An obstacle course, unlike a simple sprint to the finish line, is filled with walls to climb, tires to step through and hurdles to jump over. It's not a simple race, but a skillful art in maneuvering quickly to the finish line.
The same can be said for servicers working through loan modifications and real estate-owned (REO) dispositions. In a normal environment, servicers would have a smooth REO disposition. In the current situation, unless they map out a proper course for it—taking care of all the obstacles that stand in the way—they can face a number of unexpected hurdles.
A wall of properties in distress is the first obstacle in this race, and one that sustains itself through regulatory hurdles set up by the federal government to try and keep borrowers in their homes.
Some of those hurdles include the Home Affordable Modification Program (HAMP) and the second phase of the Home Affordable Refinance Program. I think of them as hurdles because they are obstacles that do not necessarily align servicers with their responsibilities to the investors or residential mortgage-backed securities (RMBS) trusts. Indeed, these obstacles sometimes stand in the way of a servicer doing what is best for the investor or the trust.
Servicers now need to maneuver and step through higher loan-to-value (LTV) and debt-to-income (DTI) ratios, forbearance and extensions while all the time, ensuring proper maintenance and condition of the property. All of these obstacles stand in the way before servicers can climb a wall of distressed properties and work toward getting to the finish line.
Normally, servicers would follow through investor guidelines and have the wind at their backs knowing that they are doing their best for the investor or residential mortgage-backed security (RMBS) trust. An unemployed borrower would go through the normal procedures, working with a servicer at trying to make their monthly mortgage payments. If the borrower could not make their monthly payments in 12 months, the house would eventually need to go into REO. The wall at the end of the course would be manageable.
Then, in a normal REO disposition, the bank would auction the property to the highest bidder, ensuring that the property brings the highest value for the investor. It was not necessarily a sprint to the finish line, but a manageable course without any major hurdles or obstacles that stood in the way, apart from prevailing market conditions.
Today, however, under HAMP, servicers need to reduce mortgage payments to levels affordable for borrowers—for a minimum of three months and up to six months for some—while these eligible homeowners can look for a new job.
Through forbearance, ratios of monthly housing payments-to-income are allowed to move up to 31 percent while a borrower is unemployed. The typical percentage of housing payment-to-income would be at 28 percent. Servicers must now offer temporary assistance to unemployed borrowers who meet specific criteria.
The criteria also factors into loans insured under the Federal Housing Administration (FHA). All servicers are required to consider an alternative modification approach that emphasizes a principal write-down for HAMP-eligible borrowers. The alternative principal reduction allows some underwater homeowners to reduce the principal balance of their mortgage in steps over three years if they remain current on payments.
However, these rules do not comply with capital-stack investors in an RMBS trust. Servicers are supposed to initially treat the write-down amount as forbearance and will forgive the forbearance amount in three equal steps over three years, as long as the homeowner remains current on payments. How does this help the loan trust or the investor if the value of the homes decline while a borrower keeps making payments?
A recent CoreLogic study found that national home prices continue to be pressured by a stream of distressed properties that threaten to push prices even lower. The report said the nation's shadow housing inventory stood at 1.6 million units, or a five-month supply in October, as the National Association of Realtors (NAR) revised its existing home sales downward by 14 percent from 2007 to 2010.
Enter the second phase of the Home Affordable Refinance Program, or HARP 2.0. Homeowners making current payments can also refinance with an unlimited LTV ratio. Despite being underwater on the home, the borrower can stay in their home if they have only missed one payment within the past six months.
The U.S. Department of the Treasury said forbearance will not cost taxpayers anything. However, the Treasury seeks to penalize future homeowners with an increase in guarantee fees for Fannie Mae and Freddie Mac because of their losses.
These programs are costing investors and capital-stack investors in RMBS trusts time and declining valuations. Servicers face a double-edged sword and are crushed by both sides of the equation. They face lawsuits by not following HAMP or HARP Phase II, but they may also face lawsuits from RMBS trust investors.
Even runners on an obstacle course have room to maneuver among the tires, hurdles they must jump over and walls they have to climb. Servicers, however, are being asked to jump major hurdles and climb huge walls in order to fulfill their priorities.
While nobody wants to see homeowners evicted from their properties, the HAMP program will cause further delays on homes likely to go into foreclosure, thus decreasing their value. As a result, this obstacle course increases a final wall of properties that may be losing value rather than gaining it.
RealtyTrac recently reported a 14 percent decline in foreclosures during the past year, but there still remains a significant number of foreclosures across the country. The same report said that with nearly 224,400 U.S. properties in foreclosure during November, a three percent decrease from the previous month, one in every 579 U.S. housing units had a foreclosure filing during the month.
A slow, methodical walk to the foreclosure finish line only means more foreclosures and, with so many REO properties already, their condition becomes more difficult to maintain.
Neighborhoods and communities can become blighted as foreclosure filings continue to increase. The result is that home values decline and, when they go to auction, the investor or RMBS trust is the one left holding the bag.
A recent survey conducted by Zillow Inc., reported U.S. home prices will continue to decline through late 2012 or early 2013, as negative equity and weak job growth hinder a real estate recovery.
More than 100 economists, property experts and investment and market strategists said prices could rise nearly three percent each year after 2013 and through 2016, but how will this be possible without job growth and purchase activity?
Investors will most likely purchase foreclosed properties, fix them up and rent homes rather than occupy them until valuations start to increase. What will that do to the communities and the home values and what will that do to new multifamily construction?
Meanwhile, if borrowers do not remain current on their payments in the HAMP program, servicers need to double relocation assistance payments for borrowers successfully completing a foreclosure alternative, up to $3,000. Under HARP Phase II, homes can remain well underwater if borrowers can refinance. How many times will they be able to refinance before not making their monthly payments?
Despite increased incentives to servicers and lenders under the HAMP program, including increased incentives for extinguishment of subordinate liens to encourage more short sales and other alternatives to foreclosure, servicers must still bear these costs, including the addition of a single point of contact under the program.
Some servicers decided to drop out of this obstacle course race and let someone else run it for them. For this reason, there has been a considerable increase in subservicers handling these loans. A recent survey found that the nation's sub-servicers were processing $386 billion of loans as of Sept. 30, a 20 percent increase from the same period a year earlier.
The key to keeping valuations high is to find true value in the marketplace through purchase activity, and to ensure that homes are properly maintained and managed to keep values from declining before they are ready to sell.
If we continue to see home values decline through 2013, as Zillow reported, and no incentives to foreclose on homes, we may see valuations decline even further to the point that they will never regain anything close to their original value.
Lower values remain a large hurdle to overcome in this obstacle course. The result will simply cause investors, including RMBS investors, to stay away from the marketplace longer and we will continue to see mortgage originations through FHA, Fannie Mae and Freddie Mac. If this happens, not only will investors and trusts end up holding the bag, but taxpayers as well. And that will be yet another hurdle—perhaps a huge wall—we will all have to attempt to climb over even after this obstacle course race has ended.
Ivan Choi is senior vice president for Matt Martin Real Estate Management (MMREM) based in Arlington, Va. He is the current president of the board of directors of REOMAC, was a senior executive in Bank of America’s mortgage organization and an expert consultant in business development and default management services prior to joining MMREM in 2011. He may be reached by e-mail at
[email protected].
