Coverage    The guidelines address: (1) first mortgage loans originated prior to 2009, (2) secured by a 1-4 family home serving as the borrower's principal residence, with (3) an unpaid principal balance that does not exceed specified limits ($729,750 for single-family). Loans in foreclosure or litigation are not disqualified. All recipients of TARP funding going forward must participate in the modification program. All servicers of GSE mortgages must also participate, at least as to eligible GSE portfolio mortgages and GSE pool mortgages. Certainly, there will be heavy regulatory pressure on all FDIC-insured institutions to participate.

Net Present Value (NPV) Comparison    The guidelines state that a participating servicer must make a loan modification available to the borrower whenever the NPV of the modified loan exceeds the NPV in foreclosure, although elsewhere the guidelines state that servicers should comply with applicable Pooling and Servicing Agreements (PSAs). The guidelines do not describe how the NPV calculation will be made, but the GSEs have promised that standardized NPV models will be published separately, presumably in the near future.

Legal Risks   Servicers could have legal exposure to borrowers for wrongful denial of modification requests and potentially to the Treasury for wrongful approval of modification requests. Also, while the guidelines could be read to reflect an assumption that servicers will not have legal exposure under their PSAs if a modification would increase the NPV of the loan (as the NPVs are computed under the forthcoming Treasury method), investors could potentially challenge the validity of NPV computations, and, in situations where mortgage-backed securities were sold in tranches, investors in one tranche could argue that they were disadvantaged, even if the overall loan NPV is increased. We hope this issue will be clarified by the Treasury or resolved by legislation, including Section 201 of H.R. 1106.

Income Verification   The guidelines provide that borrowers must represent that they do not have sufficient liquid assets to make their monthly mortgage payments and each potentially eligible borrower must be screened for an adverse change in circumstances, including impending payment shock. Interestingly, the GSE guidance seems to require an adverse change or a lack of sufficient cash reserves, not both. Borrower income must be verified through review of (1) the most recent tax return, (2) the two most recent pay stubs (for wage earners), and (3) "other third party documents that provide reasonably reliable evidence of income" (for self-employed borrowers and/or non-wage income).

Trial Period: De Minimis Limitation   The payments available to servicers, lenders, and borrowers were summarized in our legal alert of February 19, 2009. A three- to four-month trial period, with payments at the modified level, is contemplated before a loan modification becomes effective. The borrower's failure to make all required payments during the trial period will disqualify a borrower from obtaining a modification (and all parties from receiving compensation from the Treasury). Additionally, if the monthly payment is reduced less than 6 percent, the Treasury will withhold certain of the payments it would otherwise make.

Loan Modification Procedures   The guidelines specify that servicers must reduce first mortgage debt payments (excepting mortgage insurance payments) to 31 percent of the borrower's gross monthly income by following a "waterfall" consisting of the following steps, in the prescribed order: (1) determine monthly gross income and first mortgage debt payments, (2) waive unpaid late charges and capitalize arrearages, (3) reduce the interest rate to a level as low as 2 percent per annum, (4) extend the term (or, if contractually prohibited, the amortization period) up to 40 years, and (5) forbear a portion of principal until loan maturity. After five years of modified terms, the interest rate will increase up to 1 percent per year until it reaches the lesser of the original indexed rate or the Freddie Mac Primary Mortgage Market Survey rate for 30-year fixed-rate conforming mortgage loans, as of the modification date, rounded to the nearest 0.125 percent (currently, 5.125 percent). Note that requiring rate reductions before term extensions favors borrowers at the expense of lenders.

Additional Foreclosure Limitations    Under the guidelines, foreclosure proceedings must be suspended during the trial period and while borrowers are considered for alternative foreclosure prevention options. Additionally, if borrowers do not qualify for modification or if they default on a modified loan, the lender must pursue other foreclosure prevention alternatives, including deed-in-lieu and short sale programs, before resuming foreclosure proceedings. Fannie Mae has advised that servicers will be "required to consider" a borrower for refinancing into the HOPE for Homeowners program "when feasible."  It has also instructed that servicers "should offer" a HomeSaver Forbearance, involving up to a 50 percent reduction in monthly payments for up to six months, to a borrower who is in default or imminent danger of default and who does not qualify for a Home Affordable modification.

The guidelines are complex and the Treasury agreement will undoubtedly be much more so.  Counsel will need to explain the servicer’s rights and responsibilities under the modification program, recommend whether participation is advisable, review PSAs to determine when modifications are permitted, address situations where modifications may not be permitted, and prepare borrower communications and loan modifications. Ballard's Consumer Financial Services Group counsels mortgage lenders and servicers regarding relevant federal and state laws, including developments relating to the economic crisis. For further information, please contact Alan S. Kaplinsky (215.864.8544; kaplinsky@ballardspahr.com); Jeremy T. Rosenblum (215.864.8505; rosenblum@ballardspahr.com); or Barbara S. Mishkin (215.864.8528; mishkinb@ballardspahr.com).


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This newsletter is a periodic publication of Ballard Spahr LLP and is intended to alert the recipients to new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer concerning your situation and specific legal questions you have.