Some facts/observations about Servicing, Loss Mitigation, Foreclosure, etc.

[davelj]

There’s understandably a lot of confusion about servicing, loss mitigation, etc. due to recent articles (regarding EMC’s efforts, for example) and the complexity of servicing agreements. I don’t have the last word on these subjects, but a friend of mine is the head of securitizations for the mortgage subsidiary of a large investment bank and I’ll share (paraphrase) his comments with you on this subject, which follow:

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Servicing agreements come in different stripes. Some allow for more flexibility in modifying loans and working with borrowers than others. Some agreements place strict limitations on the extent to which a loan can be modified, others merely allow the servicer to engage in “the customary practices that the servicer believes will maximize the value of the loan to the lender or MBS holder.” In either instance the servicer’s hands are tied to some extent regarding what they can and can’t do, although some agreements allow for more flexibility than others.

Here are the statistics for a standard securitization from Q406 for the 90+ days delinquent bucket:

39% sent to foreclosure
30% informal payment plan enacted
16% reinstated
9% paid in full
3% official repayment plan enacted
2% short sale
1% loan modification

The 61% that were not sent to foreclosure are considered “cured.” Some definitions:

informal payment plan: the servicer and the borrower have come to an “informal” agreement that the borrower will come up with the cash s/he’s short in fairly short order to get the loan current. Generally this is for situations where the servicer looks at the situation and thinks there’s a very good chance that the borrower is going to make things whole. Often there was a short-term problem regarding employment, medical issues, etc. In other words, there’s a high degree of certainty that the loan can be brought current once things are back to “normal” with the borrower.

reinstated: the borrower came up with all of the cash to make the loan current

paid in full: the borrower found a new loan (or source of capital) to pay off the old, delinquent loan. (This is where the real fear is for servicers because this number will decline a lot with the tighter lending standards.)

official repayment plan: like the “informal payment plan” but the plan is documented in writing

short sale: agreed-upon arrangement to sell property at a loss in order to minimize the lender’s loss and damage to the borrower’s credit rating

modification: the old note is thrown out and a new note with different (more lenient) terms is put in its place

In the current environment, the servicer will lean toward foreclosure. Why? Because when real estate values are falling “the first loss is often going to be the best loss.” The true modifications will typically only come when the servicer truly believes that within a few years the borrower will be able to live up to the original terms of the loans, for whatever reason. The servicers will NOT typically modify the loan to a borrower who could afford the loan at the 3% teaser rate and will not be able to afford the fully-indexed rate for the foreseeable future. The servicer has to believe that the borrower will be able to pay the fully-indexed at some point in the near future or they will favor foreclosure. Again, the guiding principle right now is that if the borrower has no hope of getting current at the fully-indexed rate within the foreseeable future, then foreclosure is the best option for the lender/MBS holder. They realize that prices are falling.

So, while we’re reading a lot about loan modification, the fact is that this will occur with a fairly small proportion of troubled loans. But that small percentage multiplied by a HUGE increase in troubled loans will still add up to some big numbers. Despite the anecdotes we read about in the news, however, the average borrower who runs into trouble will not see much relief from the servicer.

[PerryChase]

Good summary. I’m not in the mortgage business but that’s pretty much how i see the situation also.

Thanks for sharing with us.

[SD Realtor]

This was a good post Davelj. One thing that jumps right out at me is that the 30% informal payment plan enacted verses the 3% official payment plan enacted indicates that the entity servicing the loan is still inclined to roll the dice and hope that the event precipitating the NOD status was truly a one time event. In my opinion I think that while one time events do cause homeowners to go to default, the majority of offenders are chronic. Please understand I have no hard data on this, only my opinions on the American consumer in general.

SD Realtor

[sdrealtor]

Great info DLJ that I’ve not seen elsewhere. Glad you are aboard the s.s.piggington.

[AK]

Thanks for the information, especially the breakdown. I’m surprised that only 2% of defaults go through a short sale, though I guess that may change in the future! I’m also guessing that many of the informal payment plans fall through.

[Diego Don]

deee—Lerking———ENGAGE

Been enjoying the forums for months. Moved down here from LA about 9 months ago. And like all the knowlage shared here.

What I suspect, and have no hard facts to back up is this. The lenders don’t want to do short sales. Even thought it makes sense for the individual property. Because when it is known, even it this little spot of the internet. The word will get out. And they will have to deal with the many…..more…that………are going to go through, or want the same deal. Who wants to tell that to their boss. What boss wants to tell that to the stockholders.
Or like the Elton John album, “Don’t shoot me, I’m only the piano player”

Anyway I rant to much. But am intrested in the views of this forum that short sales are artificialy low.

[davelj]

The friend I referenced above just forwarded me this piece out of CSFB’s asset-backed research department. The summary is quoted directly below. It implies that modifications and the like will be increasing going forward. I’m sure this report is more-or-less accurate, but remember what CSFB’s bias is: they would prefer, if at all possible, to not raise alarm bells that would trash the value of the billions of dollars worth of ABSs they’ve put together. Again, I’m not saying these findings aren’t correct, just noting what CSFB’s bias is.

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CSFB Research
The Day After Tomorrow: Payment Shock and Loan Modifications

Summary

• Billions of dollars of subprime hybrid adjustable-rate mortgage (ARM) loans are set to reset in 2007. Compounding this is a weak housing market and subprime lenders’ significant tightening of underwriting guidelines, which will no doubt remove the refinance option for many of the subprime borrowers facing reset.

• Adding to the above is a philosophical shift in servicing practices from rapidly moving delinquent loans into foreclosure to keeping borrowers within the home. We found that many ABS deal documents give servicers a fair degree of leeway in working with borrowers.

• While the number of loan modifications to date has been relatively small, this can be partly explained by prepayment speeds that have remained relatively fast around the first reset. Therefore, servicers have not yet needed to employ
modifications in any significant amount.

• Loan modifications are a double-edged sword. They can lessen ultimate losses, but may also reduce excess spread, delay losses to when excess spread is lower, and mask true borrower hardship. For these reasons, servicers will likely
utilize loan modifications prudently and will enhance their current modification reporting.

• Loan modifications may alleviate to some degree the widely anticipated wave of foreclosures. We expect that both the magnitude of foreclosures will be less than commonly thought and the time span over which they occur will stretch out. Foreclosures will undoubtedly increase significantly, in our view, but modifications should attenuate the magnitude and change the timing.

[no_such_reality]

Any chance of a link to the article. A quick scan of Google doesn’t find it.

Not sure what to make of the article but… Foreclosures will undoubtedly increase significantly, in our view, but modifications should attenuate the magnitude and change the timing.

Also not sure how much leeway the servicers have in turning the ABS bundles into underperforming assets. Somewhere, someone is holding a bond backed by hard assets and they’re expecting a certain cashflow every month for it.

They know they funded a 100 people with the knowledge that two wouldn’t pay this year and tow more wouldn’t pay next year, but the rest will pay and those that didn’t will get their house liquidated for 70 cents on the dollar and as a investor, you get your money. I don’t see the math working out for modification in more 1 or 2%

[davelj]

I can’t provide a link because you have to log in with a password to get to the article. My buddy provided me with his password to access it.

You’re right, “someone is holding a bond backed by hard assets and they’re expecting a certain cashflow every month for it.” But at the moment they bought that bond they were explicity agreeing to the terms of the servicing agreement for the underlying collateral, which they could have read beforehand had they so desired. It’s called “due diligence.” (I know, I know… who has time to read silly legal documents when you’re busy jamming bonds.)

And, as the article suggests, it would appear that more than a few ABS servicing agreements allow for a some flexibility where modifications are concerned.

[no_such_reality]

And, as the article suggests, it would appear that more than a few ABS servicing agreements allow for a some flexibility where modifications are concerned

I’m sure they do, but I suspect by modification, what the servicers and industry really mean is what happened to Ms. Rodriguez in referenced articles about the Mod Squad.

Call me a cynic, but what I see is pretty simple,

1. they’re giving the borrower 2 to 3 extra months to get their act together and pay the bill and penalities.

2. they’re refinancing a loan with 28 years left back into a new 30 year loan (if equity level warrents it)

3. they’re delaying the foreclosure to get their (the bank’s) act together for foreclosures.

AFAICT, loan modification really means line 1, which is literally just a couple extra months to suck it up and pay the bill.

[davelj]

n_s_r, I basically agree with you. I think the loan modifications – which I consider to include both the formal and informal arrangements – will largely be relatively short-term in nature and will also generally be accompanied by extenuating cirumstances – job loss, medical issues, etc. (as with Ms. Rodriguez).

The average schmoe who could only afford their mortgage at the teaser rate and has very little hope of getting current at the re-cast rate (with no extenuating circumstances) won’t get much relief. That’s my take on the situation, anyway, having discussed this at length with someone who’s in the middle of this.

The problem, of course, is that there are a lot more “average schmoes” out there than there are people with extenuating circumstances.

Anyhow, we’ll see how it progresses.

[Author]

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