Moody's Investors Service analysis shows that only 400,000 to one million loans will be saved from foreclosure by Home Affordable Modification Plan (HAMP), which the rating agency called a linchpin in the Obama administration's plan to stabilize the housing market.
The program is aimed at keeping millions of homeowners out of foreclosure. The number stated above is far short of the three to four million loans that the administration had hoped for when the program was first announced, according to the rating agency in its newest ResiLandscape publication.
Additionally, recent reports from the U.S. Treasury Department indicate that HAMP is starting off much more slowly than anticipated, Moody's noted in the report.
The small number of foreclosures prevented further proves the rating agency's expectation that house prices will depreciate further before they stabilize toward the end of 2010.
Number of Loans Identified
To evaluate the number of loans that would be eligible to receive a modification under the government's plan as well as estimate the plan's long-term impact on avoiding foreclosure, the credit bureau Equifax constructed a loan-level data set in partnership with Moody's Economy.com that represents the entire mortgage market.
The full details on HAMP are available from the administration's financialstability.gov Web site.
Moody's briefly summarized the main criteria for eligibility in the program. These are: (1) loans must be originated prior to January 1, 2009; (2) mortgaged properties must be owner occupied; (3) outstanding loan balances must be below the expanded conforming limit; and, (4) borrowers' front-end debt-to-income ratios must be greater than 31%.
Additionally, HAMP requires that borrowers are either currently delinquent on their payments or otherwise deemed by servicers to be at risk of "imminent default."
Utilizing Moody's Mortgage Metrics probability of default model, the rating agency identified about 8.2 million loans in the Equifax database that would meet these eligibility criteria.
According to Moody's, for the HAMP eligible population, the mechanics of the program involve reducing mortgage note rates in 0.125% increments down to a minimum of 2%. This will bring the monthly housing debt-to-income ratio down to 31%.
If this reduction in interest rate alone is not enough to reach the 31% ratio, loans may be re-amortized with a maximum 40-year loan term to futher lessen the monthly payment.
Considering currently reported income levels and outstanding loan balances in the sample data, an estimated two million loans cannot be modified to reach the DTI target of 31% by both reducing the rate to 2% and extending the term to 480 months. These loans are thus ineligible for a HAMP modification, the rating agency stated.
Next, the servicers under HAMP employ a net present value or NPV test to determine the fraction of the resulting HAMP eligible population of loans that would make economic sense to modify. That is, the NPV value after modification exceeds the NPV value without a modification. In order to meet this criterion, modification will have to result in a substantial reduction in the probability of default of the mortgage to justify the loss of income that comes from reducing interest rates.
Under the trigger-event hypothesis of mortgage default, a borrower will still fulfill his payment obligation unless he experiences a life event resulting in a disruption of income. This event might include a medical illness or a divorce or, most often, a loss of employment or a considerable reduction in earnings. As a result of the event that makes the monthly payment unaffordable, the borrower will then consider the equity in the home and might extract equity through a home equity loan if the borrower thinks the life event is only temporary. Otherwise, the borrower may consider trading down or selling the home to pay off the existing mortgage and moving to a less expensive residence. If the borrower has little or no equity in the home, then the borrower will have no other option but to default.
According to Moody's, an alternative perspective on defaults views borrowers as constantly evaluating the put option on their mortgages. As soon as the value of the option turns positive, which means the discounted present value of the outstanding loan exceeds that of the house, then the borrower will exercise the option and walk away from the loan.
Regardless of whether the default happens because of a trigger event or as the exercising of a strategic default option, equity is the main driver of the final default decision.
As such, Moody's assumes that the 30% of borrowers that have negative equity, or if their combined LTV ratios go over 100%, will have likelihoods of default that will not be materially affected by a note rate modification. In short, these homeowners are likely to default regardless of the mortgage rate.
For those HAMP eligible borrowers with equity, Moody's assumes that a fourth will either have so much equity that their likelihood of default is low even if they experience a trigger event, or their probability of default is already so high resulting from a lack of equity, poor credit and/or low income that the NPV of their loans does not turn positive with modification.
Considering all of these factors, Moody's identified 1.7 million loans with positive NPV that servicers should theoretically be willing to modify. But, the rating agency needs to adjust this estimate downward by 15% to account for servicers that are not under HAMP, according to the Treasury Department.
When borrowers receive an offer to modify loan terms, they need to accept the offer formally, provide additional paperwork to document the income they are currently receiving and make three timely payments on the mortgage under the new terms. Compliance rates might increase in the future as servicers streamline their processes, but at present, the rating agency makes the assumption that 40% of trial modifications will convert to permanent status based on government data and servicer media reports.
The projected number of both trial and permanent modifications is so much less than the Obama administration's original expectations, the rating agency said.
But, even these numbers have to be adjusted downward to account for the actual number of foreclosures avoided.
According to the rating agency, there is not a lot of data on redefaults for HAMP-modified loans considering the limited history of the program.
However, previous servicer-initiated modification programs have yielded redefault rates around 50%, according to the Office of the Comptroller of the Currency (OCC), Assuming that HAMP's documentation and trial payment requirements are more restrictive than these other plans, the redefault rate might be closer to 30%. Under this assumption, 400,000 homes would avoid foreclosure under the plan.
Given the number of assumptions behind this point estimate, the actual number of foreclosures avoided could range from hundreds of thousands up to a million. However, despite the imprecision, even the high end of this range of the projections remains well below the initial expectations for the program, the rating agency said.