Servicer Challenges in Obama Administration's
Making Home Affordable Loan Modification
Program
Washington, DC March 17, 2009
The Obama administration recently announced the Making Home Affordable Program. The key components of the program are the Home Affordable Refinance Program and the Home Affordable Modification Program (the “Modification Program”).
The Modification Program is briefly described in this memorandum, and the program guidelines released by the U.S. Department of the Treasury (“Treasury”) are attached. In particular, we describe (i) the eligibility requirements for loans to be included in the Modification Program, (ii) the modification process and (iii) the financial incentives—to servicers, lenders and borrowers—offered by Treasury for modifications. Finally, we highlight a number of unanswered questions and open issues for servicers.
Treasury is offering substantial incentives to servicers, investors and borrowers in exchange for their participation in the Modification Program. While servicer participation in the Modification Program is voluntary at its outset, participation will be mandatory for any institution that accepts future funding from Treasury’s Financial Stability Program.
Modifications under the Modification Program must be commenced by December 31, 2012.
Eligibility
Any servicer seeking to engage in modifications under the Modification Program must enter into an agreement with Treasury’s financial agent no later than December 31, 2009. No payments under the Modification Program will be made to any lender, investor, servicer or borrower unless and until the servicer has entered into such an agreement. Treasury has not yet made available a form of this agreement.
To be eligible for a modification under the Modification Program, a loan must meet the following qualifications:
• The loan must be a first lien on an owner-occupied, one- to four-family residential property.
• The loan must have been originated on or before January 1, 2009.
• The unpaid principal balance of the loan must be less than or equal to $729,750 for one unit properties. Higher limits are allowed for properties with two to four units. • The borrower’s monthly mortgage payment (including taxes, insurance and
homeowners association dues or condominium fees) must be more than 31% of the borrower’s gross monthly income.
• The borrower must be experiencing financial hardship. Hardship can include a significant change in income or expenses or “payment shock”—an adverse
readjustment of the coupon or payment on the mortgage—such that the borrower’s current mortgage payment is no longer affordable. The borrower need not be delinquent in order to qualify for a modification. The program guidelines suggest that a loan that is more than 60 days delinquent is eligible for modification, regardless of a change in circumstances.
• The loan may not have been previously modified under the Modification Program. Borrowers in bankruptcy are not automatically eliminated from consideration for a
modification, and borrowers in active litigation regarding the mortgage loan can qualify for a modification without waiving their legal rights.
Any foreclosure action will be temporarily suspended during a three-month trial period described below, or while borrowers are considered for alternative foreclosure prevention options. In the event that the Modification Program or alternative foreclosure prevention options fail, the foreclosure action may be resumed.
Modification Process
Each participating servicer must sign a contract with Treasury’s financial agent, pursuant to which the servicer must agree to review every potentially eligible borrower who contacts the servicer requesting to be considered for a modification. All loans that meet eligibility requirements and test “positive” for modification in a net present value model must be modified, unless there is fraud or the particular modification is prohibited by the servicing agreement that governs the servicing of the loan.
The modification will involve reducing the borrower’s monthly payment (including principal, interest, insurance, taxes and homeowner/condo association fees) to an amount that is no greater than 31 percent of the borrower’s gross monthly household income. The new monthly payment amount should be established using a sequential process as needed in the following order:
• Capitalizing arrearages, including delinquent payments, escrows and fees, if any (but not including late fees, which must be waived).
• Reducing the interest rate, subject to an interest rate floor of 2 percent per annum. The modified interest rate must remain in place for five years, after which the interest rate may be gradually increased as described in the guidelines. If the modified interest rate exceeds the Freddie Mac Primary Mortgage Market Survey rate in effect on the date of the modification, the modified rate will be the new note rate for the remaining loan term and may not be increased.
• Extending the term of the loan or the amortization term, up to 40 years. If permitted by the servicing agreement, the term of the loan should be extended. If extending the term of the loan is prohibited, but extending the amortization term is not, the amortization term should be extended.
• Granting partial principal forbearance. No interest will accrue on the forbearance amount. If the option to forbear principal is selected, the servicer shall forbear on collecting the deferred portion of the capitalized balance until the earliest of (i) the maturity of the modified loan, (ii) a sale of the property or (iii) a pay-off or
refinancing of the loan
The Modification Program does not require servicers to engage in principal reduction. However, servicers may choose to forgive principal to achieve the target monthly payment amount, subject to any contractual restrictions on its ability to do so under the servicing agreement that governs the servicing of the loan. Note that, except for the attempt to collect the principal at the termination of the loan, forgiving principal has the same effect as
forbearing principal.
Each modified loan would require escrow of taxes and insurance, even if the original loan did not. Furthermore, a modified loan would not be assumable (that is, we presume, would have a “due on sale” clause) even if the original loan was assumable.
Financial Incentives
For Servicers
• Payment of $1,000 for each eligible modification meeting guidelines established under the Modification Program (or $1,500 for each eligible modification meeting the guidelines made while a borrower is still current on mortgage payments).
• Payment of up to $1,000 each year for up to three years for loans that remain current. • Reimbursement of payments of up to $1,000 to junior lien holders to extinguish
junior liens, plus a $500 incentive payment for efforts made to extinguish such liens. For Lenders/Investors
• Treasury will match reductions in monthly payments dollar-for-dollar with the lender/investor, from 38% of the borrower’s gross monthly income (or, if lower, the borrower’s original monthly payment) to 31% of the borrower’s gross monthly income.
• Payment of $1,500 for each eligible modification meeting guidelines established under the Modification Program made while a borrower is still current on mortgage payments.
• Additional payments, not described in detail in Treasury’s program guidelines, linked to declines in home prices subsequent to a modification.
For Borrowers
• Payment of up to $1,000 each year for up to five years for loans that remain current. Payments are made to the servicer and credited to principal balance of the loan. • Payment of $1,500 for borrowers who are not eligible for a modification or who
default on a modification and agree to effectuate short sales and deeds-in-lieu of foreclosure.
First, and perhaps most important, the form of the required agreement between the servicer and Treasury has not been released. Treasury has indicated it should be available in April. Treasury is encouraging servicers and borrowers to modify loans without waiting for that agreement. However, because no financial incentives will be paid to any party, including a borrower, unless and until the servicer of the loan has entered into such an agreement, a servicer should be cautious about promising such incentives to borrowers until it has seen, reviewed and is comfortable signing that agreement. Servicers who do begin the
modification process for any loans prior to signing the agreement should be careful to inform borrowers that such incentives might or might not be available for their loans. Second, the program guidelines indicate that required parameters and computations for the net present value test will be “published separately,” and such details have not yet been released. These details are necessary to evaluate whether the net present value test, as implemented by the Modification Program, is consistent with a servicer’s obligations under servicing agreements and pooling and servicing agreements. And, of course, such details will be needed to implement the net present value test in modifications.
Third, the program summary released by Treasury indicates that the Modification Program will require servicers to collect or generate certain specific documentation to support a modification. Additionally, servicers will be required to collect and report certain information on the performance of modified loans on an ongoing basis and to implement controls to detect and prevent fraud. None of these requirements are specified in detail. Finally, the Modification Program includes an additional payment to loan owners based on the performance of an index of home prices. This provision is intended to provide partial protection for owners against further downward movements of home prices and thereby remove (or at least limit) the incentive to foreclose on troubled loans immediately for fear an owner might realize less as a result of foreclosure after a failed modification. However, the home price index and the amount of the payment per unit of movement in that index are not specified. Accordingly, it is impossible to judge how much protection this feature will provide.
Servicers must evaluate each eligible modification for consistency with the servicing agreement or agreements that govern the servicing of the loan.
The Modification Program does not purport to override or otherwise alter contractual relationships between lenders/investors and servicers. Consequently, it is essential that servicers perform a careful review of their servicing agreements, pooling and servicing agreements and, with respect to mortgage loans serviced for others, any other applicable servicing arrangements, to ensure compliance with any general servicing standards or
In particular, pooling and servicing agreements may restrict the following types of modifications:
• extensions of loan maturities • forgiving or forbearing principal
• modification of loans not currently in default or otherwise delinquent • balloon payments
Additionally, pooling and servicing agreements may limit the number and/or percentage of loans in a particular deal that may be modified, as well as the number and/or frequency of modifications with respect to any particular loan. Consequently, servicers should exercise caution when modifying loans that have been previously modified.
The Modification Program requires that participating servicers use reasonable efforts to remove any such restrictions and obtain waivers or approvals from all necessary parties. For loans that are securitized, however, obtaining such waivers or approvals will likely be challenging in light of the diffuse and unknown ownership of the relevant securities. There is legislation pending (the so-called “Cramdown Bill,” more formally, the Helping Families Save Their Homes Act of 2009) that would override contractual provisions in servicing agreements and provide certain safe harbors for servicers against liability to owners of whole residential mortgage loans and investors in a pool of residential mortgage loans (including securities backed by such loans) for actions taken under the Modification Program. The bill has been passed by the House of Representatives and is under
consideration by the Senate. If passed, the bill would provide some protection for servicers but would raise a host of interpretational issues of its own, and potentially some
Constitutional issues.
Incentive payments to servicers may give rise to conflicts of interest issues.
Servicers who are servicing loans for others will have to consider whether and to what extent accepting and receiving compensation (incentive payments) from the government for such servicing activities is consistent with their contractual and fiduciary obligations to the owners of the loans they service. The Cramdown Bill, if adopted, may (or may not) provide protection for servicers on this issue.
If you have any questions, please feel free to contact any of your regular contacts at the firm or any of our partners and counsel listed under “Structured Finance” or “Banking and Financial Institutions” under the “Practices” section of our website at
http://www.clearygottlieb.com.
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