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Time Is Not on Your Side: Keeping Up With Foreclosure

Editor's note: This story originally appeared in the June issue of DS News.

According to a 2009 report by CNN Money, foreclosure filings in the U.S. spiked in 2007 by more than 81% over the prior year, and increased by 225% compared to 2006. They also resulted in a series of government regulations and interventions relating to mortgage servicing practices that were primarily designed to add greater transparency to the process and protect borrowers by giving them ample notice of the servicer’s intent to claim default. To help account for this, the government-sponsored entities (GSEs), Fannie Mae and Freddie Mac, made ongoing adjustments to foreclosure timelines—with established guidelines generally longer for non-judicial versus judicial states.

Additionally, temporary foreclosure moratoriums were enacted during this period in certain states to deal with volume spikes in defaulted loans caused primarily from borrowers being “underwater.” While this resulted in an unprecedented number of foreclosed homes on the market, these moratoriums may have also given borrowers more time to work with servicers and potentially avoid a foreclosure.

The Markets Today

In 2019, there has been a significant rebound in the economy and the U.S. housing market has recovered nicely. Unemployment is down to record low levels, consumer confidence has risen, new and existing home sales have increased, and home foreclosures have come down drastically. According to CoreLogic data, as of April 2018, the national foreclosure rate was 0.6%, down from almost 4% at its peak. This has been a contributing factor in housing prices increasing substantially in many regions of the country.

With foreclosures down significantly and banks/residential mortgage loan servicers today seeing housing markets that have returned to “near normalcy,” it begs the question: why do servicers continue to struggle with adherence to GSE foreclosure guidelines? One reason may be cost avoidance associated with the servicer making necessary investments to streamline and shorten the foreclosure process.

The foreclosure process is both tedious and labor intensive. It is also highly regulated to encourage transparency and ensure borrowers are treated properly and fairly. Along with the “high-touch” servicing necessary to sustain ongoing dialogue and active interaction with the borrower to maintain homeownership, costs may force the servicer to curtail investment and hold expenditures to a minimum. This may result in servicers taking a short-sighted view of the problem and making cuts solely in the name of cost containment, thereby making it more difficult to optimize the foreclosure process (i.e. process optimization that may result from investments made in technology and staffing). This may result in an undue lengthening of foreclosure processing timelines, leading to an increase in costs and loss severities.

Additionally, controls may be compromised, potentially adding to further oversight of the servicer by rating agencies, regulators, and others in order to monitor and maintain audit and regulatory compliance. In some instances, servicers may be fined or penalized, further exacerbating costs relating to foreclosure processing. Downgrades from rating agencies and/or sanctions from regulators may result, thereby adversely impacting the servicer’s ability to acquire new business.

This short-term view on costs may result in a temporary deferment of foreclosure processing expenditures and impact the servicer’s ability to move the process along expeditiously and inline with GSE foreclosure processing timeline guidelines.

The Real Cost

In addition to the economic cost of carrying a non-earning asset on the balance sheet, delays in the foreclosure process can result in extra costs to servicers and, ultimately, to investors.

Taxes & Insurance: Foreclosure processing delays typically translate into certain variable costs such as property taxes and hazard insurance premiums that will continue to accrue and must be paid by the servicer to applicable local and state municipalities or third-party insurance providers. Protecting the collateral is essential in order to ensure the underlying property is insulated from potential liens that may be placed for failure to pay property taxes. Similarly, maintenance of hazard insurance is critical in order to shield the underlying asset from costs resulting from the damage caused by fire, floods, and other events.

Legal/Court Filing Fees: Costs relating to documentation retrieval and recovery, along with those costs necessary to properly maintain and file required documents, tend to increase the overall loss severity due to delayed foreclosure. These costs may often be avoided or greatly minimized if servicers were to instill proper care and due diligence protocols upfront versus taking a “fire-drill” approach (i.e. dealing with and reacting to specific transactions on a case-by-case basis). Other incidental fees may also accumulate as the foreclosure process continues and may include items such as certified mailings, court refiling fees, and additional attorney’s fees.

Maintenance and Repair Expenses for Abandoned Homes: Costs associated with preserving property value and complying with city and county ordinances (i.e. winterizing the home, securing the property, cutting the grass/landscaping, snow removal, changing locks, etc.) can be sizeable depending on the length of time the property remains in foreclosure. Abandoned homes that remain on the market for extended periods of time are subject to damage, vandalism, and theft. These properties quickly become cost magnets. Add to this expenditures associated with things like graffiti removal, repairing/replacing sheetrock, repainting, re-carpeting, cleaning, refuse removal, displacing and evicting squatters/occupants, and other property maintenance and repairs, total costs associated with delaying the foreclosure process can be significant. Once a foreclosure sale has occurred, property maintenance and repairs may continue (along with any associated costs) throughout the redemption period, which, in some states, can be up to one year after the sale.

Property Inspection Costs: Throughout the foreclosure process, servicers are required to perform inspections on a monthly basis to determine both the physical condition and occupancy status of the mortgaged property. Even prior to foreclosure, property inspections should be ordered on a regular basis once the loan goes into default. While the cost of a single property inspection by itself may not be significant, such costs can multiply when foreclosure delays occur over extended periods of time across multiple properties. A servicer’s diligence in adhering to prudent inspection guidelines is critical in keeping up with property maintenance and repairs in order to contain costs and eliminate or mitigate fines or penalties that may be assessed by local municipalities. It is therefore prudent that servicers minimize foreclosure timelines to decrease the susceptibility of properties from becoming damaged or vandalized, thereby resulting in increased maintenance and repair costs leading to a decline in property value.

Property Valuation Costs: In addition to property valuations ordered by servicers before starting the foreclosure process and valuations ordered directly preceding foreclosure sale, interim property valuations should be performed throughout the foreclosure period. During this timeframe, it is critical that servicers keep a watchful eye on the underlying collateral to ensure there has not been any significant change to the asset’s condition adversely impacting its value. As foreclosure timelines are extended, there is a need for ongoing property valuations. Costs of property valuations will vary depending on the type of valuation ordered, with broker price opinion’s (BPOs), AVMs, and drive-by inspections being less expensive than full and complete appraisals. Either way, the costs can add-up when foreclosure delays occur over extended periods. Property valuation declines have a direct impact on loss severity, as properties sold at foreclosure sale generally yield lower proceeds when the overall condition of the property is impaired.

Homeowner’s Association Administration (HOA) Fees: This fee, if applicable, continues to accrue and must be paid while the property remains in foreclosure. According to November 2017 Bankrate report, HOA fees normally range from $200 to $400 per month for a typical single-family home. For condominium or cooperative units, HOA fees tend to be higher as they cover costs associated with maintenance relating to the building’s common areas such as lobbies, patios, pools, grounds, elevators, etc. As with property taxes, failure to pay HOA fees can result in liens being placed on the property by the HOA. The fees will vary depending on the size of the unit, its amenities, and the property’s physical and geographic location. Additionally, communities hit with unexpected or extreme maintenance expenses that are inadequately reserved can result in special assessments that may make HOA fees even higher at defined points in time. It is therefore in the best interest of servicers to foreclose as expeditiously as possible in order to minimize the amount of HOA fees paid and avoid the uncertainties associated with special assessments.

Nonrecoverable Advances: These are expenses paid by the servicer that it deems in its good faith judgment to be nonrecoverable. Certain expenditures will continue to be advanced to avoid liens from being placed on the collateral (i.e. taxes, HOA fees, etc.), or to ensure adequate protection of the underlying asset (i.e. hazard insurance, property maintenance, and repairs). To the extent these expenditures are nonrecoverable, they will add to loan loss severity.

Blight-Related Costs: Blight caused by property neglect, damage, abandonment, or vandalism tends to increase the longer a property remains in foreclosure. When a property is abandoned, some states do not require banks to fully maintain blighted properties until the foreclosure process has been completed and they have assumed ownership. However, many municipalities across the nation are enacting ordinances setting a legal framework and establishing clear standards relating to the maintenance and repair of blighted properties. Many municipalities are imposing significant fines and penalties relating to these properties. Servicers may be liable for paying these fines and penalties while the loan remains in the foreclosure process. Additionally, there is the potential for bad press associated with such conditions. From a practical perspective, blighted properties have an impact on depressing home values in a specific region and might also have a direct impact on the reputation of a bank or servicer. It is key to remember that blight usually occurs and worsens when abandoned properties remain in foreclosure for an extended period. Consequently, the shorter the foreclosure timeline, the greater the likelihood that related blight can be prevented or contained.

Value Declines: Vacated or abandoned houses, including foreclosed properties, contribute to neighborhood blight. The result? An overall decline in property values. Delays in the foreclosure process may lead to decreases in property values, mainly due to neglect. Studies have shown that the longer a property is in foreclosure, the larger the impact will be on value declines for the property, as well as for neighboring homes. Such value declines have a direct adverse impact on proceeds received from foreclosure and real estate owned (REO) sales, thereby impacting loss severity.

Compensatory Fees: These apply to agency loans and represent compensation for damages that may be incurred as a result of a servicer’s failure to comply with specific GSE requirements or procedures relating to a defined aspect of the servicer’s performance. Specific to the foreclosure process, compensatory fees are assessed to cover costs associated with the nonpayment of interest associated with delays in foreclosure. These delays in excess of GSE standard guidelines result in costs to both servicers and investors. Compensatory fees are assessed against the servicer for the difference in the period commencing with the Last Paid Installment (LPI) date through the foreclosure sale date minus the GSE allowable foreclosure timeline for that specific state.

Undoubtedly, delays in the foreclosure process result in additional costs. It is therefore in the best interest of banks and servicers to move the foreclosure process along most expeditiously and in accordance with GSE timeline guidelines. This will likely result in fewer expenditures and reductions in loan loss severity.

About Author: Vincent Spoto

Vincent Spoto has more than 25 years’ experience in the mortgage banking and financial services sector, having held senior management roles with JPMorgan Chase, Citigroup, and Credit Suisse. Currently one of three Founding Partners and a Manag-ing Director of RRMS Advisors, Spoto provides advisory and consulting services relating to servicer surveillance, default management, asset disposition, compliance monitoring, and risk management. His firm also provides expert witness and discovery litigation support services.

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