Bob The Homeowner Versus Net Present Value

January 17th, 2010 by admin

A little known aspect of the Obama Administration’s “Making Home Affordable” plan is the “Net Present Value” test which essentially determines whether a loan modification or a foreclosure and sale will provide a better return for the investors behind the mortgage in question. The calculation takes the proposed monthly payment in a home loan modification and multiplies it over the life of the loan (payment x 12 months x 30 years). If that total comes in above what a sale and foreclosure would yield, the calculation would favor a modification. If it falls short, the calculation would lean toward foreclosure and sale.

Foreclosures in many scenarios will favor the investors while a modification often works to the advantage of the servicer. For the investor, a foreclosure and subsequent sale may result in a loss of principle but money coming back to the investor can be re-invested in other vehicles which can provide yield and returns. The disadvantage for the servicers is that, without monthly payments from the property, they lose the fees they were able to charge the investor for handling the payments, billing, and communication with the homeowner. A loan modification, on the other hand, benefits the servicer by keeping the payment stream, and the fees they can charge on it, alive. The modification hurts the investor by forcing a mark to market valuation which reflects the loss on the mortgage (also known as a haircut) due to a lower interest rate and, if applicable, a reduction in principle.

The third party in the game is the homeowner (Bob) applying for the loan modification. It’s likely that the homeowner has heard of “Making Home Affordable” and is very aware of the 2% interest rates that were part of the headlines generated by the plan. Naturally, that’s the rate he wants. Unfortunately, getting Bob a 2% interest rate is not in the interest of either the investor or the servicer of his mortgage. For the investor, the lower the interest rate goes the bigger the haircut. Memorializing it in a modification will turn a theoretical haircut into an actual loss on the books. For the servicer, an interest rate at that low level can push the NPV score to a point where the test favors foreclosure over modification. If Bob’s property isn’t considered a lost cause it’s extremely unlikely that he’s going to see anything close to that 2% rate.

One of the other variables is Bob’s commission based income. His payments are going to be capped at 31% of his average monthly income, which has dropped considerably. In fact, it’s dropped so much that even by maxing his payment out at 31% of his monthly pay he falls below the estimated foreclosure and sale score. Conditions dictate foreclosure according to the net present value test.

The investor, seeing a score that clearly calls for foreclosure takes a look at sales statistics for Bob’s town and his neighborhood. Nothing is moving and foreclosure backlogs are growing. Average bids at auctions are coming in at less than 60% of the loan amount. Less than 2% of foreclosed houses are selling at auction. The estimate on what the property can realize in a foreclosure and sale is way too high for current conditions. If the house sells, and it’s a big if, it won’t be for anything near the price used in the NPV calculation. The investor decides to pull back on the foreclosure due to the regular hits he’s already taking in his portfolio and his aversion to putting another property into the portfolio. The pullback on the foreclosure doesn’t mean he’s going to allow for a modification, however. There’s a haircut waiting with the modification as well. This property is going to sit in limbo while things work themselves out.

There won’t be any communication regarding this stalemate between Bob, the servicer, or the lender. From Bob’s point of view the servicer’s people aren’t responsive and aren’t calling him back. The truth of the matter is that the servicer’s processors know as much about Bob’s situation as Bob does; not much. The sides settle in to the day to day of nothing happening which stretches to months.

The commentary from homeowners that have tried to modify their mortgages under the guidelines of Making Home Affordable runs along a thread very similar to that of our theoretical Bob. While much of the delay can be attributed to overload, staffing, and training issues at the lenders and servicers, the stalemate between servicers and their investors is bogging things down as well. The Safe Harbor Bill, passed by Congress in May, was aimed directly at this standoff. Its main objective was to remove the threat of lawsuits filed by investors when they felt that the servicers were acting on their own best interests in approving loan modifications.

While there may be a conflict of interest currently, neither side wants to go to war over this issue. Despite the increased autonomy given the servicers, it’s likely that they will still want to be on the same page with investors to preserve long standing relationships that have worked well over time. It therefore looks like limbo, status quo, and homeowners waiting for a knock on the door will rule the day and the near term.

Tags: Homeowner, Present, Value, Versus
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