November 19, 2014

Distressed mortgage loan sale programs should be handled carefully

Distressed loan sale programs can help out homeowners, taxpayers and government organizations, but to generate these benefits, they must be set up in the right way, Sarah Edelman and Julia Gordon, who work for the Center for American Progress, wrote in a recent American Banker opinion piece.

Edelman and Gordon, who serve on CAP's housing finance and policy team as an analyst and a director, emphasized that if GSEs are careful in setting up these programs, they can help support property values, give homeowners greater foreclosure alternatives and reduce the burdens suffered by taxpayers.

Initiatives focused on GSEs and their distressed loan sales could potentially impact a wide range of homeowners, as recent data compiled by HOPE NOW shows nearly 2 million individuals are behind on their mortgages.

In addition, almost 10 million U.S. homes are underwater, according to the latest figures from Zillow. The real estate website's first quarter Negative Equity Report showed the fraction of underwater homes falling to 18.8 percent. A higher number of homeowners - 36.9 percent - held mortgages with 20 percent or less equity in their properties during the fourth quarter.

Zillow has predicted that while the fraction of homes with negative equity will continue to decline, this improvement will decelerate as home prices increase more slowly. The high portion of such properties is hindering the real estate market's recovery and helping fuel a lack of available homes.

FHA's Distressed Asset Stabilization Program
To cope with the buildup of delinquent mortgages and help reduce foreclosures, the Federal Housing Administration initiated the Distressed Asset Stabilization Program in 2012, selling large amounts of home loans.

The government agency insures many troubled mortgages, and has sold roughly 100,000 loans to investors in the last two years, the two authors noted. However, the organization has not been able to help out in all cases.

Fannie Mae And Freddie Mac have followed the FHA's lead, with Freddie Mac holding its first loan sale of seriously-delinquent debt over the summer, unloading $659 million worth of loans, according to Bloomberg. In spite of such progress, Fannie and Freddie still own vast amounts of nonperforming loans.

These GSEs, along with the FHA, are currently sitting on more than 1 million such loans, and could shore up their financial position by selling them, Edelman and Gordon wrote. In addition, if these organizations take the right approach, they could help some families avoid foreclosure. However, this would require any organizations purchasing distressed mortgage debt to offer homeowners a chance to keep their property.

In some cases, the FHA has sold bundles of loans without attaching conditions, and in others, it has auctioned them with certain caveats. Loan pools sold through the Neighborhood Stabilization Program come with specific restrictions designed to ensure that buyers help homeowners.

Outcome data
The FHA has released outcome data showing that when the organization sold bundles of loans without attaching any strings, fewer than 9 percent of families stayed in their homes, and 21 percent managed to steer clear of foreclosure. Alternatively, selling loan pools through the NSP produced stronger results, with almost one-quarter of homeowners remaining in their homes and 35 percent avoiding foreclosure.

Designing strong loan sale programs
The two authors suggested that in order to serve the best interests of taxpayers, families and neighborhoods, government organizations should obligate any buyers of distressed debt to collaborate with homeowners to modify loans in an effort to ensure the owners remain in their properties. If the parties involved cannot create this desired situation, buyers should be obligated to pursue deeds or short sales, instead of pushing for foreclosure as their first option.

When making this suggestion, Edelman and Gordon pointed to data supporting the idea that households and neighborhoods can benefit substantially when loan pools that are sold come along with requirements that are far from rigid. The authors further suggested that before placing a loan into a distressed mortgage sale program, the FHA should make sure the home in question is occupied and that mortgage servicers have met all the organization's requirements for assisting borrowers.

This would be an improvement over the current situation, as the authors reported that some buyers are taking control of homes while they are vacant, and some loans are entering distressed-debt programs before servicers have done all work required by homeowners. Finally, Edelman and Gordon spoke to the information that is available for distressed loan sales programs. They noted that Freddie Mac released almost no information before a recent debt sale, and has not offered any plans on making this data more accessible. Alternatively, the FHA took nearly two years to release its outcome data.

Banks may want to learn more about the potential impact of distressed debt sales, as being familiar with the implications could help them make better-informed decisions. In the current environment, these financial institutions face many headwinds, one of which being increased focus on the quality of data provided in a sale.

What banks can do
To effectively manage the risk of lower prices due to incomplete data, banks should focus on creating strong loan portfolios, which require significant due diligence. To expedite the process, financial institutions might benefit from speaking with Garnet Capital Advisors.

The loan sale advisory firm has significant experience in all types of debt transactions, and has helped execute several billions of dollars' worth of these sales.