Managing Mortgage Arrears - Insights from the USA

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D I S P U T E S & I N V E S T I G AT I O N S • E C O N O M I C S • F I N A N C I A L A D V I S O R Y • M A N A G E M E N T C O N S U LT I N G
Managing Mortgage Arrears
- Insights from the USA

Navigant Consulting Inc. Overview
Fast facts
International professional services company
Significant Financial Services presence in US and UK
Publicly traded since 1996 (NYSE:NCI)
2011 revenues: $1,200 M; $325 M in Financial services
Approximately 2,200 consultants globally
Services
Management Consulting
Disputes & Investigations
Economic Consulting
Financial Advisory
Industries
Financial Services
Energy
Healthcare
Construction
Public Sector
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Navigant Consulting, Inc. is an independent global consulting firm providing specialised
professional services to assist clients in improving performance, resolving conflicts and
crisis, managing and mitigating risk, and capitalising on near and long term business
opportunities.
Today’s business and economic environment demands keen market insights and
professionals who have met these challenges before. Navigant’s team of more than
2,200 professionals is equipped with industry experience and technical capabilities to
assist our clients and provide valuable, real-world, practical solutions for addressing
critical business issues.
We deliver services globally to clients seeking four core services: Disputes &
Investigative Services, Management Consulting, Economic Consulting and Financial
Advisory Services. We focus on large industry sectors that are typically highly regulated
and/or are undergoing significant change. Professionals across the world assist clients
in the Construction, Energy, Healthcare, Financial Services and Public Sectors – driving
change and transformation, ensuring compliance and optimising performance.

Navigant has extensive experience in assisting mortgage banking clients.
Consent Order testing
Strategy reviews
Servicing operations reviews
Securitization structuring and accounting
Risk analytics
Mortgage loan accounting
Troubled debt restructurings
Controls deficiency remediation
Competitor analysis / benchmarking
Forensic testing
Foreclosure compliance
Mortgage Industry Solutions
System selections and implementation
Targeted operating model development
Valuation of loans and RMBS / CMBS
Allowance for loan loss
Risk and capital modeling
Process and workflow automation
Organization design and process
HAMP / HAFA compliance
Bankruptcy compliance and monitorship
REO risk management
Repurchase defense
Navigant’s Mortgage Industry Expertise
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THE HOME AFFORDABLE
MODIFICATION PROGRAMME (HAMP)
US Mortgage Arrears

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The Making Home Affordable Program
Home Affordable Modification Program (HAMP)
• The housing crisis unfolded around 2007, with
foreclosure numbers reaching unprecedented levels.
• More than 700,000 foreclosures were started in
2007, with another two million in 2008 and even
more occurring in subsequent years.
• Foreclosures are considered costly—either because
they result in significant deadweight losses for
borrowers and lenders or because they result in
negative externalities for the society
• Thus, federal and state government efforts were
aimed at encouraging mortgage renegotiations
through loan modifications instead of foreclosing
loans.
• On February 19, 2009, President Obama announced
the Home Affordable Modification Program
(HAMP), which became a central policy tool aimed
at bolstering the rate of modifications of residential
loans.
• HAMP was first authorized under the Emergency
Economic Stabilization Act of 2008 and then
amended by the American Recovery and
Reinvestment Act of 2009.

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Making it Easy for Distressed Borrowers – “Need Help with Your Mortgage?”
The Home Affordable Modification Program (HAMP) provides assistance to struggling homeowners by
lowering monthly first lien mortgage payments to an affordable level.

• HAMP has extensive screening related to its eligibility criteria and its guidelines contain multiple eligibility
requirements that require borrowers to produce documentation of their economic hardship and danger of
imminent default.
• In addition, there is also an evaluation trial period prior to permanently changing the contract with the borrower.
• HAMP design looked to limit strategic behaviour induced by other modification programs.
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Borrower Eligibility - HAMP Design Criteria

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Borrower Eligibility - Occupancy & Delinquency Criteria

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HAMP - Minimum Payment Ratio & Limit on Multiple Modifications
An individual, as a borrower or co-borrower, may receive permanent HAMP modifications on
mortgages secured by up to six properties.
• A borrower may receive one permanent modification under HAMP Tier 1 or HAMP Tier 2 for a
loan secured by an owner-occupied property.
• For example: If the borrower loses good standing on a HAMP Tier 1 modification, the borrower
may be considered for HAMP Tier 2 permanent modification on the subject property.
• A borrower or co-borrower may receive one HAMP Tier 2 permanent modification with respect
to each of five other properties that meet Tier 2 eligibility requirements.

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Servicers are directed to establish Right Party Contact (RPC) with homeowners of delinquent HAMP
eligible loans and then evaluate the homeowners' eligibility for HAMP.
Range of performance results across top program servicers with respect to making Right Person
Contact and completing HAMP evaluations.
HAMP - Servicer Outreach to 60+ Day Delinquent Homeowners

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HAMP - Single Point of Contact Mandatory Requirement

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HAMP - Standard Modification Waterfall

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HAMP - Standard Modification Waterfall Inputs

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HAMP Standard Modification Waterfall – Step 1: Capitalization
The following items must be
capitalized:
• Accrued interest;
• Out-of-pocket escrow advances to
third parties;
• Required escrow advances that will
be paid to third parties during the
trial period;
• Mortgage insurance payments that
are due.
Advances for expenses incurred in
performing servicing obligations, such
as foreclosure fees and costs, must
also be capitalized. These costs must:
• Be consistent with the security
instrument.
• Be allowable under GSE guidelines.
• Not be prohibited by applicable
law.
Note: Late fees should not be
capitalized!

Reduce the borrower’s interest
rate:
• In increments of 0.125% or 1/8
percentage point.
• Until the target monthly
mortgage payment ratio is
reached.
• Interest rate floor is 2%.
– Incentives will not be paid
for reducing the rate
lower than the 2% floor.
• If the resulting rate is below
the Interest Rate Cap (Freddie
Mac Primary Mortgage Market
Survey, PMMS, Rate), then the
reduced rate will not increase
for the first five years.
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HAMP Standard Modification Waterfall – Step 2: Interest Rate Reduction
Current payment $ 1,872.96 Total PITIA payment: $ 2,320.07
Taxes & Insurance $ 337.11 ÷ Gross Monthly Income: $ 3,667.10 X 100
HOA Payment $ 100.00 Current Monthly Mortgage Payment Ratio: 63.3%
Future Escrow Shortage Payment $ 10.00
Total PITIA: $ 2,320.07

Extend the term:
• In one-month increments.
• Up to 480 months, which is the cap.
• As of the data collection date.
When the loan converts to a permanent modification, the term extension should be as of the
Modification Effective Date instead of the data collection date.
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HAMP Standard Modification Waterfall – Step 3: Term Extension

Principal forbearance amount:
• Is non-interest bearing;
• Is non-amortizing;
• Results in a balloon payment fully due and payable upon the earliest of the borrower’s transfer of
the property, payoff of the interest bearing UPB, or at maturity of the mortgage loan.
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HAMP Standard Modification Waterfall – Step 4: Principal Forbearance
Forbearance Limits
The greater of the
following:
• 30% of the UPB
after capitalization;
or
• An amount
resulting in a
modified interest
bearing balance
that would create a
current MTMLTV
equal to 100%.

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HAMP Standard Modification Waterfall – Worked Example

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HAMP - Alternative Modification Waterfall
The Alternative Modification Waterfall:
• Is applied in addition to the Standard Modification Waterfall for loans that have an MTMLTV ratio
greater than 115%.
• Will determine whether reducing the MTMLTV to 115% will produce a positive NPV result.
• Can be used on any loan with an MTMLTV ratio greater than 105%.
• Is used to determine the target monthly mortgage payment ratio of 31%, once the MTMLTV is
reduced to 115%.

The current UPB is reduced by an amount necessary to reach either:
• An MTMLTV ratio equal to 115%, or
• A target monthly mortgage payment ratio of 31%.
• The PRA amount:
– Is initially treated as a non-interest bearing principal forbearance;
– Is separate and exclusive of any other forbearance;
– Will be reduced over time if borrower remains in good standing.
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HAMP Alternative Modification Waterfall – Step 2: Principal Reduction Alternative (PRA)

• If the 31% target monthly mortgage payment ratio cannot be reached by lowering the interest rate to
the 2% floor, reduce the interest rate to the 2% floor, then proceed to step 4, Term Extension.
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HAMP Alternative Modification Waterfall – Step 3: Adjust Interest Rate

• If extending the term to 480 months does not achieve the 31% target monthly mortgage
payment ratio, or if the investor does not allow term extension, proceed to Step 5, Principal
Forbearance.
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HAMP Alternative Modification Waterfall – Step 4: Adjust the Term

• The principal forbearance calculation assumes 2% interest and a term length of 480 months.
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HAMP Alternative Modification Waterfall – Step 5: Principal Forbearance

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HAMP Alternative Modification Waterfall – Worked Example

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HAMP - Base NPV Model Overview

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HAMP - Base NPV Model

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HAMP – Incentives Through-out Value Chain
• Securitized mortgages issued without a guarantee from government-sponsored entities (GSEs)—
accounted for more than half of the foreclosure starts, despite their relatively small market share.
• The program provided large financial incentives to servicers, relative to their regular compensation,
in an attempt to alleviate several perceived barriers to renegotiation, such as the inability of the
private market to internalize negative externalities imposed by foreclosures and the frictions induced
by non-agency securitization.
• Incentive payments are quite substantial relative to the regular fees for servicing which amount to
about twenty to fifty basis points of the outstanding loan balance per year (roughly $400 to $1,000
per year for a mortgage with $200,000 of outstanding loan balance.
• Servicers:
• $1,000 for each completed permanent
modification
• $1,000 in annual, on-going pay-for-success
incentive payments
• current borrower bonus incentive payment of
$500 when a loan was permanently modified
• Mortgage holders/investors: one-time payment of
$1,500 for each modification agreement executed.
• Borrowers: eligible for up to $1,000 in annual, on-
going “pay-for-performance” incentives for five
years—to be used to pay down the mortgage
principal.

• The main rationale for policy intervention in debt renegotiation is to enhance such activity when
foreclosures are perceived to be inefficiently high.
• There has also been a long-standing debate among economists on the effects of such interventions.
– such policies prevent excessive foreclosures that may not only lead to deadweight losses for
borrowers and lenders, especially if debt contracts are incomplete, but also generate negative
externalities for the society. Moreover, these policies also help reduce high levels of debt that
may distort household consumption and investment decisions.
– While critics argue that such policies potentially generate moral hazard problems that are
likely to raise the cost of credit in the long run, and may also have undesirable re-distributional
consequences
• In any event, servicers responded to the program by conducting more modifications among eligible
loans, though the increase fell significantly short of the target of this intervention.
• The HAMP program would have induced about 70% more permanent modifications if all the loans
by less active servicers were renegotiated at the same rate as their more active counterparts.
• If these worse-performing banks had simply modified loans at the same pace as their better
performing peers, then HAMP would have produced about 800,000 more modifications.
• Instead of about 1.2 million modifications by the end of this year, HAMP would have resulted in
about 2 million. That's still well short of the 3-4 million modifications President Obama promised
when he announced the program back in early 2009.
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HAMP - Has policy intervention been effective?

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Nearly 1.3 Million Homeowner Assistance Actions Taken through Making Home Affordable
• More than 1 million homeowners have received a permanent modification through the Home
Affordable Modification Program (HAMP).
• These homeowners have reduced their first lien mortgage payments by a median of
approximately $539 each month – more than one-third of their median before-modification
payment – saving a total estimated $15 billion to date in monthly mortgage payments.
• 87% of eligible homeowners entering a HAMP trial modification since June 1, 2010 have
received a permanent modification with an average trial period of 3.5 months.
• Homeowners currently in HAMP permanent modifications with some form of principal reduction
have been granted an estimated $7.2 billion in principal reduction.
The Making Home Affordable Program - Scorecard
Program-to-
Date
Reported Since
Prior Period
HAMP Permanent Modifications
Started 1,076,747 16,509
2MP Modifications Started 93,865 3,863
HAFA Transactions Completed 71,403 108,312
FHA-HAMP and RD-HAMP
Permanent Modifications Started 8,692 829
UP Forbearance Plans Started
(through July 2012) 26,197 871
Cumulative MHA Activity 1,276,904 32,903

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HAMP - Re-default Rates & Moral Hazard
• To date, this analysis has shown the following results:
• Payment reduction is an important driver of
HAMP modification performance.
• HAMP modification re-default rates also fall as
the loan’s after modification mark-to-market
loan-to-value, or MTMLTV, ratio decreases (i.e.
as the size of the loan’s current principal
balance relative to the home’s value
decreases).
• As of May 2012, over 63,000 homeowners have
received permanent modifications with loan
principal reduction under HAMP Principal
Reduction Alternative (PRA).
• HAMP PRA participating servicers tend to use the principal reduction feature on loans that have relatively
riskier credit characteristics than the overall HAMP population - borrowers with much lower credit scores and
that are more seriously delinquent at time of modification.
• A logistic regression controls for these riskier characteristics. The regression shows that for a given payment
reduction, homeowners who received a HAMP modification with principal reduction perform better than
homeowners who receive a HAMP modification without principal reduction.
• An important concern regarding mortgage modification programs is that they may induce borrowers who would
otherwise continue making payments to default in order to increase their chances of receiving help.
• A recent study “Policy Intervention in Debt Renegotiation” reported an increase of 1.5% in relative terms when
compared to the pre-program mean in the treatment group i.e. results suggest that the program did not induce a
significant wave of defaults by potentially eligible borrowers relative to those who were ineligible for the program.

• Servicers responded to the program by conducting more modifications among eligible loans,
though the increase fell significantly short of the target of this intervention.
• Servicer specific factors, related to their pre-existing organizational capabilities, were found to be
responsible for differences in pre-program renegotiation activity across servicers.
• Servicers with lower (higher)renegotiation activity had pre-program organizational design that was
less (more) conducive to conducting renegotiations.
• In effect, policy failed to account for firm level factors that resulted in muted program response of
some servicers, which limits the ability of the government to quickly influence intermediaries
through provision of financial incentives.
• Servicers with low renegotiation activity in the pre-program period may not have responded to the
program since doing so would involve changing their business focus from:
– processing and channelling payments, to
– actively renegotiating loans.
• Recent findings also indicate that that there is a strong positive relationship between renegotiation
intensity of servicers in the pre-program period and the rate of permanent modifications induced
by HAMP across these entities.
• While contract, borrower, and regional characteristics of mortgages are important determinants of
renegotiation activity of a servicer, the differential and persistent patterns of renegotiation across
servicers cannot be accounted for by these factors.
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HAMP - The Role of Mortgage Servicers?

• Organizational factors are key to successful servicing; critical aspects include:
– quality, size and workload of the servicing staff,
– staff training effort,
– incentives,
– servicing call-centre capability and
– the characteristics of servicing technology.
• Recent findings conclude:
1. the number of full-time servicing staff is positively correlated with the intensity of
renegotiations
2. servicers that conducted more renegotiations had less-constrained staff, as measured by
loans per FTE
3. servicers with more renegotiation experience also are the ones who devote more hours to
training their employees
4. servicers who are more efficient in handling the phone queries, as proxied by the lower
percentage of calls dropped and the smaller average call holding time, also conducted more
renegotiations.
• Equally, from the program's launch, the administration emphasized that the program wouldn't
help the wrong sort of "irresponsible" homeowner.
• This emphasis has led to requirement that homeowners send in lots of paperwork to prove their
income, which in turn has further taxed the big servicers' inadequate systems. Most systems
were not designed for large scale mortgage arrears and modifications.
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Mortgage Servicers – Capability & Organisation Design

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Office of the Comptroller of the Currency (OCC)
Accountability - Consent Orders & The Independent Foreclosure Review
• The OCC consent orders required servicers to retain independent consultants to conduct a
comprehensive review of their foreclosure activity in 2009 or 2010, to identify financial injury that
resulted from deficient foreclosure practices, and provide compensation or other remedy for that
injury (338,447 files currently for review).
• To be considered in scope and eligible to request a review, a borrower must meet three criteria: 1)
the loan was active in the foreclosure process between January 1, 2009 and December 31, 2010;
2) the property securing the loan was the borrower’s primary residence; and 3) the loan was
serviced by one of the OCC listed servicers .
• Lump sum payments can range from $500 dollars to $125,000 plus equity in the most egregious
cases. The remediation amounts contained in the financial remediation framework are intended to
reflect financial harm caused by errors in the foreclosure and loss mitigation process.
• The OCC consent orders required extensive changes in mortgage servicing and foreclosure
processes to correct unsafe and unsound practices documented in the 2011 consent orders .
• Servicers continue to work to implement detailed action plans describing activities to correct
deficiencies in mortgage servicing activities, oversight and management of third-party service
providers, activities related to the Mortgage Electronic Registration System (MERS), management
information systems, risk assessment and management, and compliance oversight.
• Implementation of the plans is a multi-step process, first requiring development of new or revised
policies and operating procedures, addition and training of staff, and development or
modification of existing work-streams and processing systems as applicable.
• Effectively dealing with borrowers in distress is serious business – it must be undertaken with due
care and diligence to avoid serious penalties and/or reputational damage.

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INSIGHTS AND RELEVANCE TO IRELAND
Mortgage Arrears

US Mortgage Arrears Practices
Insights & Relevance to Ireland
1. The simplicity of US waterfall measures i.e. capitalisation, interest rate reduction, term extension,
forbearance – no ambiguity! By comparison, is Ireland’s approach complicated? Banks here are using
numerous solutions requiring complex system and operational capability.
2. The US modifications are permanent in nature. To date many loans in Ireland have been modified
using short term interest only periods. Will the various new modification initiatives that have been
flagged result in a change in the mix and tenure of modifications in Ireland?
3. The US is using DTI to determine sustainability of a modified mortgage. Having a formula creates
transparency, comparability, ease of understanding and accountability . Would Ireland benefit from
such an approach?
4. How does Ireland deal with distressed borrowers who have (unmanageable) levels of unsecured
debt? Personal Insolvency legislation is in train yet Ireland does not have a national credit register.
Buy-to-let is another area complicating the situation in Ireland.
5. How well placed are banks in Ireland in dealing with mortgage customers in distress? Much has
been done, but how well defined are customer journeys, modification programmes and are they
supported through effective organisational design, people and systems capability? How would Banks
in the Irish market perform under a Consent Order regime?
6. How confident are Boards and Executives that their respective MARS programmes are effective? Is
Back Testing & Quality Assurance reported on as a matter of course?
7. Naturally, all forbearance measures need to be sized in terms of their capital impact i.e. the country’s
& sectors ability to fund. Yet this is also key to attracting investment in to the banking sector.
8. Finally, when will Ireland know that it has been successful in dealing with mortgage arrears? What is
our Success Criteria – it can’t be just an activity report. This is a critically important issue!

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For Further Information, please contact:
Dr. Ray Nulty | Managing Director Financial Services | Europe
Mobile: +44 788 750 3854 / +353 87 0541416| Office +44 297 015 8716
ray.nulty@navigantconsulting.com
Tony Moroney| Director | Financial Services | Ireland
Mobile + 353 872 556947 | Office + 44 207 015 8801
Tony.Moroney@Navigant.com
Navigant Consulting Inc.
5th Floor, Woolgate Exchange | 25 Basinghall Street | London, EC2V 5HA

Managing Mortgage Arrears - Insights from the USA

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