Joseph Smith II is president and CEO of Default Mitigation Management LLC, a Kentucky-based company that helps borrowers and lenders negotiate and resolve defaulted loans.
Q: You've had the opportunity to meet with legislators on Capitol Hill. Coming away from those conversations, how would you assess legislators' understanding of the issues?
Joseph Smith: With CARES – the Committee for Actual Real Estate Solutions – we have met with 16 members of Congress, Senate or their staffs. I have found most to be very aware of the problems and potentials for disaster. Unfortunately, there are those who perceive this as a bank/loan servicer issue instead of an investor issue.
CARES has been asked to provide additional insight and information on several of the current legislative matters and to assist in some of the legislation aimed at increasing the opportunities for loss mitigation.
Q: Do you think the Obama administration is on the right path with its Homeowner Affordability and Stability Plan? What tweaks do you believe are needed?
Smith: My feelings on the plan have improved with the review of the details. The modification portion is very similar to what we have been doing for the past six years with one client. I wish there was more counseling for all the borrowers on how to live in their new budget. I do like the fact that if you are going to use gross income as a measure, at least [the government] reduced it from 38% debt-to-income to 31%. I much prefer net income. Coming up with a standard formula and forms is priceless.
There are two missing parts. One is the indemnity for servicers with the investors or a process to establish both REMIC and tax accounting incentives for the insured investors to allow the modifications. The securitized loans where the investor does not agree to modifications would not benefit from the plan.
The second missing part is the big-value-loss properties on the coasts. Something will need to be done to address those properties, even though you can make up a lot of ground with interest and term. One item I would change is [the use of automated valuation models] for the valuation. They are part of what created this overvalued and fraud-filled marketplace. It only takes one or a few bad comps, which can become the basis for all valuations.
Q: At the time of this writing, bankruptcy cramdowns have not yet been approved by Congress, although anecdotal evidence indicates things are headed in that direction. What impacts of cramdown legislation do you foresee?
Smith: The new House version that passed is a compromise that actually should gather a lot of interest. It fortifies the new modification plan and fills the gap on large-dollar value losses, and it compels the insured investors to consider the modification.
Some have raised [the concern of] the potential for increased costs and fees in new loan originations if the cramdown passes. I do not see it. If new originations are based on sound underwriting going forward using the DTI front and back ratios with real verification of income and a true appraisal of the properties' values, then the valuation and affordability issues should be minimized.
If the industry is planning on going back to fully electronic originations with minimal verifications and explanations, it will deserve what will happen on the default side. It should not be easier to get a house than to get a car!
Q: What skills are crucial for a loss mit specialist to possess?
Smith: The basic skills are empathy for the borrower and the ability to listen and develop the preliminary "triage" budget of the borrower and then apply the loss mitigation criteria against it. Loss mit specialists make the contact, get the financial info and then review the budget in detail.
Our loss mitigators talk with the borrower, inform them of the options and allow the borrower to make an informed decision. It is a big difference from doing everything behind the scenes and then telling the borrowers what they have to do. The loss mitigator needs to understand the big picture, and in those situations where the borrower cannot, under any scenario, afford the home, ease them into the pre-foreclosure sale or [deed-in-lieu of foreclosure].
In most redefault scenarios, the loss mitigation is not a review of the loan and the creation of an affordable payment; it involves placing the borrower in one of several boxes, whether they fit or not.
Q: Are loan modifications appropriately scalable in nature?
Smith: There is nothing about loan modifications that is scalable, if you want to have a low redefault rate. Each loan modification has to be designed to fit the borrowers' ability to pay and leave them with a surplus income to handles life's little surprises.
I believe modifications should be done on a net income – not a gross income – basis. Of course, you can take into account voluntary deductions for 401(k) plans, etc. But I have seen too many 38% gross DTI calculations that do not take into account court-ordered child support and other financial information, which makes the modification untenable for the borrower.
I have seen a borrower with a steady job who is behind because of a rising interest rate but who could have made their base payment well into the future, denied and foreclosed upon.