1D 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 RY • 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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4D 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 RY • M A N A G E M E N T C O N S U LT I N G4

THE HOME AFFORDABLE

MODIFICATION PROGRAMME (HAMP)

US Mortgage Arrears

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The Making Home Affordable ProgramHome 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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The Making Home Affordable ProgramMaking 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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The Making Home Affordable Program Borrower Eligibility - HAMP Design Criteria

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The Making Home Affordable Program Borrower Eligibility - Occupancy & Delinquency Criteria

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The Making Home Affordable Program 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.

The Making Home Affordable Program HAMP - Servicer Outreach to 60+ Day Delinquent Homeowners

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The Making Home Affordable Program HAMP - Single Point of Contact Mandatory Requirement

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The Making Home Affordable Program HAMP - Standard Modification Waterfall

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The Making Home Affordable Program HAMP - Standard Modification Waterfall Inputs

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The Making Home Affordable Program 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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The Making Home Affordable Program 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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The Making Home Affordable Program 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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The Making Home Affordable Program 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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The Making Home Affordable Program HAMP Standard Modification Waterfall – Worked Example

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The Making Home Affordable Program 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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The Making Home Affordable Program 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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The Making Home Affordable Program 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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The Making Home Affordable Program 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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The Making Home Affordable Program HAMP Alternative Modification Waterfall – Step 5: Principal Forbearance

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The Making Home Affordable Program HAMP Alternative Modification Waterfall – Worked Example

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The Making Home Affordable Program HAMP - Base NPV Model Overview

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The Making Home Affordable Program HAMP - Base NPV Model

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The Making Home Affordable ProgramHAMP – 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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The Making Home Affordable ProgramHAMP - 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 ProgramThe 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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The Making Home Affordable ProgramHAMP - 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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The Making Home Affordable ProgramHAMP - 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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The Making Home Affordable ProgramMortgage 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.

34D 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 RY • M A N A G E M E N T C O N S U LT I N G

INSIGHTS AND RELEVANCE TO IRELAND

Mortgage Arrears

US Mortgage Arrears PracticesInsights & 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!

36D 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 RY • M A N A G E M E N T C O N S U LT I N G

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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