Foreclosing Foreclosures

The Homeowners Affordability and Stability Plan (“HASP”) is one of the many different packages of new legislation introduced recently as part of the U.S. government’s efforts to stimulate the economy. HASP was announced by President Obama on February 18, 2009, and is intended as a “foreclosure prevention plan” to help 7 to 9 million families restructure or refinance their mortgages so as to avoid foreclosures. This article provides a brief summary of the key components of HASP and its impact on banks.

Although HASP and its regulations are still under development, the U.S. Treasury released an executive summary and other details of HASP on February 18, 2009. Guidelines detailing protocols for loan modifications and defining key concepts under HASP are expected to be announced by March 4, 2009. The key components of HASP, as described in the executive summary and related materials, are as follows:

1. Refinancing Program. A mortgage refinancing program to provide for access to low-cost refinancing for “responsible homeowners” who have been negatively impacted from falling home prices. This component will provide homeowners with conforming loans owned or guaranteed by Freddie Mac or Fannie Mae the opportunity to refinance at a lower rate. For example a family with a mortgage of $200,000 on a home worth $220,000 would still be able to qualify under this program for a low interest rate loan, even though the homeowner’s equity is only about 10% (below the 20% typically required for a lower interest rate).
2. Homeowner Stability Initiative. This initiative will combine a variety of benefits to assist “at-risk” homeowners in obtaining low-cost refinancing. The benefits will include an interest rate reduction (the cost of which is partly shared by the lender), incentives to mortgage servicers, including success fees, incentives to borrowers to stay current, incentives to mortgage holders, and a partial FDIC guarantee initiative.
3. Strengthening Confidence in Fannie Mae and Freddie Mac. The U.S. Treasury will take steps to strengthen confidence in Fannie Mae and Freddie Mac, such steps to include increasing its funding commitment to ensure the strength and security of the mortgage market and to help maintain mortgage affordability, increasing its Preferred Stock Purchase Agreements (from the original $100 billion each to $200 billion each), continuing to purchase Fannie Mae and Freddie Mac mortgaged backed securities, and increasing the size of their retained mortgage portfolios by $50 billion.

Other critical components of HASP, which are particularly relevant to banks and other mortgage lenders, include the following:

• Developing Guidelines for Loan Modifications. The Obama Administration is working with the FDIC, other federal banking and credit union regulators, the FHA and the Federal Housing Finance Agency, to develop guidelines for sustainable mortgage modifications for all federal agencies and the private sector. The U.S. Treasury will develop guidance for loan modifications across the mortgage industry. All financial institutions receiving Financial Stability Plan financial assistance going forward will be required to implement loan modification plans consistent with Treasury guidance. In addition, these guidelines will apply to loans owned or serviced by insured financial institutions supervised by the OCC, the OTS, the Federal Reserve, FDIC and the National Credit Union Administration.
• Require Participation in Foreclosure Mitigation. All Financial Stability Plan Recipients going forward will be required to participate in foreclosure mitigation plans consistent with the U.S. Treasury’s loan modification guidelines.
• Allowing Judicial Modifications of Home Mortgages during Bankruptcy. The Obama Administration intends to seek changes to the personal bankruptcy provisions so that bankruptcy judges can modify the terms of mortgages in a bankruptcy proceeding. The complete details are not yet known, but in general mortgage loans in excess of the current value of the mortgaged property (as determined by the judge) would be treated as unsecured. This will allow a bankruptcy judge to develop an affordable plan for the homeowner to continue making payments. Homeowners in bankruptcy will need to have complied with certain conditions before being eligible for this relief (such as first requesting lenders for a modification and complying with reasonable requests for information).

Clearly, HASP will have a significant impact on the mortgage lending business. One of the important details of the Homeowner Stability Initiative is the interest rate reduction and the participation of the lender in this reduction. For a sample household with payments adding up to 43 percent of its monthly income, the lender would first be responsible for bringing down interest rates so that the borrower’s monthly mortgage payment is no more than 38 percent of the household income. Further reductions are matched dollar-for-dollar with the lender to bring that ratio down to 31 percent. The lower interest rate must be kept in place for five years, after which it could gradually be stepped up to the conforming loan rate in place at the time of the modification. Presumably participation in this part of the initiative will be on a voluntary and case by case basis for lenders. However, as certain regulated financial institutions (and all Financial Stability Plan recipients going forward) will automatically be subject to loan modification guidelines, no assumptions can be made.

Another significant aspect of HASP is the proposal to allow bankruptcy judges to modify mortgage terms and to “cram-down” principal amounts of loans. While the lending community may not be able to change the legislation, the lending markets typically adjust for any perceived increase in risk by adjusting interest rates upwards. The details of this proposal will be carefully watched by the lending community.

This article provides a summary description of the primary components of HASP, focusing on those aspects that affect banks who hold and make residential mortgage loans.