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Bank of America's Loan Modification Program: A Loan Affirmation in Disguise?

|Includes: Bank of America Corporation (BAC)

Bank of America, operating as a loan servicer called BAC Home Loans Servicing, LP, is offering loan "modifications" to certain borrowers (See this link for an example dated October 8, 2010).

While BAC euphemistically calls this a loan "modification," I suspect BAC's "modification" is a hidden attempt to solve its documentation issues rather than a goodwill attempt to assist borrowers. Why the skeptical view? This program does not include an equitable loan modification of the principal balance; rather, it maintains the loan balance at par while foregoing interest on 35% of the principal for the duration of the loan. This is fairly strong evidence to support the view that underlying loan values are impaired and can no longer be held at par on balance sheets.

Principal reduction has long been been discussed as a solution for overleveraged homeowners. After all, overleveraged lenders were bailed out by the Fed and the Treasury, so why not extend the largess down the leverage chain? After all, most of these overleveraged homeowners happen to be the taxpayers who have (and continue) to save overleveraged lenders from insolvency.

Some highlights from BAC's loan modification:

  • The interest rate has been reduced initially from 6.0% to 2.0%, but the interest rate rises in increments to 4.375% in 2017.
  • In the tradition of "extend and pretend," the loan has been extended until 2050, 40 years after the "modification."
  • The "Unpaid Principal Balance" of $297,690.62 is actually increased to $339,324.90. The Delinquent Balance of $41,634.28 is added to the new unpaid principal balance.
  • The Delinquent Balance of $41,634.28 includes $34,709.74 for delinquent interest, $1,875.15 for fees and costs, and $5,049.39 for a delinquent escrow.
  • The "Interest Bearing Principal Balance" of the loan is $221,216.41, only 65.2% of the $339,324.90.
  • The "Deferred Balance" of $118,108.49 is non-interest bearing. "Interest will not accrue on the deferred portion of your principal balance." This Deferred Balance never becomes current-pay but becomes "due in full upon sale or transfer of the property securing the loan, including a foreclosure, payoff or refinance."
  • No notary signature is required except in California (where it is likely a legal requirement)
  • The agreement contains a mysterious Modification Bankruptcy Disclosure Rider. Although this rider is not disclosed, the borrower is probably asked to surrender some protections offered by bankruptcy courts. Note that no notary signature is required for this rider, not even in California.

With increasing scrutiny into "who holds the title," I suspect BAC's real motiviation is to solve its documentation issues. One solution is to convince borrowers to reaffirm the lending relationship via a cleverly-termed loan "modification." Since rates have fallen greatly (thanks to the Fed's cheap money policy), banks can reduce the interest rate on these loans at virtually no cost. Simultaneously, the borrower is asked to reaffirm the loan (and is required to pay for a a new property inspection, appraisal and title report) in order to eliminate any documentation issues.

Note that this document does not specify the name of the lender; it may be BAC or it may be a pool of securities. Only the party holding title can foreclose, and without the proper documentation, lenders lack legal standing. The legal requirement to prove standing is to protect lenders and borrowers. Imagine a case in which an improper foreclosure was finalized; subsequently, the actual title holder would still want to sue the borrower for foreclosure and loan repayment. In this case, the borrower would want protection against being sued again for the same claim, and the actual title holder would want to ensure that its monetary position is not compromised.

If I were the borrower, I would do the following:

(i) Ask the bank to provide evidence of standing. Real estate law is clear – only the party holding title can foreclose.

(ii) Require that any loan modification include a principal reduction, in this case by a minimum amount of the Delinquent Balance ($41,634.28). Ideally, this principal reduction would include the Delinquent Balance ($41,634.28) *and* the Deferred Balance ($118,108.49). Realistically, permanent money at 0% interest is a gift, not a loan.

(iii) Stipulate that the interest rate remains constant at 2% for the duration of the loan.

(iv) Refuse to sign any Modification Bankruptcy Disclosure Rider. There is no incentive to waive any rights provided by law, although this could be modified with a genuine principal reduction.

If it is a hidden affirmation, BAC's program, conveniently ignores a potentially larger issue relating to trust law. Even if the lenders are able to solve the documentation issues, the issue relating to "who holds the collateral" will remain unsolved.

The pooling and servicing agreements in the servicing process are fairly detailed and rigid. One of these reasons: tax avoidance. These trusts, if properly constructed, are not required to pay taxes. As such, most trusts have very strict requirements which are stipulated in their governing agreement relating to the types of loans which may be accepted and also the timeframe for completing this transfer. These steps were to have been certified at multiple points by the trustee.