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Daily, in the newspapers, radio, television and the internet, articles are written about the difficulty that borrowers face in getting loan modifications.  These reports come not just from reporters, but from loan modification companies and also attorneys who are attempting to do the loan modifications.

At the same time, the Federal Government and the Obama Administration announce new programs to assist homeowners in getting loan modifications. These programs are going to solve the problems that homeowners have, and are going to save their homes. Yet, closer inspection of the program’s details raises eyebrows about if the new program will benefit homeowners. Then within a few months of implementing the program, reports come out that the programs are not working. Homeowners are not getting the needed help. Foreclosures are increasing.

Next, states like California decide to try and pass legislation to prevent homeowners from paying money upfront to loan modification companies and attorneys for assistance in dealing with the Lenders and Servicers. Then President Obama declares that homeowners should not pay for loan modifications and that their lenders and servicers are doing the modifications for free.

Who does a homeowner believe? What is the real truth? This article will attempt to shed some light on the issues. I will focus primarily upon loans that have been securitized. These are loans that have been sold to investors, unlike portfolio loans that are kept by banks and lenders. Portfolio loans can be easier to modify, if the lender is cooperative.

What type of help can be expected from the lenders and servicers?

Typically, when a borrower falls behind on a mortgage, there are few programs available to help them get current. Refinances are generally out of the question, and bankruptcy is not a viable option for most people. What can homeowners then expect from the Servicer?

• The First Program likely to be offered is a forbearance agreement. This is an agreement that “allows” a homeowner to catch up on his late payments, without really modifying the loan. The Servicer will “offer” the homeowner a choice of usually from 4 to 12 months of higher payments, to bring the loan current. These payments are generally $1,000 or more higher than the original payments, and will often at the end of the time period end up requiring a lump sum payment to get caught up. There is no attempt by the Servicer to address the root causes of the payment issues, so the positive effects of this program are dubious to say the least.A variation of this program is to have the borrower bring in a lump sum payment at the beginning of the forbearance plan, a “Good Faith Payment”. After 4 months of making regular payments, the Agreement is made to sound like if you complete 4 months of payments on time, you will have the loan modified to something that you can afford. If you can’t make the payments, then you must come in with the rest of the lump sum that is due. Almost always, you are denied for the loan modification. The reason for the denial is that you did not meet the guidelines. In reality, you have proven that you can make your regular payment, so why give you a loan modification?This offer has been quite typical of what America’s Servicing Company does.
• The Second Program you are likely to see is an actual Loan Modification. In this program, an actual Loan Modification will be offered to the homeowner. The offer, if sincere, will usually entail an interest rate reduction down to anywhere from 2-5%. It is good for a limited period of time, before the rate increases again. I have seen these programs last from 6 months, up to 5 years. Occasionally, I will see one for thirty years, but that offer will have interest rates that are 5-6% usually.What is bad about these offers is that at the end of 5 years, you are back where you started. Either you can make the monthly payment due then, or you have to seek another loan modification, or you prepare to sell or lose your home. Most lenders will make this type of offer.
• The newest offer being made by the Fannie Mae and Freddie Mac backed loans is similar to the second program. A trial period of 4 months is offered to see if you can make the new payment. At the end of the trial period, if you have made all payment in a timely manner, then the Servicer is supposed to offer you a loan modification. This program is too new to get any reliable reading on it yet. Within the next month or two, we will begin to see if the lenders will offer permanent changes.
• There is another program for loan modifications that homeowners are hoping to get. That involves a reduction in principal on the loan amount. These offers are very rare, as I will explain later.It must be noted that the Fannie Mae and Freddie Mac programs do offer loan reductions, as well as World Savings loans on occasion. Do not be fooled by these offers. They require that if you sell the home, or when you come to the end of the loan and you think that you have paid off the mortgage, you will pay back the principal reduction that was given to you at first. So it really is no reduction at all. It simply forces you to stay in your home for many, many years, with no hope of selling or moving up until your home has appreciated in value again.

I must warn homeowners that any company who says that they are doing loan modifications and getting principal reductions of any significant amount, i.e. 25% or more, and then represent that they are getting these results continuously is likely a scam. I know of no companies regularly getting such reductions. When a company claims to do so, I ask for proof, and never hear from them again.

Why Aren’t Servicers helping homeowners?

This is the question that people are asking. Occasionally, you will hear a partial answer to the question, usually like a recent New York Times article whereby the author stated that by starting foreclosure and delaying the process, the Servicer earns more fees through late payments, attorney fees and other junk fees. This is a short-sighted answer from someone who really does not understand the process. The actual reason is much more complicated.

When loans were executed, they were usually sold to investors in the process known as Securitization.  To simplify the explanation, loans were “bundled together” by the lender and placed into trusts for IRS tax purposes and then for sale to investors. The “Issuing Entity” of the Securities “sliced and diced” the loans into “tranches”. Theses tranches were sold to securities dealers who could then sell the tranches to investors, or if they desired, they could again slice and dice the tranches again into smaller pieces and have these sold to investors.

To ensure that all parties were paid monthly, a trustee was named to oversee the payments and the correct functions of all the parts and parties to the transactions.  The trustees often included US Bank, Citibank, Chase, Deutsche Bank, Lasalle Bank, Lehman, and others.

All factors related to the Securitization Process is governed by the “Pooling and Servicing Agreement” for each trust.  The Agreement covers all aspects of the transaction from the origination of the loan, to the final disbursements.  This Agreement is where the problem in negotiating loan modifications and principal reductions occur.

The Agreements all have similar language regarding loan modifications.  Paraphrased, the Agreements authorize the Master Servicer to do loan modifications when the default of a particular loan is inevitable or likely.  It is this phrase that “prevents” servicers from modifying a loan that the borrower is up to date on payments. Here is the wording of a New Century Agreement regarding defaults:

“The servicer will be required to act with respect to mortgage loans serviced by it that are in default, or as to which default is reasonably foreseeable, in accordance with procedures set forth in the servicing agreement. These procedures may, among other things, result in (i) foreclosing on the mortgage loan, (ii) accepting the deed to the related mortgaged property in lieu of foreclosure, (iii) granting the mortgagor under the mortgage loan a modification or forbearance, which may consist of waiving, modifying or varying any term of such mortgage loan.”

(including modifications that would change the mortgage interest rate, forgive the payment of principal or interest, or extend the final maturity date of such mortgage loan) or (iv) accepting payment from the borrower of an amount less than the principal balance of the mortgage loan in final satisfaction of the mortgage loan. These procedures are intended to maximize recoveries on a net present value basis on these mortgage loans.

Notice the portion that is underlined. The Servicer must act with regard to what actions will maximize the money returned to the investor and will minimize their losses.

Furthermore, the Servicers of these loans have no vested interest in doing loan modifications.  They are simply acting as “collection agencies” most of the time.  In fact, not foreclosing is in the worst interest of the Servicer. There is another section of the Agreement that must be considered:

“The servicer is required to make P&I Advances on the related Servicer Remittance Date with respect to each mortgage loan it services, subject to the servicer’s determination in its good faith business judgment that such advance would be recoverable. Such P&I Advances by the servicer are reimbursable subject to certain conditions and restrictions, and are intended to provide both sufficient funds for the payment of principal and interest to the holders of the certificates. Notwithstanding the servicer’s determination in its good faith business judgment that a P&I Advance was recoverable when made, if a P&I Advance becomes a nonrecoverable advance, the servicer will be entitled to reimbursement for that advance from any amounts in the custodial account. The Trustee, acting as successor servicer, will advance its own funds to make P&I Advances if the servicer fails to do so, subject to its own recoverability determination and as required under the trust agreement. The servicer (and the Trustee as successor servicer and any other successor servicer, if applicable) will not be obligated to make any advances of principal on any REO property. “

This is the second part of the problem. Simply stated, for each payment missed by a homeowner, the Servicer, from its own money, must “Advance” funds from its own money, to ensure that the payment stream to the Trust and Investors are kept up. They must keep advancing this money until they foreclose on the property and take back the home. At that point, they no longer need to keep the Advance on that property going, but they will still not be able to recover their own money until the property is actually sold.

To be totally blunt, it is in the best interest of the Servicer to foreclose on the property as fast as possible to stop having to make advances out of their own money. This was the true purpose of TARP, to give the servicers money so that they would have money to continue to advance funds to the Trusts, without having to trigger a gigantic foreclosure wave (this also explains why so many people are getting to live in their homes even when they are not making payments – Uncle Sam is substituting the payments for them).

At this point, another factor comes into play, “Net Present Value”.

Net Present Value

Net Present Value is a mathematical equation. Its purpose is to determine what will earn an Investor the best return for different potential investments. The equation takes the payments to be made over a period of time for different investments in different time frames and calculates what the return would be in today’s dollars. It is a methodology that compares “apples to apples” instead of “apples and oranges”. An attempt to fully explain the equation and the process of determining Net Present Value is not in the purview of this article.

When a request for a loan modification is made, the Servicer must determine what will be of most benefit to the Investor. Which of these three options will return the most income to the Investor?

• Make no modification of the loan and balance the likelihood of the homeowner being able to repay the loan against the risk and percentage of default and the potential payments in Present Dollars.
• Modify the loan and determine the payments to be made in Present Dollars.
• Foreclose on the property and after all costs and losses, determine the Present Dollars left to the Investor.

In addition to the Net Present Value Test, the Servicer will also factor into the decision as to what will get them back their “Advances” to the Trustee.

• If they don’t modify the loan and foreclose immediately, then they must continue paying the Advances.
• If they modify the loan and do not get an upfront payment of past due amounts from the homeowner, then they must wait to get back Advances as the borrower makes the “larger” payment than what was before.
• If they modify the loan at a lower payment than what is contractually required, then the Servicer must make up the difference in Advance payments, unless the Investor has agreed to the modification (this virtually never happens).
• If the Servicer forecloses, then they stop making the Advance payments and when the property is sold, they keep their Advances out of the proceeds.

As can be seen, it is certainly in the best interest of the Servicer to foreclose on the property.

Determining Net Present Value

The process for determining the Net Present Value of either not modifying the loan or else foreclosing on the property is relatively straight-forward. The calculations are not that difficult. However, when considering the Net Present Value of the Loan Modification, that is where the issues arise.

To determine the Net Present Value of the Loan Modification, the Servicer must determine exactly how much the homeowner can afford to pay. Pay too much, and the homeowner will still likely default. Pay too little, and the Investor is losing money. So the Servicer must do a Debt Ratio Analysis like when the loan was approved, except that instead of it being Stated Income and having either a 45% or 50% total Debt Ratio, the income must be totally documented and the Housing Debt Ratio must usually be 31% for Fannie Mae, and can be up to 38% for private investors. In essence, the Servicer is now going to try and correct the mistake of not properly qualifying a person when he got the loan, and with default in evidence, the Servicer will do things “right”.

To submit for a loan modification, the Servicer will require that the homeowner provide verification of all income and all debts and expenses. The income must be realistic and meet underwriting standards, no non-verifiable income allowed. The expenses must be realistic as well. If the homeowner claims that food costs are $800 per month for a family of three, then receipts had better be provided showing it is realistic and steak and lobster is not being eaten twice a week. Clothing expenses and entertainment expenses will not be accepted.

At the point that all documentation has been provided, the Servicer will then determine what modifications are necessary to get the homeowner down to a 31% Debt Ratio. (Most are going to use 31%, because it makes qualifying for a loan modification much more difficult.) The Servicer will start reducing the Interest Rate incrementally until such time as the 31% is achieved. If the lowest level of Interest Rate is reached and the 31% Debt Ratio is still not present, then the Servicer will play with reducing the principal, if it is allowed. (The minimum basis Interest Rate is 2% above the 10 Year Monthly Treasury Average, the MTA Index.)

If principal reduction is not allowed, and the homeowner cannot reach the 31% Debt Ratio at the minimum Interest Rate, then the modification will not be approved. If principal reduction is allowed, it is likely that the reduction amount will be “forgiven” only until such time as the borrower can repay the loan at which time he must pay the “forgiven” amount, or when he sells the home and then must pay the amount.

Let us assume that the borrower has been able to reach the 31% Debt Ratio Guidelines. At this point, the lender will now do the Net Present Value Test for the modification. The Servicer will factor into the Test the likelihood of the borrower defaulting even after the modification, and other various events. (This gives the Servicer the ability to manipulate the data.) The results are compared to not doing a loan modification and for foreclosing. What works out best for the Investor is what the Servicer will chose, while also considering how quickly they can get their own money back.

I previously mentioned that the Net Present Value calculation for foreclosure was relatively easy. I still hold to that statement. However, there are issues with the calculation.

For one, the Servicer is the party that determines all the factors and the values used in determining the Net Present Value. And, it is the values that are assigned to particular factors that will determine the outcome. Some factors to consider:

1. The easiest factor to manipulate will be the current value of the property. The Servicer will provide a value to the property that may or may not be realistic. This value would set the baseline for the Test.
2. How long it takes the property to sell and at what price it would sell then.
3. Condition of the property and how much it would cost to bring the property back up to resale shape.
4. Cost of foreclosing.
5. How much in Advanced Payments had been made to the Investor.
6. Sales commission.
7. Legal Costs.

Depending upon the values assigned to these and other factors by the Servicer, the decision to foreclose or not to foreclose could be easily manipulated.

It must also be remembered that the Servicer is likely to believe that this crisis will continue for many years. Foreclosures are going to continue. Unemployment is going to increase as the economy turns worse. Home values are going to continue to drop. And, as homeowners become further underwater in home values, the decision to simply walk away will become much easier. Under these circumstances, for the Investor, it would make sense for the Servicer to foreclose on every property that they could, when they could, and to salvage as much of the remaining value of the investment as possible, instead of waiting for the “inevitable” loss. One could easily compare it to the Stock Market, where you sell early, take what you can when you can, and limit your losses.

What You Can Do About It

Now that I have presented such a gloomy picture of what to expect with foreclosure, what can be done about it with the homeowner who is in trouble and looking to save his home? After all, the Servicer is not on his side, and can work the numbers so that the Net Present Value Test will indicate that foreclosure is the best option. So what is the homeowner to do?

Having seen the games that the Servicer plays time and again, trying to discourage the homeowner to such a point that he gives up and walks away, the answer is at least simple to say:

Fight Back!!!!

Don’t let the Servicers beat you into submission. They created this mess with inappropriate lending. Chances are that you should probably have been declined for the loan, but since the lender did provide you the loan, then they have to answer for it. (This may be hard for many to accept that you really did not qualify for the loan, but it is likely the truth.)

In my opinion, based upon what I have seen the past two years, the best way to fight back will be to obtain an attorney, have a true forensic audit done on your loan, and then prepare to do battle because you are going to war against the lender.

If the lenders want your home, make them pay for it. Make them realize that you will take them to court and fight them every step of the way. If you lose a round, you come back even stronger on your appeal and fight harder.

But beware. Don’t set it up in your mind that you are going to go to court and have the jury award you the home free and clean, and putative damages. It will not usually happen, and mostly because the lender has more resources and money than you have, and they can afford to drag the proceedings out until you run out of money.

Instead, your goal is to get the lender “to the table” whereby reasonable and frank discussions can occur that will lead to resolving the situation. Often, this can occur with as little action as the filing of a Restraining Order temporarily stopping the auction of your home. Sometimes, it might take sterner terms. But the goal is to use the “minimum amount of legal force necessary” to bring the lender to the table.

By following this type of action, you may be able to save your home and have an excellent modification or reduction. Does it always work? No. There are no guarantees. But, it is better than simply walking away, letting the lender have your home, and then regretting the decision for the rest of your life.

The problem is that most people, including loan modification companies and attorneys do not understand what they are fighting against.  Nor are they helped to understand the fight because of incompetent “audit” companies who do not understand this either.  LFI will attempt to shed light on this subject as we continue our series of articles.

Disclaimer:  Pulatie and LFI are not attorneys and do not dispense legal advice. The purpose of LFI is to assist attorneys and homeowners in their fight.

by Aaron Krowne and Moe Bedard

A story we broke this past Tuesday in regards to the Ohio Federal Court Deutsche Bank ruling has been getting a tremendous amount of attention, and probably rightfully so. It wasn’t long after we posted it here that dozens of bloggers and forums were circulating the news around cyberspace.

Calculated Risk’s Tanta did a total of three blog posts of follow-up (here is one, and another), largely intended to rebut our points, and Gretchen Morgenson did a great New York Times piece yesterday, bringing much more visibility to the issue. Even Nigel and the Haterz gave us credit where credit is due:

“It may be a Casey fantasy, but it is true in real life. I Am Facing Foreclosure broke a story that was respected enough and accurate enough to be stolen by the New York Times.”

Well, maybe not stolen… but apparently we were on the right track.

Tanta had numerous issues with our conclusions and apparently those of April Charney (who is actually an attorney on these sorts of cases, mind you). We wanted to reply to some of the those objections here. We don’t believe the issue is settled, and our lawyers aren’t budging.

But first, we want to establish that even Tanta seems to agree with us on one critical point: foreclosures are going to be more expensive for investors in mortgage-backed securities than they might have hoped. Perhaps much more expensive. While Deutsche Bank may have a chance to “get its ducks in a row” yet, since the foreclosures were not dismissed with prejudice, that ain’t exactly nothing.

Tanta might not see this as a big deal or game-changer, but we suspect investors will.

That point aside, there is something more profound going on here. Tanta’s core criticism (as we understand it) is that finding the assignments was simply a matter of due diligence that Deutsche Bank was attempting to shirk out of sloth. Not being legal gurus ourselves, we went back to April Charney for further comment and clarification. She had this to say:

“First of all, it is not a fair assumption that “nobody could find the original assignments.” The “original” assignments from the originating lender to the trust don’t exist to be found until after the foreclosure actions are filed and the loans are already supposedly in default. It would be very interesting to see where these nonperforming loans have been booked until now. This is an epidemic across the country.

As to the real ramification of the Ohio decision, aside from slowing the foreclosure trains, is that the fact that there were no “original” assignments rendering the sales of the mortgages to the trusts, in violation of the true sale obligations imposed by securities law. ”

That, again, does not seem like nothing to us.

April also passed us this link for a primer on the true sale issue. She further directed us to this article By Tim Reason (love the name) regarding true sale in securitizations, which is from 2003.

What we gleaned is that the “true sale” issue (specifically as it comes to securitization) has never been settled. One would think from the Reason article that securitizations would have fallen out of favor after the tech stock collapse, where they were used for various sorts of accounting legerdemain and producing synthetic AAA-ratings (including, famously, in the Enron case). Instead, the problems were swept under the rug and everyone got back on the merry-go-round a second time for the housing bubble. Reason’s article contains this ominous quote on that subject:

Kenneth Kettering, associate professor at New York Law School, argues that the securitization industry owes its very existence to the willingness of rating agencies to rate ABS securities based on “extravagantly hedged” true-sale opinions. “No competent lawyer ever gave a simple flat opinion that the asset transfers involved in a securitization transaction constitute a ‘true sale.’ Indeed, given the absence of controlling case law, a lawyer could not responsibly do so,” he wrote in a letter to Congress. “These all-but-liability-proof legal opinions underline the fact that the parties to a securitization transaction are knowingly assuming a serious legal risk.”

Somehow we suspect that nobody explained this state of affairs to your local pension fund, the Chinese, the Europeans, the Canadians, and other sundry parties exposed to questionable securitized MBS pools. But hey, what’s a few trillion between friends? (We’re all friends, right?)

So this time around, securitization was scaled-up to a greater extent than ever before, despite the fact that the fundamental issues of ownership were not settled. Echoing (and reinforcing) the pay-to-play ratings complex that emerged at the same time, the securitization complex chugged merrily along, while profits were high and defaults were low.

But now these fundamental issues are getting their day in court again, and if this Deutsche Bank ruling is indicative, it isn’t going well for the investor class. Will there be another muddle-through, like last time?

The conflagration seems unlikely to blow out quite so easily this time around. Previously, true sale challenges could be counted on to be rare and occur only in the occasional large-scale corporate bankruptcy—i.e., when a creditor or the bankrupt company itself wanted to “raid” the assets of a securitization to satisfy obligations. Now, the challenges are threatening to proliferate right along with the exploding number of foreclosure cases across the country.

We followed up with California mortgage attorney Nathan Fransen about this landmark case and its implications:

“California is a non-judicial foreclosure state. This means the banks do not file a complaint in court to foreclose on the property. They simply execute a Trustee Sale. This requires them to provide notices in strict accordance to the applicable laws. The sale is a private action that effectively terminates ownership rights by the borrower.

Typically the sale is followed up by an unlawful detainer proceeding to evict the former owners. The way in which the logic of this court could be used is by filing a complaint and Preliminary Injunction in a court in the county where the property is located. The injunction would stay any foreclosure proceedings by the trustee. A declaratory judgment could also be obtained that would declare the rights of the trustee invalid and thus prevent them from taking future actions against the homeowner.

There are other claims worth exploring that are derivatives of all this. For example, perhaps a claim for slander of title since the trustee did not have the rights to initiate the foreclosure process. Claims under California Business and Professions Code Section 17200 (UDAP statute) may also be available. The leverage that a consumer attorney could use from this type of an action may very well make the difference between a homeowner staying in their home, or packing their bags.”

So quoth the lawyers. Hence we take it that, far from a trivial matter of paperwork, Boyko’s decision is serious business – a tangible ray of hope for distressed homeowners, and a huge headache for securitized mortgage investors (we’re not even sure it’d be proper to use the term “holders” or “owners” anymore).

(Update, Nov 16: And now, apparently, the decision has been reinforced again, with another ruling.).

by Moe Bedard and Aaron Krowne

Judge Christopher A. Boyko of the Eastern Ohio United States District Court, on October 31, 2007 dismissed 14 Deutsche Bank-filed foreclosures in a ruling based on lack of standing for not owning/holding the mortgage loan at the time the lawsuits were filed.

Judge Boyko issued an order requiring the Plaintiffs in a number of pending foreclosure cases to file a copy of the executed Assignment demonstrating Plaintiff (Deutsche Bank) was the holder and owner of the Note and Mortgage as of the date the Complaint was filed, or the court would enter a dismissal.

The Court’s amended General Order No. 2006-16 requires Plaintiff (Deutsche Bank) to submit an affidavit along with the complaint, which identifies Plaintiff as the original mortgage holder, or as an assignee, trustee or successor-interest.

Apparently Deutsche bank submitted several affidavits that claim that Deutsche was in fact the owner of the mortgage note, but none of these affidavits mention assignment or trust or successor interest.

Thus, the Judge ruled that in every instance, these submissions create a “conflict” and they “do not satisfy” the burden of demonstrating at the time of filing the complaint, that Deutsche Bank was in fact the “legal” note holder.

While the decision is great for homeowners in distress (due to providing a new escape hatch out of foreclosure), it is a big blow to the cause of sorting out the high-finance side of the mortgage mess.

Jacksonville Area Legal Aid Attorney, April Charney, broke this news to us via email and made these comments in regards to the Ohio Federal Court ruling (emphasis ours):

This court order is what I have been saying in my cases. This is rampant fraud on every court in America or nonjudicial foreclosure fraud where the securitized trusts are filing foreclosures when they never own/hold the mortgage loan at the commencement of the foreclosure.

That means that the loans are clearly in default at the time of any eventual transfer of the ownership of the mortgage loans to the trusts. This means that the loans are being held by the originating lenders after the alleged “sale” to the trust despite what it says per the pooling and servicing agreements and despite what the securities laws require.

This also means that many securitized trusts don’t really, legally own these bad loans.

In my cases, many of the trusts try to argue equitable assignment that predates the filing of the foreclosure, but a securitized trust cannot take an equitable assignment of a mortgage loan. It also means that the securitized trusts own nothing.

So with this decision, it appears confirmed that investors in the mortgage debacle may in fact own nothing—not even the bad loans they funded! It seems their right to the cash flow from the underlying properties does not extend to ownership of the properties themselves; thus clouding the recovery picture considerably.

Charney further remarked to us:

This opinion, once circulated and adopted by state and Federal courts across the country, will stop the progress of foreclosures, at first in judicial foreclosure states, across America, dead in their tracks.

We agree with additional remarks Charney made pointing out that this decision has major adverse implications for the prospects of an amicable financial workout for the various investor contingents in mortgage-backed securities (MBSes). Doubt is cast on where the full write-downs will eventually land, and this uncertainty can only be expected to further harm the market value of MBS and MBS-based synthetic securities, already in shambles purely due to rising underlying delinquencies. Investors in these securities might have assumed—wrongly, it turns out—that they actually owned some “real estate” in these deals.

To paraphrase Jim Cramer, “They own nothing!”