In an attempt to jump-start the effort to encourage lenders to modify outstanding mortgage loans, today the Federal Deposit Insurance Corporation (the “FDIC”) published details of a proposed mortgage modification program (the “Program”), which is based on the modification program instituted by the FDIC at IndyMac Federal Bank. The FDIC believes that the Program could be applied to the estimated 1.4 million of non-GSE1 mortgage loans that were past due at June 30, 2008 and an additional 3 million non-GSE mortgage loans that FDIC projects will become delinquent by the end of 2009.2 The FDIC believes that nearly half of these loans could be eligible for modification under the Program.
The Program would pay mortgage servicers $1,000 to cover expenses for each loan modified in accordance with the Program and would provide for the government to share in 50% of any losses incurred if a modified loan subsequently re-defaults.
The Program would have the following basic terms:
- Eligibility limited to loans secured by owner-occupied properties.3
- To promote sustainability, loss sharing would be available only after the borrower has made six payments on the modified mortgage.
- Loss sharing for loans where the loan amount is greater than 100% of the value of the underlying asset (“LTV”) would be progressively reduced from 50% to 20%. No loss sharing would be available where the LTV exceeds 150%.
- Loan modification decisions would be based on a standard test comparing the expected net present value of modification versus foreclosure, using an “affordability” criteria where a borrower’s debt to equity ratio could not exceed 31%.
- Participating servicers would be obligated to review all loans under management and to modify all loans that pass the testing criteria. Failure to do so would result in disqualification from further participation in the Program until a systematic program was put in place. No modification would be required in cases where the modification does not reduce the monthly payment by at least 10%.
- Loss determination calculations would be based on the difference between the net present value of the modified loan and the amount obtained in a disposition by refinancing, short sale or foreclosure sale, net of disposal costs.
- Loss sharing would end eight years after the modification.
The FDIC estimates that approximately 2.2 million loans could be modified under the Program at a cost of approximately $24 billion. These estimates are based on the assumption that re-default rates would be 33%.4 On that basis, the FDIC estimates that a total of approximately 1.5 million foreclosures could be avoided under its Program. The FDIC’s calculations are based on an “average Program cost” of 5.5% of the amount of mortgages modified. The FDIC has not provided any detail on its calculation of that cost estimate, so testing the Program cost using other assumptions is not possible at this time.
The FDIC program differs in several important respects from the program announced on Tuesday by Fannie Mae and Freddie Mac. That program would, among other things, require borrowers to have missed three monthly payments and uses a higher debt to equity ratio of 38%, which would presumably increase the risk of future re-defaults.
According to published reports, the FDIC’s proposed Program has the support of leading congressional Democrats. However, Treasury Secretary Paulson, in a speech yesterday, opposed funding the Program out of the existing TARP program. In light of Treasury’s resistance, further Congressional action may be required to implement the Program.