As the U.S. government continues to unveil measures aimed at preventing foreclosures and shoring up liquidity in the capital markets, industry participants have widely expressed concern over the lack of activity in the loan modification space.
Services have been handed the job, but with limitations in the pooling and servicing agreements and REMIC restrictions (see cover story), they have not been able to effectively carry out these measures.
"We are sitting here expecting the servicers to take advantage of these programs, but it is not going to happen," said Ron D'Vari, chief executive officer of NewOak Capital, who published a proposal last week aimed at jumpstarting the loan modification process.
D'Vari's plan calls for a government guarantee of existing mortgage loans or those that have been modified to fit the borrower's current financial circumstances. In return, the government would receive a certificate of participation in the equity of the home. This would entitle the government to an initial 100% of the extra value above the loan amount, ramping down for the first five years to 50% and staying at 50% thereafter, D'Vari said.
For example, say a borrower has a $120,000 home with an original loan amount of $100,000. However, now the house is worth $80,000, and the loan has been modified to 98% of that value or roughly $78,000. The noteholder would get, from the government, a 30-year amortizing note for the difference between $100,000 and $78,000.
"Instead of the loan holder taking that loss, the government will take it," D'Vari said.
In conjunction with the guarantee, the government would receive equity participation in the house for anything above $78,000. So if the home sold or refinanced for $110,000 three years from the date of the guarantee, the government would be entitled to receive 70% of the $32,000. If the home is sold after five years from the date of the guarantee, the government would take 50% of the equity.
The loan will stay in the pool, the servicer will receive the coupon, and it will go into the trust as if it were a payment. As the servicer receives the payments, it will pay the investors.
"This [proposal] immediately makes all of the securities that were under water golden," D'Vari said. "It puts value back in the securities, which are in CDOs and banks, causing capital requirements to disappear and restarting the process of lending again."
Furthermore, according to D'Vari, the plan provides incentive to keep borrowers in their homes and maintain upkeep on the house, not only reducing the overhang in abandoned homes that are driving down home prices, but also allowing the government and the borrower to profit in the end.
To reduce the tax burden, the government could also set terms with mortgage holders to share the ultimate costs.
The government will need to set up a panel to decide which loans will be modified subject to this type of guarantee, D'Vari said, along with establishing "commercially reasonably criteria" to make such decisions.
"The bottom line is if you are on a sinking ship, even if you have not caused it to go down, you need to save it," he said.
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