Principle Foregiveness – Barclays Capital Examines Implications of Bank of Americas “Earned” Forgiveness Plan

Don’t Believe the Hype

In yesterdays press release Bank of America stated;

Bank of America announced it will look first at principal forgiveness ahead of an interest rate reduction – when modifying certain subprime, Pay-Option and prime two-year hybrid mortgages qualifying for its National Homeownership Retention Program (NHRP)

Several enhancements are being made to the program, including the introduction of an earned principal forgiveness approach to modifying mortgages that are severely underwater.

These new components of the agreement apply to certain NHRP-eligible loans that also meet the basic qualifications for the government’s Home Affordable Modification Program. They include:

• A first look at principal reductions in calculating an affordable payment through an earned principal forgiveness approach to severely underwater loans.
• Principal forgiveness through a reduction of negative-amortization on certain Pay-Option ARMs.
• Conversion of certain Pay-Option ARMs to fully amortizing loans prior to a recast.
• Addition of certain prime two-year hybrid ARMs as eligible for the NHRP mortgage modification programs.
• Inclusion of Countrywide mortgages originated on or before January 1, 2009, as eligible for modifications under the terms of the NHRP.
• A six-month extension of the term of the NHRP program to December 31, 2012.

“The centerpiece of these enhancements is a program of earned principal forgiveness that addresses severely underwater mortgages with some of the highest rates of delinquency – specifically subprime loans, Pay-Option ARMs and prime two-year hybrid ARMs that are 60 days or more delinquent with a principal balance of 120 percent or more,” said Barbara Desoer, president of Bank of America Home Loans.

“At the same time earned principal forgiveness helps homeowners, it also recognizes and addresses the interests of mortgage investors by ensuring that forgiveness is tied to the homeowner’s performance, reducing the probability of a future default under the modified terms, and adjusting the total amount to be forgiven in light of any gains in property values that might occur in an economic recovery.”

Earned Principal Forgiveness

Bank of America is taking an innovative “earned principal forgiveness” approach to HAMP modifications of the NHRP-qualifying mortgages that are at least 60 days delinquent with current loan-to-value (LTV) ratios of 120 percent or higher.

• An interest-free forbearance of principal that the homeowner can turn into forgiven principal over five years resulting in a maximum 30 percent decrease in the loan principal balance to as low as 100 percent LTV.
• In each of the first five years, up to 20 percent of the forborne amount will be forgiven annually for borrowers that remain in good standing on their mortgage payments.
• Forgiveness installments for the first three years are set at the 20 percent level.
• In the fourth and fifth years, the amount of forgiveness will be dependent upon the updated value of the property, so that the LTV will not be reduced below 100 percent through principal forgiveness.

Innovative Solutions for Customers with Pay-Option ARMs

Bank of America has begun offering two other affordable and sustainable payment solutions on certain Pay-Option ARMs.

• If the principal balance on the loan has grown because the borrower selected an option to make payments that did not cover the interest due and this payment difference was added to principal – known as negative amortization – the bank will consider offering a HAMP modification eliminating the negative amortization feature and forgiving all or part of the negative amortization amount to reduce principal to as low as 95 percent LTV.
• If a pending recast of a Pay-Option ARM will increase the customer’s monthly payments, a preemptive modification that eliminates the negative amortization feature of the mortgage and converts it to a fully amortizing market rate loan may be offered.

Impact of Mortgage Modification Efforts

The bank estimates that it will be able to offer these enhanced principal reduction solutions to about 45,000 customers who qualify for a HAMP modification, for an estimated $3 billion in total reduced principal “offered” under this NHRP enhancement.

Yea, kinda like the same “estimates” and “offers” for HAMP.

The program will be “offered” to about 45,000 who “qualify for a HAMP modification“…

That should make a dent…

Well wouldn’t you know Barclays Capital released a “first-pass” analysis on Wednesday, examining the new modification plan’s implications for non-agency mortgage-backed securities. Although they primarily focus on the money loses, they recognize not all “eligible” borrowers will get the mod…

BarCap Examines Implications of BofA Earned Forgiveness Plan

The program targets only Countrywide/BofA option adjustable rate mortgages (ARMs), subprime, and prime 2/1 hybrids with more than 120 mark-to-market loan-to-value (MTM LTV) ratios. According to BarCap, for securitized subprime and option ARMs, about 40 percent to 45 percent of delinquent borrowers and 20 percent to 25 percent of current borrowers have MTM LTV ratios above 120 percent.

If all of these borrowers see forbearance of about 30 percent and the loss is recognized immediately, it could result in a write-down of the bottom 9 percent to 10 percent of the capital structure, BarCap said. However, researchers believe the effect will be somewhat smaller in reality. An NPV test will be used to determine which borrowers to modify, but BarCap said all the eligible borrowers are unlikely to get the modification.

So if I am reading this correctly, 45,000 will be offered the modification and 55 – 60 percent of delinquent borrows won’t qualify due to their LTV ratios.

So if less than HALF of the 45,000 qualify, how many do you think will be made permanent?

Nice… I’ll put the over under at 800. Yes, eight hundred…

Even if I am interpreting the numbers wrong, and 45,000 do “qualify”, it still isn’t going to be a very impressive number of permanent mods in the grand scheme of things. (Since this program was forced on BOA anyway in my opinion)

It is not clear if the forborne amount will be recognized as a loss upfront. But given the administration’s stance on Home Affordable Modification Plan (HAMP) forbearance, BarCap’s inference is that it should be. The only argument against not recognizing the loss is the likelihood of recovery of forborne principal if and when the loan is paid in full. BarCap notes that under this program, BofA is explicitly giving up the notion of recovering at least 60 percent of this balance.