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Investors, Servicers & Regulators Launch Foreclosure Plan

5 year rate freeze for some subprime ARM borrowers

December 6, 2007


A plan to streamline loan modifications for subprime adjustable-rate borrowers was unveiled today. The framework, designed by investors of mortgage securities, was endorsed by a number of groups and regulators but had mixed support from ratings agencies.

In a press statement, the White House said 1.2 million subprime borrowers with adjustable-rate mortgages are expected to qualify for fast track loan modifications outlined today. To qualify, borrowers must be current on their loans, qualify for payments at their current rate and demonstrate they cannot afford payments at a higher reset rate.

For borrowers who do qualify, their interest rate will be frozen for five years.

A press conference was held today announcing the plan.

Among those presenting was George Miller, executive director of the American Securitization Forum. The group's sponsorship of the plan was critical to its success.

"Today's announcement focuses on those other alternatives to foreclosure in ways that servicers, consistent with their obligations to securitization investors ... can focus and expedite delivery of home retention options and resources to borrowers in need," Miller said. "This framework is based upon, and further advances, the alignment of interests that exists between the operation of the securitization markets and society's interest in foreclosure avoidance.

"The economic mandate to minimize losses to securitization investors aligns with the policy interest of keeping mortgage borrowers in their homes."

Miller explained that investors have expectations that servicers will act in the best interest of investors and will attempt to maximize recovery on defaulted loans. He noted that without this confidence in servicers, investors might abandon buying mortgage securities or require higher returns.

photo of Henry Paulson, George Miller & Alphonso Jackson
Henry Paulson, George Miller & Alphonso Jackson

In a 34-page report, ASF said the streamlined framework applies to first mortgage borrowers who originated their loans between Jan. 1, 2005, and July 31, 2007, and face a reset between Jan. 1, 2008, and July 31, 2010. They can have no more than one 60 day late during the past month and cannot be more than 30 days delinquent at the time of modification. Borrowers' credit scores cannot exceed 659 and they must occupy the property securing the loan. In addition, their reset payment must increase by more than 10 percent.

Servicers are required to open up communications 120 days prior to the reset and not violate the pooling and servicing agreement, according to ASF. They can use automated valuation models in cases where the loan-to-value is below 97 percent, and would need any second lien holder to subordinate.

Servicers can begin implementing changes based on the new framework in a matter of weeks, Wells Fargo Home Mortgage co-president Mike Hyde said at the press conference. The Securities and Exchange Commission has already begun the process of clarifying accounting treatment, and the IRS is reportedly close to an announcement on REMIC tax treatment.

Hyde noted the inability to communicate with borrowers is the biggest single obstacle in resolving potential foreclosures.

photo of Henry Paulson

Treasury Secretary Henry Paulson said 1.8 million subprime resets are projected next year and in 2009. A standard loan-by-loan evaluation process currently used in the industry is inadequate to handle the volume of work, so the industry needed a streamlined approach to address this increased volume.

"The industry standards announced today do not change the nature of the responsibilities in the servicing industry -- servicers will continue to modify loans when it is in the best interests of the investors," Paulson said.

He noted up to 1.2 million subprime ARM borrowers will be eligible for fast-tracking.

"This is a private sector effort, involving no government money," Paulson added. "With the investor community on board and as a clear beneficiary of this approach, the risk of litigation should be manageable."

Standard & Poor's issued a statement indicating that freezing rates on subprime ARMs could negatively impact residential mortgage-backed securities unless they also lead to offsets in default frequency or loss severity.

"It is our opinion that, absent any real offset to default frequency and loss severity that may result from the enactment of any loss mitigation proposal, simply freezing interest rates on some U.S. first-lien subprime mortgage loans would have a negative impact on the ratings of certain U.S. first-lien subprime RMBS," S&P stated.

"By extending the initial interest rate that homeowners paid during the fixed-rate period of their hybrid ARM loan terms, the potential for payment shock may be mitigated, thereby potentially reducing the risk of default. However, as a possible consequence of these actions, there may be a corresponding reduction in excess spread that was initially incorporated into our ratings analysis.," S&P said. "Although loan modifications that extend the mortgage's fixed-rate period may result in lower defaults, the reduction in excess spread may offset the benefits of lower defaults resulting in diminished investor protection."

The ratings agency explained that borrowers who default after their loans are modified represent a greater risk to bond investors than if the loan was instead liquidated. In addition, investors used the original loan terms when considering whether to invest in the securities, and the potential loss or lower returns may discourage their participation in the U.S. subprime RMBS market.

Paulson noted subprime mortgage investors are scattered around the world.

Moody's Investors Service also issued a statement, noting that too few loan modifications have been made to date on subprime loans -- contributing to the large number of recent downgrades.

"The proposed framework seems to provide a reasonable approach for identifying borrowers suitable for streamlined modifications and should expedite the number of modifications going forward," Moody's stated. "We believe that judicious use of loan modifications can be beneficial to securitization trusts as a whole"

The agency added that while the ability of smaller servicers to determine a borrower's eligibility for FHA Secure or other refinancing options may vary, larger servicers with both servicing and origination arms may be better equipped to manage the process.

Office of Federal Housing Enterprise Director James B. Lockhart said Fannie Mae and Freddie Mac, which have seen their market share of new mortgages climb to 60 percent this year from 38 percent in 2006, hold $160 billion in AAA subprime securities. He warned that Congress needs to pass reform legislation for the two companies to ensure they can continue to support the market.

The Mortgage Bankers Association also weighed in.

"By providing clear and concise criteria that will help facilitate loan modifications for borrowers who meet the guidelines, this plan will not only help those borrowers who qualify but will also free resources for servicers to work with other borrowers who may also benefit from a loan modification, repayment plan, forbearance or the bevy of other tools that servicers have to keep troubled borrowers in their homes," MBA Chairman Kieran P. Quinn said in an announcement.

photo of James B. Lockhart
James B. Lockhart

"I want to thank President Bush and Secretaries Paulson and Jackson for their leadership in bringing all the relevant players to the table and facilitating a private-sector approach, rather than a government-mandated one," MBA's Quinn stated.

photo of Sheila Bair
Sheila Bair

Other speakers at the press conference included Housing and Urban Development Secretary Alphonso Jackson, Comptroller of the Currency John Dugan and Federal Deposit Insurance Corp. Chairman Sheila Bair.

The National Association of Home Builders released a statement about the plan.

"The administration's plan to help struggling borrowers stay in their homes is one of several steps that can help stabilize the housing market and reassure consumers and investors in the mortgage market," NAHB's President Brian Catalde said in the announcement.

Sam Garcia worked in mortgage lending for twenty years prior to becoming publisher of MortgageDaily.com.

e-mail: [email protected]

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