Robert K.

Ramers
Tel: 415-730-4514 Top Gun Auditor fax: 707-885-0500 email: topgunauditor@gmail.com

Figures dont lie but liars figure . How Loan Servicers Profit by using the Net Present Value Calculation to deny Loan Modifications
By Robert K. Ramers

Who can use this information?

Have you been denied a loan modification, or had your property foreclosed and wondered why this happened, since you felt that your lender would actually benefit more by giving you a modification or allowing you to refinance your property at its fair market value? Are you in litigation with your lender, and trying to get them to settle with you or provide a loan modification to which you feel you are entitled and cannot understand why they are fighting so hard to avoid this outcome? If so, the information in this article may shed some light on these financial mysteries and explain the apparently illogical behavior of your lender!

Who are the players and why is that important?

Before we even begin to discuss the New Present Value issue (we will refer to it as the NPV from now on), it is important to understand who is involved in your loan transaction, what their roles are and how these roles might lead to a conflict of interest. In other words, who actually lent you the money, who is the actual owner of your loan right now and is entitled to your mortgage payments, who is the party collecting your monthly loan payments, and who will benefit or lose money in a loan modification, foreclosure or short sale (we identify these parties and their responsibilities in our Chain of Title/Securitization Analysis reports).

Original lender
The party named on your promissory note and deed of trust is the original lender. It might be a mortgage company or a bank. It is very likely that this party did not use their own funds for your transaction, but used investor funds that they got from a Trust set up to buy your promissory note and receive your mortgage payments to provide tax free income to the bond holders of the trust.. It is likely that the original lender sold or transferred your promissory note to another party. This party could have sold it to a third party, who then may have sold it to a Trust, which had raised money from institutional investors such as pension funds and governmental agencies. This process is know as the securitization of your loan, because your loan was used as collateral for securities (bonds) that were sold to investors.

Current owner of your loan

If your loan was securitized, the owner of your loan are actually the investors in the Trust that is holding your note and deed of trust as collateral. The trustee of the trust, usually a bank, is charged with the responsibility to make sure that all of the assets ( including your promissory note) have been put into the trust when they were supposed to have been, i.e., the closing date of the trust. The Copyright Robert K. Ramers 2014 1

Robert K. Ramers
Tel: 415-730-4514 Top Gun Auditor fax: 707-885-0500 email: topgunauditor@gmail.com

trustee is also responsible for making sure that all of the loan payments that are coming into the trust are distributed to the investors based on the investments that they made, and that the financial interests of the investors are protected. It is important to note that it is only the actual current owner of your note (or an agent that they appoint) has the authority under the Deed of Trust that you signed, to negotiate a loan modification, to assign your note to somebody else, to substitute trustees, or to foreclose on your property.

The Servicer of your loan

If your loan was securitized (or even if it wasnt), you are probably getting monthly statements from and making payments to the servicer of your loan. This party is often a bank also, and you might think that they are your lender. However, they are merely a debt collector. They were hired by the Trust or other party that actually owns your loan to manage the Trusts portfolio of loans, to collect payments negotiate loan modifications, manage foreclosures and short sales and report the status of the loans to the trust and its investors1. These servicers are, of course, supposed to act in the best interests of their clients, and here is where the plot thickens! Servicers are paid handsomely for these services. Often they get from .025% to .05% of the payments that they collect as a servicing fee. Many of these trusts have thousands of loans in them, and the monthly payments from these loans can amount to millions of dollars. For example, a fee of 0.5% of $3,000,000 a month is $150,000 a month! In many cases, the fees paid to servicers are HIGHER if they are servicing a loan that is in default. This situation creates the first conflict of interest, since a servicer will profit by dragging out a default situation to increase the fees that they earn. This benefit for the servicers does not come without obligations. In many of the contracts between the Trusts and the servicers that I have examined (they are called Pooling and Servicing Agreements), the servicers are required to do the following in exchange for getting paid their servicing fees: 1. If the borrower does not make a monthly payment when due, the servicer must advance this payment to the trust to maintain the cash flow to the investors. 2. If the servicer makes a modification to the original terms of the loan, and this modification reduces the payments to the trust, the servicer must make up the difference. In some cases, the only way that the servicer is allowed to modify the loan is if they purchase it back for the current loan balance. In no cases is the servicer allowed to make a modification that would threaten the tax free status of the trust. So, you can see why a loan servicer might not want to offer you a loan modification and is motivated to drag out the time you are in default as much as possible they make more money! They not only earn higher fees by managing a defaulted loan, but they also avoid having to buy back your loan from the trust or make up the difference in any reduced mortgage payments from a modification.

Information about securitized loans, including who owns the loan, the payment history, payments to the servicer, responsibilities of the servicer and other information is available using the Bloomberg financial software and the Securities and Exchange Commission database. We use these sources in our chain of title audits and NPV analysis.

Copyright Robert K. Ramers 2014

Robert K. Ramers
Tel: 415-730-4514 Top Gun Auditor fax: 707-885-0500 email: topgunauditor@gmail.com

But wait, you might say, dont the servicers have to keep making my payments to the trust if I do not make them? Isnt this costing them a lot of money? Yes, it is. We have specialized software that lets us see the amount of these servicer advances. We have seen advances amounting to more than $200,000 on a single loan. Now here is where the real conflict of interest comes in. In many cases, the only way that the servicer can get reimbursed for the advances it has made to the trust, whether these advances are due to nonpayment by the homeowner or because of reduced payments due to a loan modification, is through foreclosure of the property! Furthermore, the servicer gets paid BEFORE any money goes to the investor, regardless of the sale price of the property. This explains the apparently illogical situation where a servicer will foreclose on a property at a huge loss, when on the surface a loan modification would have been better for both the homeowner and the actual owner of the loan. The software that we use allows us to see the amount of these losses, called the loss severity. In the more than 400 audits that we have done, we have documented loss severities of 50% to over 70% on loans that have been foreclosed on by loan servicers. In some cases, these losses have actually amounted to over 100% of the loan value, probably due to legal expenses and other fees charged by the loan servicers to the Trust that owns the loan. These facts explain the apparently illogical behavior of loan servicers. What they are doing is perfectly logical in financial terms, since they make more money. However, both the homeowner and the actual owner of your loan are being damaged. How can the servicers get away with this, you might say? One of the tools that they use is the way that they calculate the Net Present Value figure to justify their decision to foreclose on a property rather than offering a loan modification.

What is the Net Present Value?

We will discuss this in more detail below, but here is a brief outline of how the Net Present Value is calculated and used. This calculation is used to compare different investment opportunities. To evaluate which investment opportunity is more profitable, businesses first determine how much money they will have to invest and how much money they expect to get back for each opportunity. However, cash investments are made over a period of time and cash income is received over a period of time, and money that you get a year from now is not worth as much as money that you get today, since you could invest the money that you have today to make more money. Manually comparing a long string of cash outlays and income to see which opportunity is more profitable would be difficult, but the NPV approach condenses all of these numbers into a single figure. This figure can be calculated for different investment opportunities to see which is the most profitable for the investor. The NPV calculation is based on the fact that money NOW is more valuable than money LATER ON. Why? Because you can invest the money that you have now at some interest rate to earn more money, but you cannot invest money you get in the future until you receive it. Copyright Robert K. Ramers 2014 3

Robert K. Ramers
Tel: 415-730-4514 Top Gun Auditor fax: 707-885-0500 email: topgunauditor@gmail.com

Example Lets say you can earn 10% interest on your money. If so,getting $1,000 today should be the same to you as getting $1,100 in one year, since you will earn $100 in interest in that year (10% X $1000 = $100, plus your original $1,000 equals $1,100). If you reverse this logic, you should be just as happy to get $1,100 in one year as you would be to get $1,000 today, since all you could earn on your $1,000 is 10% for the next year. By discounting the stream of cash outlays and income (using the interest rate you think you can earn on your money) back to the present, you come up with a single number from each cash flow stream. You can then compare these numbers to decide on the most profitable investment opportunity.

The Net Present Value in Modification and Foreclosures

This is how lenders use the net present value calculation to see if it would be more profitable for them to foreclose on a property than to provide a loan modification. First, they calculate how much money they would get if the foreclosed on a mortgage. They should take into account the market value of the property and all of the costs of a foreclosure and sale of the property, including real estate commissions, the time they will have to hold the property before they can sell it and any other expenses related to the foreclosure. Consider this number investment opportunity A. Then they calculate how much money they would get if they got a stream of payments from you under various scenarios. These scenarios can involve extending the term of your loan to 40 years, lowering the interest rate to 2% or reducing the principal amount owed. This calculation would be their investment opportunity B. However, they do not just add up these payments under these scenarios, but they DISCOUNT them using the interest rate they could earn on the money if they could have it today to come up with the NPV of this investment opportunity. In other words, they calculate the NPV of the cash from the modification and compare it with the NPV from a foreclosure, and see which figure is bigger. If the NPV from a foreclosure is greater than the NPV for a modification, they are justified in proceeding with the foreclosure because it will provide a greater return to the owner of the loan. However, with a mortgage, it is more complicated because: 1. Often it is not the actual investor who is making this calculation, but the loan servicer. The loan servicer is motivated to come up with a figure that results in a decision that will benefit them but not be in the best interests of the actual owner of the loan or the owner of the property. 2. In a foreclosure or modification situation, there are many assumptions that have to be made about WHEN money will be received, what COSTS are involved in getting the money, and how the money will be DIVIDED among the parties involved in the transaction. These complications provide an opportunity for those doing the calculations to make the NPV numbers come out to support the outcome that is most beneficial to them. Few homeowners (or attorneys for Copyright Robert K. Ramers 2014 4

Robert K. Ramers
Tel: 415-730-4514 Top Gun Auditor fax: 707-885-0500 email: topgunauditor@gmail.com

that matter) understand or challenge the calculations. Not understanding and challenging the NPV calculation can result in losses to both the homeowner and the investor who owns the loan, providing a financial benefit only to the loan servicer.

Why an accurate NPV calculation is critical

The NPV is used as one of the first barriers to see if you are eligible for a HAMP modification. Even if you are not eligible for a HAMP modification for other reasons, the NPV calculation is often required to determine if a denial of your modification complies with state laws that require that a loan modification is required if it would yield a higher return to the lender than a foreclosure.

HAMP NPV issues

The Making Home Affordable Program Handbook for Servicers of Non-GSE Mortgages, version 4.3 as of September 16, 2013 states the following about the NPV test and how it is used:

Copyright Robert K. Ramers 2014

Robert K. Ramers
Tel: 415-730-4514 Top Gun Auditor fax: 707-885-0500 email: topgunauditor@gmail.com

State law NPV issues

State laws vary as to whether or not NPV issues have been codified. In California, the law, as stated in the California Homeowners Bill of Rights that became law in January of 2013, is clear that the servicer of a loan is required to maximize the NPV for the investors (i.e., the party who actually owns your loan):

Copyright Robert K. Ramers 2014

Robert K. Ramers
Tel: 415-730-4514 Top Gun Auditor fax: 707-885-0500 email: topgunauditor@gmail.com

How liars figure

Unfortunately, to understand how the NPV calculation can be misused to profit loan servicers at the expense of both homeowners and the actual owners of your promissory note (i.e., your current lender), we have to dig a little deeper into the NPV formula and how it is calculated. The detailed math used in the calculation is beyond the scope of this paper, but we will examine enough of what is used in the formula to understand what is actually happening. (We use our specialized software to calculate alternative NPVs based on what we will present below.) The basic NPV formula is as follows:

Where

The Making Home Affordable formula is a little more complicated (from the Home Affordable Modification Program Base Net Present Value (NPV) Model v5.02 Model Documentation Handbook):

Copyright Robert K. Ramers 2014

Robert K. Ramers
Tel: 415-730-4514 Top Gun Auditor fax: 707-885-0500 email: topgunauditor@gmail.com

The actual formula used in the case of a default to determine the NPV is as follows:

Copyright Robert K. Ramers 2014

Robert K. Ramers
Tel: 415-730-4514 Top Gun Auditor fax: 707-885-0500 email: topgunauditor@gmail.com

An NPV Calculation example

Dont worry about the details in the above formula. For purposes of understanding what it going on, we only need to understand what is not included in the above calculations and who gets the money in both the foreclosure and the modification scenarios. Lets use an example to explain what we mean. EXAMPLE Original loan amount: $750,000, at 7% interest for 30 years (Lets say that the loan has been in default for some time, and the servicer has had to advance $50,000 to the trust that is claiming ownership of the loan) Current market value of property: $575,000 Foreclosure/REO costs (using state averages, no lawsuit or delay): $30,000 Discount rate for NPV calculation (specified by HAMP): 4.0% Possible loan modification: Interest rate lowered to 4%, term extended to 40 years, principal reduced to $500,000.

Copyright Robert K. Ramers 2014

Robert K. Ramers
Tel: 415-730-4514 Top Gun Auditor fax: 707-885-0500 email: topgunauditor@gmail.com

The make believe numbers the fox in the chicken house

Remember, the person who is doing these calculations is the loan servicer, who has a vested interest in making sure that they maximize their profits. In almost all of the cases that I have investigated, the loan servicer ALWAYS makes more money from a foreclosure than from a loan modification! The formulas are so complex, and there is so much discretion in the assumptions used in the formulas that the party making the calculations can often manipulate the numbers to show whatever is in their best interests, but do not reflect reality. Net present value from foreclosure If the property forecloses, lets simplify and assume that the net proceeds would just be the market value of the property, $575,000, less the foreclosure costs of $30,000, or a net of $535,000. (The actual number would be less if we take timing issues into consideration.) Net present value from a modification: If the loan were modified using the above assumptions, the NPV of the cash flows for the next 40 years would be $499,991. Based on these figures, it would make more sense to proceed with the foreclosure, right? The net proceeds would be $35,000 more than through a loan modification on a NPV basis.

The real numbers

But wait a minute. The calculations above were done by the servicer, and the net proceeds do not go to the actual owner of the loan. We need to make some adjustments to the money that the investor, who owns your loan, actually gets and to consider other costs if the homeowner decides to litigate: 1. First, the servicer is going to deduct the $50,000 that they have advanced to the trust and any past due fees for servicing the loan before paying anything to the owner of the loan. That reduces the net proceeds to at least $485,000 in the foreclosure scenario. 2. If the homeowner files a lawsuit, the servicer will incur legal costs that will be reimbursed before any proceeds go to the investor. Lets say that these legal costs are $35,000. Even if the servicer eventually wins the lawsuit and proceeds with the foreclosure, this may not happen for up to a year, which will reduce the NPV of the sale proceeds. Also, the servicer will deduct all of their costs from the proceeds. Lets assume that these events reduce the actual proceeds to the investor in the foreclosure scenario to $450,000. Now when we do the comparison, the loan modification alternative looks a lot more attractive to the owner of the loan. If the loan is modified, the lender will receive an NPV amount of $499,991, but if the servicer proceeds with a foreclosure, they will only receive $450,0002. If these figures were used in the HAMP NPV model, the servicer would be obligated to offer the loan modification. Even if HAMP was not used, it is possible under state law that the servicer would be required to offer a modification, since it would be in the best interests of both the homeowner and the owner of the loan. The only party that benefits from the foreclosure is the loan servicer.

The actual formulas are more complex, and take into consideration the probability of a re-default and other variables.

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Robert K. Ramers
Tel: 415-730-4514 Top Gun Auditor fax: 707-885-0500 email: topgunauditor@gmail.com

Conclusion Dont let the fox guard the chicken coop!

I have rarely seen this type of analysis and challenge to the calculations made by loan servicers when they deny a loan modification. Also, I have not seen this challenge made in a lawsuit against a loan servicer. The reason is probably because of the lack of understanding of the Net Present Value calculation and the lack of access to information about the agreements between the Trusts that may own a loan and the servicers who are responsible for managing the loan portfolio of the trusts. Challenging the Net Present Value calculations made by the loan servicer and understanding the potential for a conflict of interest on the part of the loan servicer can help insure that homeowners are treated fairly in their attempts to get a loan modification and save their homes.

ROBERT K. RAMERS
Robert K. Ramers is a chain of title and Certified Securitization Auditor. He has conducted over 400 investigations on behalf of homeowners. His prior experience includes positions as Financial Vice President and CEO of several corporations. He is available to perform NPV and Securitization Analysis and as an Expert Witness. He can be contacted at topgunauditor@gmail.com

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