Edward J. Fay is CEO of Fay Financial, which was launched last year and owns a boutique shop, Fay Servicing LLC. In this edition of Person of the Week, Fay, who formerly headed Countrywide Home Loans' portfolio retention group, shares his thoughts on HAMP, HVCC and servicer-investor relations.

Q: How do you assess the Treasury's handling of the Home Affordable Modification Program thus far? Has the federal government overstepped its role as it relates to preventing foreclosures, or does it need to become even more involved?

Edward Fay: I should mention first that we are not a HAMP servicer, but we do know the program well, because we do modifications according to HAMP guidelines for clients who need us to do so. The difference is that we don’t take government money to do them.

Keeping borrowers in their home is always the preferred option, and the concept behind HAMP is the right one. Unfortunately, the details of the program are causing problems. We think the program should be more focused on getting servicers to be responsive to customers who can’t afford their mortgages and less focused on incenting servicers to process modifications. The truth is that, on many occasions, the borrowers’ situations have changed so dramatically that HAMP modifications could never lower their payments enough to make [the mortgage]affordable.

For example, banks that took TARP money now have to follow HAMP guidelines, which force them to do modifications that use a standard waterfall of steps to reduce the payment so that it’s 31% of a borrower’s gross income (i.e., front-end DTI ratio). The problem is most people have other expenses, such as credit card debt, auto loans, child care and medical expenses. When you add all those into the equation (back-end DTI), the ratio goes way up, and it’s easy to see the HAMP modification isn’t going to be a long-term solution.

The other problem we see is with the incentives. Although the benefit is shared between the investor, the borrower and the servicer, it’s the servicer who has the most to gain with the least at risk if the HAMP modification isn’t successful. Servicers also have the most discretion in determining whether or not a borrower qualifies for a HAMP modification. That’s a big risk. We think we’ll see a lot more taxpayer money going directly to servicers, when it’s really the borrowers and lenders who need it the most.

We don’t think the government needs to become more involved, but there are opportunities to improve the program by rethinking the 31% front-end DTI requirement and the incentives.


Q: We’ve all heard of the more prevalent obstacles facing HAMP servicers, including their need to almost immediately adjust operations in order to meet changes made to the program. What are some examples of other HAMP challenges that are, perhaps, less obvious?

Fay: The key issue facing HAMP servicers is that they need to re-underwrite the loan to create an effective workout strategy. It’s unrealistic to think traditional servicing can do this with an operations mind-set in a call-center environment. I think it’s important to have a more hands-on approach - more like what someone with origination expertise is used to.

While I’m sure a lot of servicers can figure out how to implement HAMP and deal with changes to the program, they will likely fall short in two main categories: talent and culture. Regarding talent, today you need problem solvers, not bill collectors, which is really all traditional servicing has had to be for the last 15 years. A more traditional servicing environment and its compensation structure aren’t competitive enough to attract and retain the talent needed to create long-term solutions.

As far as culture goes, most servicers are used to being reactive and unsympathetic, whereas now, they need to be proactive and empathetic with the borrower. Unfortunately, you simply cannot make that kind of cultural change overnight.


Q: Do you believe HAMP will ultimately be the game-changer that the Obama administration is hoping for? How do you envision the problem will evolve over the next six to 12 months?

Fay: While I’m tremendously hopeful that the mortgage crisis will subside in the next year, I don’t believe that HAMP will bring about drastic change. The main reason is that the guidelines focus on the front-end DTI ratio, which doesn’t guarantee an affordable payment.

Another big issue I envision over the next 12 months is growing concern from the investor community as they begin to recognize the long-term ramifications that this program will have on their investments. HAMP modifications can create lower payments over the remaining life of the loan, not just during the time borrowers need help to get back on their feet. That’s because the interest rate for the remaining life of the loan is capped at the Freddie Mac Primary Mortgage Market rate when the HAMP modification was done, which is currently 5.42%.

HAMP is more like a refinance than a modification. We’ll see borrowers staying in their current loans a lot longer than they otherwise would have because of the lower rate. That means investors will get a lower return over a longer period of time. In the short term, it’s really going to scare potential investors away at a time when investment is scarce. In the long term, investors are going to require higher margins to compensate for the risk, so rates will go up.


Q: When it comes to asset liquidation, what REO strategies have proven most successful in your experience?

Fay: We do everything we can to avoid an REO, but sometimes it’s unavoidable, even to the best of servicers. However, REO isn’t the only option. For servicers who become property owners, the best strategy is to know your price and cut out the bureaucracy involved in negotiating offers. Prospective buyers want a decision in hours and won’t wait six months while lenders and servicers argue over the price. I’d rather take a slightly lower price today to avoid losing the buyer. The price is most likely going to go down while I wait for the next offer to come in.

What’s really proven most successful when it comes to liquidation is to be rational with customers, take the time to explain things and work with them to identify their best alternative. There are often cases when people just simply have too much house. Servicers have two options: foreclose or work with the borrower and jointly sell the home. In the latter, we get more money for the property, so it allows us to help the homeowner with moving expenses, security deposits, rent payments and, sometimes, puts a little cash in their pocket.

It is cost-effective for us, because we save on legal bills and get better execution and selling price on the sale. Believe it or not, we can actually do an assisted sale that benefits the investor, homeowner and their neighbors.


Q: How would you characterize investor-servicer relationships in this unprecedented environment?

Fay: I would say these relationships are pretty tense in the MBS world, and it is probably going to get worse before it gets better. Again, the devil is in the details, and investors are now learning that when mortgage-backed security documents were drafted, those documents typically benefited the residual tranches, because they were often also the servicers.

When the market was up and everyone made money, it didn’t matter. But now that the unthinkable has occurred, investors are painfully realizing that the way these documents were written gave bondholders very little power to institute meaningful changes regarding servicing strategies. Many investors who thought they were buying AAA securities now find themselves owning distressed assets, and the legal details they now need to understand makes this a very frustrating process for them.

However, in the world of whole loans, things are much different. Unlike MBS investors, whole-loan investors have complete decision-making authority on modification and liquidation strategies. So more and more, you are seeing investors choosing non-HAMP special servicers who share the same views on maximizing portfolio value, and those relationships are extremely mutually beneficial.


Q: The Home Valuation Code of Conduct has become a huge talking point for anyone involved with appraisals. What are the main flaws of the HVCC, and how can they be corrected?

Fay: Further analysis needs to be done on loans booked by brokers who had access to their appraiser and loans booked by larger retail institutions where mortgage reps were not allowed to speak with appraisers. (HVCC was, for all intents, already in place.)

This will tell us if the issue is as large as it is believed to be. I think the analysis will show that there is a vast difference in valuation when an originator has access to the appraiser.

However, it is a good program in a stable market; unfortunately, it is perpetuating a race to the bottom, as appraisers are using distressed sales and causing problems for sellers. As someone in the industry, I would like to see it put on hold for a while, but if I were an investor in mortgages, I would like to see it remain in place.


Q: What are the main points of interest for investors interested in portfolio acquisition nowadays?

Fay: Buying at the right price is critical, but in today’s environment, the real alpha is in the servicing. Any decision to invest in mortgages has to take into account the servicing and exit strategy for each loan. Servicing is no longer a commodity business; effective servicing requires the right talent and structure to develop customized workout strategies that ensure long-term success.

Investors should understand that a servicing and exit strategy that maximizes loan value needs to be deeply integrated with the acquisition process. Once the loan is purchased, the workout path is typically complex, and investors will want a servicer who can manage a borrower through difficult decisions over the course of many months or years.