It’s “politics as usual” in California – more publicity than substance.

On December 20, 2011 the California Attorney General’s office announced a settlement with Wells Fargo Bank (WFB) “worth more than $2 billion to Californians with risky adjustable-rate mortgages.” It didn’t say that this value is possibly attained only IF all eligible borrowers complete the modification process, accept the terms and then pay the resulting 40 year mortgage over the life of the loan for an average monthly relief value of $280 month. (Read on to see how I come upon that amount – or less.)

Just what does this news release mean? I’m sure that few people reading the news articles will ever read the actual 27 page “Assurance” which is available for registered readers of this blog in the preceding article. You can surf over to my earlier article and download your very own copy.

I’m sure that far fewer people will understand it. I’ve given it a “quick read” and must admit that it would take several hours for me to really get a strong understanding, but let’s take a look at some points from the “Assurance” that can be understood in looking over it briefly.

Keep in mind, the document is titled “Assurance.” I guess that’s political-speak for a “settlement” because the Attorney General’s “news release” calls it a settlement. On page 23, the title of Article XI of the assurance refers to the issue of a future “More Favorable Settlement” in any other State. Otherwise, you won’t see much reference to the word “settlement” in the Assurance.

For reference, Wells Fargo Bank has already entered into agreements regarding pick-a-pay loans with Arizona, Colorado, Florida, Illinois, Nevada, New Jersey, Texas and Washington.

The Assurance is signed by WFB but the signature for the California Attorney General (AG) is merely “Approved As To Form and Content.” Wells Fargo is simply “assuring” to the State of California that it will follow the terms of the document – probably just like it has told thousands of borrowers that it won’t foreclose their homes during the loan modification or short sale applications yet does so anyway.

The “Effective Date” is left blank in the first paragraph [specifically, “this ___ day of December, 2010], while the signatures are dated December 16, 2010. A business-to-business “settlement” would never look like this (at least from my law office). I’m guessing it’s effective December 16th.

Page references in this article are to the Assurance.

Few Loans Affected

Keep in mind also that this only affects the “pick a payment” mortgage loans originated or acquired by Wachovia or World Savings that Wells acquired in taking over those failed banks (page 7). These are called an “Eligible Mortgage.” If you’re a borrower with any other WFB loan, stop reading – this doesn’t affect you.

$32 Million “Foreclosure Relief Program”

Article IX (page 17) of the Assurance provides $32,000,000 to “be distributed to borrowers who experienced a foreclosure sale on a property secured by an Eligible Mortgage between January 1, 2005 and the Effective Date (presumably December 16, 2010). If you’re a borrower with an Eligible Mortgage and you get foreclosed after December 16 and before you get an “assured” loan modification, you’re apparently out of luck. This is estimated to benefit more than 12,000 pick-a-pay borrowers who lost their homes to foreclosure. My arithmetic says this will average less than $2,666.66 per borrower. I guess that’s better than nothing now that they likely are renters.

The AG “may hire a third party settlement administrator to distribute payments to eligible foreclosed borrowers.” However, the Assurance does not state any formula for allocation. Should it be based on the principal value of the loan? Maybe the negative equity in the home? Should it be lower based on the size of the borrower’s default (the value of missed payments which allowed the borrower to live in a home without paying)? Can you get more moeny if you’re a friend of the settlement administrator? All of these questions raise interesting omissions.

$2 Billion of Future Loan Modifications Averaging $280 Per Month of Relief?

The AG’s news release says the “total value of modifications mandated by the settlement is projected to be more than $2 billion.” Again, this is political “news-speak.” The Assurance does not state this number, nor does anything state the basis for the calculation of this amount. As you will read below, this could be an entirely fabricated amount.

It certainly doesn’t mean that there will be anything like $2 billion in principal reductions.

Since modifications can be stretched up to 480 months, this could be less than $50 million per year in calculated “value.” The news release estimates that 14,900 borrowers could be offered these “affordable loan modifications.” Divide that into $50 million and my arithmetic shows an estimated annual savings of $3,356, or about $280 per month. Keep in mind that much of this “value” is likely never realized if the borrower sells the property .

The news release does not estimate how may borrowers will actually avoid a future foreclosure with $280 per month net present value of relief. Frankly, now that I’ve made that calculation, I’m wondering why the AG invested the time to write the 27 pages and likely investigated and negotiated for hundreds of hours.

I’m wondering if I’ll even write much more about this. A “WOW!” new release starts to turn into a real “ho-hum” event when one does a little arithmetic.

I recall the typical figures are that less than half of the people who begin a loan modification process finish all of the paperwork and then fewer than half of them keep up on the new “affordable” payments. When one gets through those odds, the NPV of the “potential” $2 billion settlement whittles down to about half a billion dollars.

Frankly, Wells Fargo is taking a pretty good gamble on this “settlement” not costing them very much over 40 years.

The “Waterfall” Loan Modification Process

Article V (page 9) of the Assurance sets forth a “waterfall” method for determining the loan modifications to be offered. The first level is a HAMP modification under the federal government’s Home Affordable Modification Program which most commentators have considered a miserable failure.

This means that the first requirement of the Assurance is “business as usual” – offer a federal loan modification that doesn’t work and that few borrowers want. If the borrower does “not qualify or elect a HAMP modification” only then does the borrower come under the new “MAP2R Modification” program created by the Assurance.

Two tests must be met before a MAP2R loan modification must be offered (Section V.B.1, pages 9-10). First, the “waterfall steps” must result in a debt to income ratio (DTI) of 31%. Second, the modifications to reach 31% DTI must pass the “NPV test.”

The DTI is the ratio of the borrower’s first-lien monthly payment, including principal, interest, escrow, taxes, hazard insurance and homeowners’ association or condominium fees, if applicable, to the borrower’s gross monthly income. All as determined in accordance with HAMP, as defined in Treasury’s Supplemental Directive 9-01 of April 6, 2009 (page 4).

Keep in mind that the factors of taxes, insurance and HOA fees won’t change in any method of calculating a loan modification. Hence, it will take a lot of reductions in the loan itself to reach the 31%. Then the remaining modified loan payments must meet the NPV test.

The “NPV Test”

Section V.B.3 (page 12) states that WFB “shall not be required to offer the borrower a MAP2R modification that yields an NPV negative result.” So one must review the definition of the “NPV Test” on page 7 of the Assurance.

The definition states that the “NPV calculation is arrived at using a proprietary formula developed by Wells Fargo.” Say what? My understanding of a “proprietary formula” is that it is essentially a trade secret that will not be revealed. What kind of standard is that? How will this calculation actually be made? How is WFB allowed to “cook the books?”

The definition further states: “If the NPV of the modification would be greater than the NPV if there was no modification, the result is deemed ‘positive.’ If the NPV of the modification would be less than the NPV if there was no modification, the result is deemed ‘negative.’ ”

Let’s think about that. NPV is the investment value of the loan. If the modification of the loan is not required if the NPV is negative, then where is the $2 billion value in the settlement?? There is no “loss” in investment value of these loans, so there is no effective benefit to borrowers.

In fact, if the NPV is not positive (a better deal for WFB), then WFB is not required to offer the loan modification!

Either I don’t get it or WFB pulled a good one in this Assurance. This sure sounds like WFB is not required to offer a loan modification if there is an actual benefit provided to the borrower over time (that’s what “net present value” is all about).

Here’s where I turn this article over to your comments below.

Am I reading this wrong? Or does this “Assurance” merely assure that WFB and the AG get some publicity but the borrowers do not get any real benefit?