process. Mortgage security holders, servicers and securities trustees did not comprehend or prepare for the current magnitude of foreclosures. According to Kurt Eggert, securitization also amplifies the risk of foreclosure by making it harder for borrowers to obtain appropriate loan modifications. Securitized loans are exhibiting higher foreclosure rates than non-securitized loans, not only because of the effect securitization had on underwriting, but also due to the fact that third-party servicers act on behalf of investors to collect mortgage payments, monitor defaults and also foreclose. Securitization makes it more difficult for borrowers to resolve problem loans due to such factors as “tranche warfare” whereby a servicer is concerned that a loan modification may benefit one tranche of a mortgage deal above others, leaving the servicer open to claims of favoritism and breach of the fiduciary duty to treat all classes fairly (Eggert, 2002).
  16. 16. Servicers self-interest also encourage excessive foreclosures, as servicers may benefit more from the foreclosure then they would from a loan modification (Eggert, 2007). Mortgage servicers earn revenue in three major ways. First, they receive a fixed fee for each loan. Typical arrangements pay servicers between 0.25% and 0.50% of the note of each loan. Second servicers earn “float” income from the interest accrued between when consumers pay and when those funds are remitted to investors. Third, servicers often are permitted to retain all, or part, of any default fees, such as late charges that consumers pay. In this way, a borrower’s default can boost servicer’s profits.
  17. 17. A significant portion of the servicers’ total revenue comes from retained-fee income. Servicers’ incentives upon default may not align with investors’ incentives. Some observers are concerned servicers have incentives to make it difficult for consumers to cure defaults. As a result, there is neither confidence nor a well designed process in place to respond to the crisis.
  18. 18. The key is to get the mortgage servicer back to their intended function of servicing the mortgages as opposed to getting involved in loan modification detail. Mortgage servicers got bigger and bigger as the housing market grew. But the current deluge of foreclosures has overwhelmed servicers and unfortunately many servicers have not been able to keep up with necessary internal checks and balances to ensure compliance with the very complex sensitive process, which has led to a widespread delay or even halt of foreclosures and to investigation by a task force of 50 states Attorneys General.
  19. 19. Mortgage servicers had few financial incentives to invest in their default handling capabilities within their servicing operations. A mortgage servicer’s investment in people, training and technology costs them a lot of money and they have no incremental incentive to staff up. Technically in a majority of the cases they were not the originator nor are they the holder of the mortgage. Their duty is to service and they are neither equipped to negotiate modifications on a massive scale nor are they authorized, without specific directives from the holder, to take any write downs (not to be confused with the write-off a holder takes against a security). If for example a mortgage generates an annual fee equal to 0.25 percent of the loan’s total value (unpaid principal balance) this only provides approximately $500 a year in annual fees on a $200,000 mortgage. That revenue will evaporate once a loan becomes delinquent, while the cost of a foreclosure can easily reach thousands of dollars and the mortgage servicer’s share of that cost will eliminate the profits generated from primary business activity of handling healthy performing loans.
  20. 20. 2124075986790Box 1 - Solution Variables00Box 1 - Solution Variables223647012534902303145125349000206692598679000This explanation is not intended to excuse or accuse any of the constituent parties. It is intended to point out the practicality of the situation and set of overwhelming obstacles to previously attempted resolution efforts. This proposal starts with a clear set of parameters and rules for all parties. There is no attempt to blame or admonish, but rather design a balanced set of procedures that is both corrective and stimulative as it takes affect. Under this proposed solution the borrower candidates would be handed off to a cadre of “loan counselors” equipped with the tools to determine the optimal solution incorporating the borrower’s ability to repay and the needs of the relevant holder into account.
  21. 21. The GIE would issue clear Rules and Procedures. For example, a reasonable rule would be all SFR’s with a current combined Debt to Income (DTI) of over A % and under B % (e.g. A =31% and B = 60%) would be eligible. The loan to current value ratio (LTV) would need to be less than C % (e.g. C = 175 %). All borrowers must be able to prove they have the available funding to meet their calculated revised payments (that is a payment that achieves a DTI of A). The use of the residential asset as collateral for a new loan would be prohibited. For the readers convenience the suggested level for these and other variables are listed in Box 1. The variables identified above are criteria that would in turn be utilized in a specially developed “Quality Risk Index” (See section 7.0) designed to support a standardized view of the quality of all mortgage portfolios.
  22. 22. -514352755265Box 2 - Crisis Management Plan00Box 2 - Crisis Management PlanThe GIE, on an ongoing basis, would confirm the income source (e.g. from an employer, binding contracts and tax returns etc.) and obtain proof of installment loan balances annually along with a certificate as to the true and correct information (annually). The GIE would also get a certificate of borrower occupancy (annually) and make an initial disbursement to the Holder (e.g. lender or investor) either directly or through the designated trustee or servicer. The GIE would also ensure that the Title, Deed, and other relevant mortgage documents properly reflect the GIE investment and related rights and interest. The GIE would also ensure the sale is properly documented during the first D years (e.g. D = 5). The GIE would oversee all secondary market activity and control the terms and structure of private sector activity in order to minimize speculative activity. Each State would be required to provide periodic reports on all relevant activity such as status of property tax rates and payments for each mortgage in the program.
  23. 23. -5143510985500
  24. 24. -3186430259080-326326520066000The GIE would need to put in place an effective crisis management plan as shown in box to the left.
  25. 25. If a borrower is willing to accept the conditions then, all homeowners would be invited to participate regardless of delinquency status. The GIE investment will be limited to the amount needed to bring the DTI to a minimum standard A % (e.g. A = 31%) after risk adjusting the interest rate and term on the mortgage. The borrower can remove requirements by repaying the GIE investment. As stated earlier there would be a prohibition on the use of the property collateral but it could be waived for either confirmable education or health reasons.</li></ul>2.0 Local and State Government Role<br /><ul><li>The local government role is important and needs to be supportive of the objectives of the GIE. For example, state programs are to be used in conjunction with the proposed program. The basic theme of our proposal flows from the philosophy that once the housing market stabilizes then confidence, jobs and spending will return to the local communities.
  26. 26. The state must agree to adjust the Real Property Tax basis to reflect the adjusted loan balance for the first 5 years. The state and municipal governments would need to agree to accept past due taxes on participating properties over an E year period (e.g. E = 5) which will be calculated into the DTI ratio and be included in escrow.
  27. 27. The state will need to provide periodic reports on their activity. Each state must provide a supporting semi-annual report of tax rates and payments on participating residential property. State and local governments may not introduce new tax programs to make up for the lost tax revenue as a result of adjusting the tax basis. Each state may augment or enhance the program for specific needs but cannot modify the roles or responsibility of the borrower, holder or servicer.</li></ul>3.0 Borrower Applications<br /><ul><li>The borrower would need to submit a detailed application and present proof of sources of income as well as disclose other installment obligations along with proof of ownership in the residence through title received at purchase. The borrower would also need to agree to add the GIE to the title of the property to the extent of the investment. The borrower will be allowed to pay an authorized financial consultant up to $500 to assist in preparation and submission of the required application. If there is a default on more than F payments (e.g. F= 2), then the borrower agrees to a fast track foreclosure.
  28. 28. If the borrower should become delinquent on F payments and foreclosed upon, the borrower will be allowed to rent the property upon meeting pre-established conditions and submit annually the proof of occupancy. The borrower is to provide an updated financial statement-of-condition (e.g. source of funds, proof of installment borrowings etc.) and also certify the accuracy of the information. The borrower may pay a loan counselor up to $100 to assist in the filing and preparation of the annual documentation required. The servicer will be required to provide documentation showing payment on the specific loan each month.
  29. 29. If the borrower is delinquent G payments (e.g. G = 2) then the GIE will give notice to borrower and holder of intent to take title to property. Delinquency of the H payment (e.g. H = 3rd) will automatically initiate a fast track foreclosure. The intent is to keep this all doable quickly and allow all who wish to participate an opportunity to do so. Nevertheless, in doing so, those that participate must agree to specific terms that will be monitored and enforced. If the borrower defaults on the third payment then the property is transferred to the GIE who takes over the obligation or delivers to the holder depending on the specific program involved.
  30. 30. If the borrower is able to resume monthly payments equal to the mortgage payment then the borrower, who is fast tracked may rent the property indefinitely without making up delinquent payments. If they are able to pay at least 75% of the original payment, then the borrower may rent until the residence is sold. The rent period is guaranteed for I months (e.g. I= 6) from the time of the last delinquent payment. If the borrower is able to pay the delinquent amounts (and other conditions are met within an allowed timeframe) then the borrower will be permitted to regain ownership (similar to a lease to own program).</li></ul>4.0 Lenders and Investors (“Holders”) Benchmark Targets<br /><ul><li>The Lenders and Investors (“Holders”) will be required to submit benchmark targets for minimum Return on Equity (ROE), Loan Loss Reserves (LLR), Operating Overhead factor, and a servicing factor (collectively the “Benchmark Criteria”). These factors are variables used to determine the holder’s point of preference for an “acceptable solution”. The holder point of preference contributes to determining the requisite adjustment to get the payment to the desired level. The underlying asset is to be held in portfolio unless the ownership exchange is proven to be and is approved as “Risk Tolerant” to all constituents. The holder would be required to provide an annual update and verification of the borrower information and condition as well as annually certify its Benchmark Criteria.
  31. 31.
  32. 32. Variables provided by holders must fall within an industry range and must be supported by documentation. The objective is to get holders back into an “indifferent” position toward the asset by bringing it into an acceptable risk position and yielding a risk adjusted return acceptable to the industry. These portfolios should not yield higher than the industry average ROE. Further, since the holder is not taking a write-down they would pick up the costs of the loan modification and related filing requirements.
  33. 33. The Benchmark Criteria along with the Borrower Solution Variables listed in Box 1 would provide the basic input into determining a portfolio’s (and individual loan) Quality Risk Index discussed in Section 7 below and the Risk Adjusted Return on Capital (RAROC) calculation outlined in Section 10 and Figure 4.</li></ul>5.0 Second Lien Holder<br />The second lien holder would have to agree to restructure and accept terms proportionately (i.e. maturity, interest rate and payment) and become a participant in subordinated interest over the term of the modified borrowing. In other words, this structure avoids the possibility of the second lien holder being crammed down in exchange for accepting the same terms as the first lien holder. Even as unappealing as this may seem, it is worthwhile pointing out that current programs call for the second lien holder to be crammed down significantly to a level permitting only minimal recovery. The significance of this is that a large number of first mortgage holders also have substantial second mortgage portfolios (in securities or otherwise) and accepting current modifications on one hand causes substantial losses on the other. Of the approximately $1.03 trillion of second liens outstanding 73.8 percent are held in banks’ portfolios rather than being securitized or held by other institutions. Of those loans, approximately 58 percent are held by just four banks – Bank of America, Citibank, JPMorgan Chase, and Wells Fargo. These four institutions all have significant exposure to second-lien loans.<br />Figure 2 - Second Liens as a Percentage of Tier 1 Capital<br />20052006200720082009Citibank23.8%42.6%46.7%28.9%21.0%JPMorgan Chase10.6%17.4%19.6%14.6%9.7%Wells Fargo58.3%43.6%50.0%30.2%22.4%Bank of America11.9%12.0%26.1%29.2%18.1%<br />Figure 3 - Second Liens as a Percentage of Tier 1 Common Equity<br />20052006200720082009Citibank26.5%48.9%66.3%149.6%25.5%JPMorgan Chase12.9%20.7%23.6%22.9%12.2%Wells Fargo68.5%50.0%58.7%75.5%32.1%Bank of America14.5%15.2%36.4%55.8%24.1%<br />The second lien holder will receive a proportionate amount of investment by the GIE. The percentage of the payment and interest income to the second lien holder would be proportionate to the total of the new loan balance. The goal is to get second lien holders their principle back but they must agree to keep their loan on a fully subordinated basis.<br />6.0 Other Lien Holders<br /><ul><li>We also need to consider the interests of the other lien holders such as a mechanics lien on a new plumbing system. All liens beyond the first and second mortgage must be released. If the scheduled payment on any one obligation exceeds 5% of the original DTI then the indebtedness would be subject to a series of conditions. For example, lien holders must accept a write-off or agree to extended unsecured terms of payment. The borrower and lender/creditor must agree to extended terms of payment according to clearly described criteria. The interest rate cannot exceed J% (e.g. J = 15%). Past due payments are to be added to that specific loan/debt obligation balance. Also, there would not be any real property security interest allowed on that particular loan/debt obligation. The payments will be amortized over 15 years or the original term whichever is greater. These loans/debt obligations only enjoy the opportunity to get repaid over a modified period. This would not apply to transactions entered into by the borrower with a vendor where term financing was not offered on the transaction originally.</li></ul>7.0 Matching Borrower Ability and Holder Criteria<br /><ul><li>It is important to establish a cadre of “Loan Counselors” in order to match up borrower ability and holder criteria. The loan counselors need to be trained to use tools to find an optimization point and use the data to construct a “Quality Risk Index” (QRI). The QRI would be used to support a standardized risk based view of the quality of the portfolio.
  34. 34. An ongoing test of the capability of borrowers to make the new payment would also be required. This would help keep borrower data electronically organized and indexed. This is central to a pragmatic approach to initially moving past the current crisis and putting checks and balances in place to minimize future adverse events of the magnitude currently being experienced. </li></ul>8.0 Borrower Requirements and Conditions<br /><ul><li>The borrower needs to agree to a number of requirements and conditions:
  35. 35. Consent that the funds, once determined and approved, go directly to holder(s) to reduce the loan(s) outstanding;
  36. 36. Share K% (e.g. K = 25%) the gain on sale after the initial GIE investment is returned;
  37. 37. Put GIE on title to reflect investment and right of final consent on any ownership changes until investment is returned and it receives its proportionate share of any gain realized;
  38. 38. Stay in their home D years (e.g. D= 5) unless required to relocate for employment or health reasons;
  39. 39. Provide updates on pertinent personal data every six months for the first 2 years and once a year every year thereafter; and,
  40. 40. Provide authorization to share pertinent information regarding the loan on the SFR property to the GIE who in turn can share the information from time-to-time with specific investors as the case may dictate. For example, income information would be pertinent. The purpose of these conditions is to raise transparency between all parties toward “early-warning” signals of individual as well as systemic trends that need attention. </li></ul>9.0 Holder Note and Title Documents<br /><ul><li>The holder would be responsible to initiate the change in note and title documents. Specifically, the holder would be required to modify the loan documents in order to reflect a change in terms and priority preference. The holder must also agree to modify documents to reflect GIE status. The importance of this is that if the GIE is not on the title then the property could be transferred or used as collateral without GIE approval or knowledge. The investor(s) or lien holder(s) would be asked to absorb the cost of changing the loan documents and updating the filing of new title and gathering of data.
  41. 41. The ongoing updating of the operating and risk information (e.g. payment experience) would be reported monthly in order to avoid problems similar to what has taken place in Mortgage Electronic Registration Systems (MERS). MERS is an industry-owned registration system that oversees millions of home loans. This industry-owned registry, which was supposed to eliminate the need to record changes in property ownership in local land records, did not measure up to the task and has been criticized for sloppy practices. This new standard of data integrity and tracking must be an integral part of this new procedure. The indexing standard that links borrower, property, title, loan history, legal documents throughout life of loan will ensure and preserve data integrity.</li></ul>10.0 Fund Investment<br />If portfolios are performing well, it will lead to an enhanced economic activity on all fronts. The program would be structured to ensure that the GIE releases the pre-determined funding to the servicer or holder as directed by the latter once all criteria defined above have been met and certified in place. Quarterly reports would be made to Congress on key indicators produced by the GIE. For example, these reports would include cumulative and the latest period activity as well as highlight relevant operational risk issues. In some cases, officials at mortgage servicers signed hundreds of documents a day with barely a chance to review them (so called “robo-signers”).<br />Doubts have arisen about the veracity of the original documents compiled as part of the foreclosure process. 20123158064500The foreclosure machinery in many states recently ground to a halt. For example, certain major institutions (Bank of America, JP Morgan and GMAC Mortgage) halted foreclosures in many states. As a result, foreclosed homes remain on the investor’s or bank’s books while racking up thousands of dollars in extra costs. Lengthy foreclosure delays impose substantial losses on taxpayers, by some estimates, $30-40 per day and $10,000 to $15,000 per year for every defaulted loan. Wall Street regarded the foreclosure issue as a risk to originators’ or banks’ reputations rather than their bottom line. A report on Bank of America (compiled by Branch Hill Capital, a San Francisco hedge fund) suggested that the nation’s largest bank could be facing massive losses from mortgage securities that it may have to repurchase from Fannie Mae and Freddie Mac, as well as private investors. As this unfolds it will certainly affect others in the industry as well. The objective is to create a program that is operationally sound from a risk perspective and a privilege to join. <br />17716502927350017716508255The program should be designed to minimize abuses by participants and to “game the system” as well as meet RAROC objectives as shown in Figure 4 to the right. At the same time, the objective is to get holders, servicers, and government entities back to business. As indicated earlier, the GIE would also need to put in place and effective crises management plan in order to protect itself in extreme markets as outlined in Box 2. <br />11.0 How It Works<br />Perhaps an illustration would best demonstrate how this solution would work in practice. If a borrower meets the criteria suggested earlier (See Sections 1.0 and 3.0 above) and holders of the first and second mortgage choose to participate in the program then the example below covers the full cycle from modification through various final disposition results.<br />177801005840Table 1 - Example Mortgage Loan020000Table 1 - Example Mortgage LoanExample: The candidate borrower has total mortgage debt equal to the original appraised value but the current market value has resulted in a combined loan to value of 160% (=$200,000/$125,000) and the borrowers combined monthly Mortgage Debt to Available Income (DTI) is 45% (=$1,325/$2,942). <br />606425123825507365571500<br />After adjusting the blended term and interest rate this borrower has a DTI of 31% (=$912/$2,942). The borrower needs an investment from the GIE of $20,000 (to reduce the total of the combined loan amounts from $200,000 to $180,000), a reduction in interest rate of 2% (from 6.50% to 4.50% and an extension in the term of the loan for 3.75 more years (from 26.25 years to 30 years) in order to bring the DTI down to 31%. There are various combinations of adjustments to achieve this outcome but the important factor is the GIE investment is not a write-off, forgiveness of debt or a grant. It is an investment in the underlying collateral.<br />Table 2 - Illustrative Loan Modification Solution<br />425450176530749306223000<br />For simplicity we have not factored in time or the expected reduction in principle balance (through normal amortization) over time in this example. Nevertheless, including these factors would have incremental positive influence on the solution.<br />The arrangement either terminates when the property is sold or the loan(s) are paid off through normal term amortization or early payoff from another source. If the property is sold and the loan(s) are paid off from proceeds then the GIE (or investors who bought into the opportunity) would begin to realize its return. First, the proceeds go to satisfy remaining outstanding balances due on the first and second mortgage note. Next, the investment made by the GIE (in this example $20,000) is returned. If there is a gain beyond the amount needed to satisfy the GIE investment as a result of market appreciation, it will be distributed 75% to the borrower and 25% to the GIE (or investors to allow for secondary transfer of the investment as the product and market evolve and matures). Finally to further demonstrate the application of our proposal, let’s say the value exceeded what was needed to pay off the loans and return the principal investment to the GIE by $50,000 in the above scenario. In this situation $12,500 (=25%x$50,000) would go to the GIE in addition to the investment amount ($20,000) and the remaining $37,500 (= 75% x $50,000) would accrue the borrower. This generates a reasonable direct reward for GIE investment in the residential home (Note: we have not tried to quantify the indirect economic benefit we believe this program will generate when in place); and, at the same time creates a reasonable incentive for the borrower to stay with the mortgage and make the payment.<br />If in the few cases where the borrower pays off the loan(s) or stays in the home long enough for the loan(s) to fully amortize, the borrower would be obliged to have the property appraised by an approved appraiser and arrange to borrow or otherwise come up with the funds in an amount sufficient to buyout the GIE (or investor) and meet the agreed upon share of the excess value (according to the previously agreed appreciation sharing formula). If the borrower cannot meet this part of the agreement the GIE would retain its interest on title until such time as the borrower is able to fulfill their buyout commitment. If there is a loss on final disposition then the GIE would not experience any greater loss than would a GSE guaranty cost the government. The GIE would however not have the added costs of foreclosure since quick uncontested transfer was agreed to by the borrower at the inception of the modification.<br />12.0 Next Steps<br />-2032021590The next steps are to first obtain approval for the use of earmarked funds for this proposal. Second, is to charter the GIE to invest as well as monitor/track investment performance. It will also be necessary to recruit the leadership. The GIE needs a clear mandate to establish infrastructure for their proposal, such as a baseline for product and tools to be used. The baseline needs to include the investment information and data requirements which addresses and assures the capture and retrieval of document and performance data. We would have to establish tools to drive toward success at loan level and new dashboard tools to facilitate monitoring loan level and aggregated performance. Also, indices are needed to guide investments and behavior prediction as well as to write rules for compliance, regulation, monitoring and enforcement. We also need to set parameters A though K (described earlier in our paper) such that they offer the highest chances of success for our proposal. <br />Einstein once said: “The definition of insanity is doing the same thing over and over again and expecting different results”. It is time for some lateral thinking.<br />36372801006475A measured and deliberate implementation of the solution suggested in this proposal will help families stay in their homes while remaining responsible and accountable. It will limit the economic impact on holders of these assets to a more normalized credit exposure and interest rate exposure. It affords the solution provider, first the GIE and ultimately the private sector, a new level of controls and transparency as well as the ability to get paid back with a reasonable return. Finally, it provides a basis for significant broad based economic stimulus across all sectors of the USA that will serve to avoid a much deeper crisis than we already face and introduce a proactive solution towards a brighter day.<br />It is the intent of the authors to extend the discussions on comprehensive loan modification solutions in our next paper to include a drill down of subjects of interest from our readers. <br />To have a more extensive conversation about how this subject may affect your business, please contact:<br />Mitch Grooms<br />Partner<br />(970) 720-3477<br /> <br />Dr. Robert Mark<br />Partner<br />(925) 212-7348<br /> <br />Ranga Rangarajan<br />Partner<br />(339) 364-0380<br /> <br />Rick Greenwood<br />Partner<br />(949) 466-3399<br /> <br />About the Authors<br />Dr. Robert Mark <br />Dr. Robert Mark is one of the preeminent global risk managers. Dr. Mark is one the few financial professionals who has been honored to receive the prestigious Global Association of Risk Professionals (GARP) “Risk Manager of the Year” award. In addition, Dr. Mark has been a major leader of the establishment and advancement of Professional Risk Managers International Association (PRMIA) the most significant association of international risk managers currently comprised of 75,000 risk management professionals worldwide. Dr. Mark is also the co-author of the two bestselling books on the subject of risk management, “Risk Management” and “Essentials of Risk Management.”<br />Dr. Mark is capable of designing and implementing a complex comprehensive enterprise-wide risk management program effectively, including current issues related to Basel III and Dodd-Frank. A typical engagement schedule for Dr. Mark includes a top down ERM design & execution for a Top 10 global financial service client, Board/C-level risk management education & consulting, creating new, innovative risk management analytics to address current economic scenarios, state of the art enterprise stress testing and more. Dr. Mark is a former member of the Management Committee, Chief Risk Officer & Corporate Treasurer of a large bank. Dr. Mark is the Founding Executive Director of the Masters of Financial Engineering Program at UCLA Anderson School of Management and an expert in financial engineering structures for Structured Investment Vehicles (SIV’s), including funding.<br />Richard Greenwood<br />Mr. Greenwood is a seasoned senior management risk executive with extensive experience at the Board and C-level managing financial intermediaries. Mr. Greenwood is familiar with the entire core banking business enterprises and is adept at developing complex business solutions across the enterprise to enhance corporate performance and shareholder value. Mr. Greenwood’s skills thrive in an environment of economic challenge and rapid growth. Mr. Greenwood’s specialty is in strategic and tactical risk management where Mr. Greenwood is responsible for taking new business concepts designing business plans to operationalize the new businesses and successfully executing these designs with teams of financial professionals harnessing lateral thinking to change business paradigms.<br />Mr. Greenwood’s unique career highlights have a demonstrated successful track record in Financial Institution and Technology Executive Leadership, Basel II, III, Treasury & Asset Liability Management, Capital Markets and Foreign Exchange, Creditor Rights & Loss Mitigation, Advanced Technology & Payment Systems, Financial Industry Trade Association (former Chairman of the Association of Financial Services Holding Companies) and Risk Management Board Leadership.<br />Mitchell Grooms<br />Mr. Grooms is a leader, visionary, innovator, business manager of risk management and advanced technology applications for financial intermediaries. Capable of managing and generating high volume sales and revenue streams annually for new risk management businesses. Mr. Grooms specializes in development of businesses for financial intermediaries and related strategic planning to solve complex business problems and provide significant earnings. Mr. Grooms specializes in focusing on enterprise risk management driven businesses utilizing various advanced technology applications to solve numerous risk management problems while generating new sources of revenue: Basel II, III, Dodd-Frank, credit risk, credit risk default, Asset Liability Management, operational risk, security, authentication and specific investment objectives, i.e., Community Reinvestment Act and Green risk management investment vehicles to meet Regulatory mandates. Current emphasis is on credit risk default loss mitigation and consumer credit risk competitive analytics business solutions.<br />Ranga Rangarajan<br />Mr. Rangarajan has extensive education and over 30 years’ experience in the financial services industry. He is a seasoned business executive with a proven track record of working effectively as a CEO & CFO with corporate executives and board level management. His major strengths include creative problem solving skills, ability to link technical solutions to business strategy, staff development and motivation, and thought leadership. Business experience and exposure covers broad areas of financial services including retail and commercial banking, capital markets, wealth management, leasing and asset based lending, mutual funds and brokerage, and property and casualty insurance. <br />Mr. Rangarajan’s experience covers diverse project areas with particular emphasis on risk management solutions and strategy evaluations (advanced analytics, modeling of Retail and Wholesale Banking Credit, Market, and Operational Risks, Basel II, III implementation including Economic Capital modeling, stress testing, scenario modeling and risk mitigation strategy modeling), product pricing and profitability models, Asset-Liability modeling, customer analytics, decision support systems (AI & expert systems), forecasting, strategic planning, advanced business valuation modeling to support Mergers, Acquisitions, and Investment decisions, market segmentation, litigation support modeling, portfolio management, and Model Validation. Mr. Rangarajan has extensive experience, depth and insights, providing analytics for innovative structured solutions and products, including finance programs.<br />Bibliography<br />Michel Crouhy, Dan Galai, and Robert Mark, 2001, “Risk Management”, McGraw Hill<br /> <br /><ul><li>Michel Crouhy, Dan Galai, and Robert Mark, 2006, “The Essentials of Risk Management”, McGraw Hill </li></ul>Congressional Oversight Panel (COP)<br />COP A Review of Treasury's Foreclosure Prevention Programs, 12/14/10, pages 1-192, <br />COP Examining the Consequences of Mortgage Irregularities for Financial Stability and Foreclosure Mitigation, 11/16/10, pages 1-127, <br />COP Examining Treasury's Use of Financial Crisis Contracting Authority, 10/14/10, pages 1-159, <br />COP Assessing the TARP on the Eve of Its Expiration, 09/16/10, pages 1-153, <br />COP Evaluating Progress of TARP Foreclosure Mitigation Programs, 04/14/10, pages 1-230, <br />COP Taking Stock: What Has the Troubled Asset Relief Program Achieved? 12/09/09, pages 1-182, <br />COP An Assessment of Foreclosure Mitigation Efforts After Six Months, 10/09/09, pages 1-209, <br />COP The Continued Risk of Troubled Assets, 08/11/09, pages 1-145, <br />COP Assessing Treasury’s Strategy: Six Months of TARP, 04/07/09, pages 1-151, <br />COP Foreclosure Crisis: Working Toward a Solution. 03/06/09, pages 1-198, <br />COP Hearing with Treasury Secretary Timothy Geithner, 12/16/10, <br />COP Hearing on TARP Foreclosure Mitigation Programs, 10/27/10, <br />COP Hearing on Treasury's Use of Private Contractors, 09/22/10, <br />COP Hearing with Treasury Secretary Timothy Geithner, 06/22/10, <br />COP Hearing with Treasury Secretary Timothy Geithner, 12/10/09, <br />COP Hearing with Assistant Treasury Secretary Herbert M. Allison, Jr., 10/22/09, <br />Philadelphia Field Hearing on Mortgage Foreclosures, 09/24/09, <br />COP Hearing with Treasury Secretary Timothy Geithner, 09/10/09, <br />COP Hearing with Assistant Treasury Secretary Herb Allison, 06/24/09, <br />COP Hearing with Treasury Secretary Timothy Geithner, 04/21/09, <br />COP Hearing: Coping with the Foreclosure Crisis in Prince George’s County, Maryland, 02/27/09, <br />Clark County, NV: Ground Zero of the Housing and Financial Crises, 12/16/08,<br />General Accounting Office (GAO)<br />GAO Management Report: Improvements Are Needed in Internal Control Over Financial Reporting for the Troubled Asset Relief Program, 06/30/10, pages 1-23, <br />GAO Troubled Asset Relief Program: Treasury's Framework for Deciding to Extend TARP Was Sufficient, but Could be Strengthened for Future Decisions, 061010, pages 1-56, <br />GAO Troubled Asset Relief Program: One Year Later, Actions Are Needed to Address Remaining Transparency and Accountability Challenges, 100909, pages 1-112, <br />GAO Treasury Actions Needed to Make the Home Affordable Modification Program More Transparent and Accountable, 070909, pages 1-68, <br />GAO Troubled Asset Relief Program: Status of Efforts to Address Transparency and Accountability Issues, 0109, pages 1-112, <br />GAO Troubled Asset Relief Program: Additional Actions Needed to Better Ensure Integrity, Accountability and Transparency, 1208, pages 1-72, <br />The Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP)<br />SIGTARP Factors Affecting Implementation of the Home Affordable Modification Program, 032510, pages 1-60, <br />SIGTARP Quarterly Report to Congress, 1010 pages 1-338, <br />SIGTARP Quarterly Report to Congress, 0710, pages 1-287, <br />SIGTARP Quarterly Report to Congress, 0410, pages 1-241, <br />SIGTARP Quarterly Report to Congress, 0110, pages 1-224, <br />SIGTARP Quarterly Report to Congress, 102109, pages 1-256, <br />SIGTARP Quarterly Report to Congress, 072109, pages 1-262, <br />SIGTARP Quarterly Report to Congress, 042109, pages 1-250, <br /><ul><li>SIGTARP Initial Report to Congress, 020609, pages 1-189,
  42. 42. End Notes