The following updates our previous alert summarizing President Obama's Homeowner Affordability and Stability Plan (the "Plan"), which was first announced on Feb. 18, 2009. This update includes a summary of the additional guidelines (the "Guidelines") which were published by the Treasury Department on March 4, 2009, to implement the Plan's objectives.
As we previously stated, the Plan is aimed at accomplishing three key objectives: (i) refinancing mortgages for up to 4-5 million "responsible homeowners" in order to prevent additional foreclosures; (ii) providing a $75 billion initiative to help up to 3-4 million "at-risk homeowners" primarily through the use of uniform loan modifications; and (iii) keeping mortgage rates low by strengthening confidence in the government-sponsored entities ("GSEs"), Fannie Mae and Freddie Mac. While the Guidelines address each of these objectives in part, the Guidelines primarily set forth parameters for the loan modification program as well as guidance on the implementation of the Plan by lenders and servicers in conjunction with the U.S. government. Significantly, the Guidelines provide that servicers may immediately begin to modify eligible mortgages under the modification program. We have outlined the Guidelines below.
I. Refinance of "Responsible Homeowners"
As originally announced under the Plan, the Administration seeks to refinance the mortgages of up to 4-5 million "responsible homeowners." Responsible homeowners are those borrowers with conforming loans1 that are currently owned or guaranteed by Fannie Mae and Freddie Mac, and who are current with their mortgage payments, but have a greater than 80 percent loan-to-value ratio ("LTV"). Due to the depreciation of housing values, these borrowers are ineligible for most government and private refinance programs because their LTVs have been greater than 80 percent. Under the Plan, Fannie Mae and Freddie Mac will allow the refinance of these loans that they hold in their portfolios, or that they placed in mortgage-backed securities. These responsible homeowners will have the opportunity to refinance at today's low rates, which are generally lower than what the borrowers qualified for in the past couple years when their loan was originated.
The refinancing program would include loans where the new first mortgage, including any refinancing costs, will not exceed 105 percent of the current market value of the property. Note that borrowers with two liens on the property will still be eligible for the refinance program as long as the amount due on the first mortgage is less than 105 percent of the value of the property. In the case of two liens, the borrower's eligibility for the program will depend in part on the second lien holder agreeing to subordinate and remain in the second lien position. The current value of the property will be determined after the borrower has made the application to refinance. To qualify, each borrower must prove sufficient income to make the new refinance payment and provide proof of an acceptable mortgage payment history with their current lender.
II. Loan Modifications for "At-Risk Homeowners"
The Guidelines extensively detail the implementation of the loan modification program (the "Program") for "at-risk homeowners." At-risk homeowners are those borrowers in owner-occupied homes with conforming loans2 who have high combined mortgage debt compared to income or who are "underwater."3 Significantly, only first mortgages that were originated on or prior to Jan.1, 2009, are eligible for a loan modification. However, the Guidelines contain incentives (cash payments up to $1,500) to encourage servicers to eliminate second mortgages or other liens on the modified loan.
In addition to borrowers that are already in default, the Program also includes borrowers who are current on their payments but who are at risk of imminent default. Further, borrowers who have high total debt (i.e. not just housing debt, but also including car loans, credit card debt, etc.) equal to 55 percent or more of their income may still qualify for the Program, but will be required to enter a Department of Housing & Urban Development ("HUD") approved counseling program as a condition for the loan modification. All borrowers must fully document income, including signed IRS 4506-T, two most recent pay stubs, and most recent tax return, and must sign an affidavit of financial hardship.
Importantly, benefits to borrowers participating in the Program include the temporary suspension of any foreclosure action for the first three months of the Program and the absence of any minimum or maximum LTV ratio for participation in the Program. However, loans may only be modified once under the Program. Eligibility for the Program will sunset on Dec. 31, 2012.
B. Details on Modifications Methods and Incentives to Parties
The Program will have five primary components, as described below.
i. Joint Effort to Reduce the Borrower's Monthly Payment
The United States Treasury Department will work with financial institutions and investors to reduce the homeowners' monthly mortgage payments to an affordable level, which the Program targets as equal to a 31 percent "front-end" debt-to-income ("DTI") ratio.4 Under the Guidelines, the lenders must first reduce the current interest rates on mortgages down to a 38 percent front-end DTI. The Treasury will then match further reductions in interest payments, dollar-for-dollar with the lender, down to the 31 percent DTI target ratio. The reduction in interest rates must be accomplished in increments of 0.125 percent, to as low as two percent in order to achieve the target 31 percent DTI. Lenders are required to keep the modified payments in place for five years to ensure long-term affordability. After five years, the payments can increase annually by a rate of 1 percent until the modified rate is the lesser of the fully indexed contractual rate or the Freddie Mac Primary Mortgage Market Survey rate for 30-year fixed rate conforming loans.
If the reduction of the interest rate to the two percent floor is insufficient to bring the front-end DTI to 31 percent , then the lender must extend the term of the loan up to 40 years from the date of modification (if a term extension is not permitted, the amortization period must be extended). If the interest rate reduction and the term extension fail to achieve the target 31 percent DTI, the lender must forbear principal. No interest will accrue on any forbearance amount but the forbearance principal will become due on the first to occur of: (i) the maturity date; (ii) the sale of the property; or (iii) upon payoff of the balance.
Importantly, the Program also allows, but does not require, lenders to bring down monthly payments to these DTI affordability targets by providing principal reductions (i.e. principal forgiveness). The Program will provide a partial share of the costs of this principal reduction, up to the amount the lender would have received for an interest rate reduction.
The foregoing modifications are subject to the lenders' determination that modification under the Program is less costly than the process of foreclosing on the loan. Each lender is required to apply a Net Present Value ("NPV") test on the loans which compares the NPV of cash flows expected from a modification of the loan to the NPV of cash flows expected in the absence of a loan modification. If the NPV is greater with the modification, the lender must modify the loan. If the NPV is greater without the modification, the lender does not have to participate in the Program but must seek other foreclosure prevention alternatives including deed-in-lieu of foreclosure or short sale programs.
ii. Incentives to Servicers
The Program calls for an up-front fee of $1,500 to lenders/investors and $500 to servicers for each eligible modification that meets the Guidelines. Servicers will also receive "pay for success" fees, which will be awarded monthly as long as the borrower stays current on the loan and remains in the Program. These pay for success fees are capped at $1,000 each year for three years. To qualify for the "pay for success" fees, the modification must satisfy a de minimis test where the monthly PITIA payment, as modified, is reduced by 6 percent or more of the monthly PITIA payment prior to modification.
iii. Incentives in Cases Where Default is Imminent
The Program also includes an incentive payment of $1,500 to mortgage holders and $500 for servicers for loan modifications made in cases where the borrower is current on his or her payments, but is at risk of imminent default. Because the Administration believes it is essential to provide at-risk homeowners with assistance prior to imminent default, the Administration wants to incentivize modifications in these instances.
iv. Incentives to Borrowers
The Program also provides an extra incentive for borrowers to keep current under the modified loan, by giving a monthly balance reduction payment on the borrower's behalf that goes directly towards reducing the principal balance on the modified mortgage loan (the "pay for performance success payment"). If the borrower stays current on his or her payments, the borrower may receive up to $1,000 each year for five years in principal reductions. To qualify for the "pay for performance success payment", the modification must satisfy a de minimis test where the monthly PITIA payment, as modified, is equal to 6 percent or more of the monthly PITIA payment prior to modification.
Borrowers are also eligible to receive a payment of $1,500 in relocation expenses in order to effectuate short sales and deeds-in-lieu of foreclosure if they fail to qualify for loan modification under the Program.
v. Home Price Decline Reserve Payments
The Administration, together with the Federal Deposit Insurance Corporation (the "FDIC"), has created a partial guarantee program. The Plan calls for an insurance fund to be established by the Treasury Department in an amount up to $10 billion dollars. The insurance fund will be designed to discourage lenders from opting to foreclose on mortgages that could be viable in the present day, due to fear that home prices will fall even more in the future. This fund would incentivize lenders to make additional modifications in the present day by assuring that if home valuations decline more going forward, lenders will have access to insurance reserves. The Program states that owners of loans that are modified would be provided with an additional insurance payment on each modified loan that will be tied to declines in the S&P/Case-Shiller home price index. These payments could be set aside as reserves, providing a partial guarantee in the event that home price declines, and therefore losses in cases of default, are higher than expected.
C. Additional Key Points to the Modification Program
Note that the Program will focus on creating "sound modifications." Under the Program, if the total expected cost of a modification for a lender taking into account the government payments is expected to be higher than the direct costs of putting the homeowner through foreclosure, that borrower will not be eligible for modification. Moreover, Treasury will not provide subsidies to reduce interest rates on modified loans to levels below 2 percent. Finally, note that unless lenders received funds available under the Financial Stability Plan (announced by the Administration on Feb.10, 2009), they are not required to participate in the Program. However the Administration expects most major lenders will participate in the Program due to the new incentives provided for modification. The Treasury Department will require that all Financial Stability Plan fund recipients participate in the Program.
Under the Guidelines, servicers must adhere to any existing express contractual restrictions with respect to modification of loans. Significantly, this guidance contrasts sharply with the language under another legislative proposal, H.R. 788, sponsored by Congressman Paul Kanjorski, which would expressly permit servicers to disregard pooling and servicing agreements for purposes of loan modifications.
D. Other Salient Aspects of the Plan
i. Uniform Guidelines for Loan Modifications
In connection with the Program, the Administration will work with the FDIC, the Federal Housing Administration (the "FHA"), the Federal Housing Finance Agency (the "FHFA"), and the federal banking agencies, to develop uniform guidelines for sustainable mortgage modifications for all federal agencies and the private market. The Guidelines published today reference further uniform guidelines to be published by each agency.
ii. Bankruptcy Cramdown Provisions
Importantly, the Plan notes that the Administration will seek careful changes to bankruptcy law regarding individual bankruptcy filings. Under the changes the Administration feels are necessary, when an individual enters personal bankruptcy proceedings, their mortgage loans in excess of the current value of their property would be treated as unsecured debt. This change would allow a bankruptcy judge to develop an affordable plan for the homeowner to continue making payments. The Plan seeks to permit bankruptcy judges to modify mortgages originated in the past few years as a last resort when borrowers have exhausted other options. The Plan states that this "cramdown provision" will apply only to existing mortgages under Fannie Mae and Freddie Mac conforming loan limits.
Please note that the Obama Administration's more measured approach to bankruptcy cramdown legislation is at odds with Congressional Democrats' more aggressive stance on the issue. In fact, the House is expected to pass legislation on March 5, 2009, that incorporates provisions that are considerably more far reaching than those set forth in the President's proposal.
iii. Oversight and Quarterly Meetings
Loan-level data from modifications made under the Program will be gathered in order for the government and the private sector to measure success and make necessary changes, where required. To this end, the Treasury Department will meet quarterly with the FDIC, the Federal Reserve, HUD, and the FHFA, to ensure that the Program is on track to meeting its goals.
iv. HOPE for Homeowners and Local Programs
In order to ensure that more borrowers participate in the Hope for Homeowners Program, the FHA will reduce fees paid by borrowers, increase flexibility for lenders to modify troubled loans, permit borrowers with higher DTIs to qualify, and allow payments to servicers of the existing loans. In addition, as part of the American Recovery and Reinvestment Act (the "Recovery Act") signed by the President on Feb. 17, 2009, HUD will award $2 billion in competitive Neighborhood Stabilization Program grants for innovative programs that reduce foreclosure. The Recovery Act also includes an additional $1.5 billion to provide renter assistance, reducing homelessness and avoiding entry into shelters
III. Strengthening Fannie Mae and Freddie Mac
The third part of the Plan provides more strength and resources to Fannie Mae and Freddie Mac. The Plan announced that the Treasury Department is increasing its Preferred Stock Purchase Agreements with Fannie Mae and Freddie Mac to $200 billion each from their original level of $100 billion each. The Treasury Department notes that it will also continue to purchase Fannie Mae and Freddie Mac mortgage-backed securities to promote stability and liquidity in the marketplace. Simultaneously, the Treasury will begin increasing the size of the GSEs' retained mortgage portfolios by $50 billion to $900 billion (along with corresponding increases in the allowable debt outstanding). The Administration will work with Fannie Mae and Freddie Mac to support state housing finance agencies in serving homebuyers across the nation on the state-level. Finally, the Administrations emphasizes that the $200 billion in funding commitments are being made under the Housing and Economic Recovery Act and do not use any money from the Financial Stability Plan or the Emergency Economic Stabilization Act or the TARP programs.