Determining Value is the Key to Maximizing New Programs
- Lenders Can Maximize Revenue From Government Investment and Modification Programs by Automating Valuations - The first quarter of 2009 was marked by the release of many programs and proposals from the government designed to protect homeowners, restore capital to banks and kick-start lending. Three new announcements in March will have a particular impact on servicers and lenders.
The Public-Private Investment Program (PPIP), announced March 22, promises to kick-start investment into troubled or toxic loan portfolios. Related to PPIP, the Federal Standard Accounting Board (FASB) announced changes to mark-to-market accounting standards, which outlines methods banks could revalue assets to more closely reflect their pre-recession value. Finally, all participants in the government's Troubled Asset Recovery Program (TARP) will be required to apply Net Present Value (NPV) tests for any home at risk of foreclosure. The lynchpin to all three of these programs is collateral value. Being able to quickly and accurately assign values to loans in portfolios will determine whether investors, bankers and taxpayers successfully embrace the programs or ignore them. Finding Middle Ground Between Investors and Lenders In order to jump-start investor interest in real estate purchases, PPIP outlines a three-part program that supplements investor purchases of mortgage loans with public funds. In short, the Federal Insurance Deposit Corp. (FDIC) will guarantee up to 85 percent of distressed mortgages bought through the PPIP, easing the risk investors would normally take to purchase the assets. The assets are sold at auction to the highest bidder.
The sticking point for this program to work is price. The New York Times' March 23 article on the TARP program explains, "Taxpayers could profit from the interest paid by the public-private partnerships on the government loans - the interest rate has not yet been set - and if the troubled assets rise in value above the prices paid to acquire them. ... The other potential obstacle could be on the side of the sellers - the banks. Because banks would probably have to sell their mortgages at a substantial discount to their original value, they would also have to write down the value of the mortgages and book a loss in the process. In turn, that could force many banks to raise more capital." Banks have so far been reluctant to part with loans at deep discounts, which in some cases could be 50 percent less than the original price. Conversely investors have had no incentive to take on the risk for mortgage loans that may or may not recover to their previous peak values. This expectation gap between buyers and sellers has kept the market stagnant for months.
A key component to breaking this gridlock is to have accurate collateral value determinations when analyzing loan packages for auction. This will enable both sides to make solid business decisions that minimize the loss to lenders, while allowing investors to be confident enough in the collateral values to offer a price that will protect a reasonable expectation of returning future profits. Mark-to-Market Changes Accounting Rules To help provide more leverage to banks holding onto loans, the FASB passed revisions to its accounting rules easing the requirements for mark-to-market reporting. Under mark-to-market reporting rules, banks must re-value held assets to the current market conditions and write down losses as actual losses.
The new rules, while still being clarified, allow banks to keep the value of assets being held at a previous level under the assumption that today's distressed prices are a temporary drop and will return to a previously established level. While the rule gives banks more leeway in making a determination on assets it keeps in its portfolio, the challenge comes when those assets are put on the market.
Again, both lenders and investors need a fast, accurate way to arrive at both historical and current price points on loan packages to ensure a transaction that maximizes revenue for both parties. Lenders holding onto assets also need historical value data to ensure they are minimizing the losses they must report on assets being held to term. Modifying Loans for Homeowners The third program where value plays a significant role is in loan modification. A clear understanding of property value is critical to making informed decisions on whether to foreclose or modify a loan for borrowers in default. According to the March guidelines for the "Home Affordable" program, any servicer receiving funds from TARP must submit loans in default to a NPV test before foreclosing. An NPV test uses a mathematical formula to try and determine in current dollars what the future value for an asset will be.
The Treasury's guidelines state that a NPV test must be run comparing returns on a loan modification versus returns on a foreclosure. If the NPV of the expected cash flow is greater with modification, the lender must modify the loan barring evidence of fraud or other contractual prohibitions.
The lynchpin is once again value - both current value and projected future value. Homes with significant equity built in, even in their depressed value, may be more likely to experience foreclosure, because the return could be greater for a home with positive equity. Likewise, loans with negative equity would most likely be forced to modify a loan since partial income would still bring in more revenue than a home auctioned for a loss. Automating Valuation for Bulk Portfolios For servicers facing tough decisions on their portfolios, being able to quickly and accurately value large holdings of mortgages can provide the data needed to maximize revenue and reduce the risk of loss.
There are three types of automation tools available to servicers that can make this process easier and more cost-effective. The first is the widely accepted use of Automated Valuation Models (AVM). AVMs use standardized variables, such as comparable sales, square footage and location, among others, to arrive at a value.