Editor’s Note: This article was originally featured in the October issue of DS News, available now.
It’s been nearly a decade since our country’s financial crisis, the worst in our history since the Great Depression of the early 1930s. A confluence of events related to the subprime mortgage industry and the excessive risk-taking of banks turned our crisis into an international one. The main tipping points included fraudulent underwriting practices, capital markets worldwide creating capital liquidity through reduced interest rates, and loose credit conditions spiking homeownership rates nationwide among first-time buyers. Rising home values, ease of credit, and lenders having access to funds essentially led to the popping of the housing bubble and caused a massive uptick in foreclosures.
Going Back in Time
The early 2000s saw foreclosure rates remaining steady with approximately 2 percent of home sales in the U.S. represented by foreclosures. With lenders giving out exotic mortgages requiring little to no down payments, that number peaked to nearly 28 percent during the height of the crisis in 2009. There were many lessons and takeaways from our Great Recession, and the 2010 signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act helped steer our economy back in the right direction.
More stringent lending regulations, such as the creation of the CFPB, rising home prices, and improvements to the job market have set the market on a healthier path, with foreclosures nationwide meandering back down to single-digit rates. Moreover, delinquency rates—the number of homeowners behind on mortgage payments but not yet in the foreclosure process—have fallen to a 17-year low.
Before the subprime and exotic mortgage boom, Federal Housing Administration (FHA) loans enabled first-time homebuyers and others with a credit score of just 580 and down payments as low as 3.5 percent to achieve the American Dream. Those with credit scores between 500 and 579 who shelled out just 10 percent for a down payment were able to become homeowners.
The Trouble With FHA Loans
Originally enacted by the National Housing Act of 1934 to assist homebuyers after the Great Depression, FHA loans have always bred inherent risk because loan requirements are eased in comparison to traditional ones. Since 2001, FHA-originated mortgages have hovered in the 20 percent range, with a large spike in 2009 of more than 43 percent. Despite the higher lending practices being enacted by both lenders and regulators, FHA loans are three times as likely to be defaulted upon than traditional loans. As of the summer of 2016, approximately 11 percent of all FHA loans were delinquent, compared with the 3 to 4 percent percent range of traditional GSE products. The fourth quarter of 2016 saw the first increase in delinquency rates for FHA loans after continuous, quarter-after-quarter improvement stretching back to 2006. Nevertheless, FHA loans and their late-pay rates have always walked hand-in-hand with housing market woes, though the continued improvements to these types of programs have seen the overall REO inventory reduce.
FYI’s on CWCOT
Claims Without Conveyance to Title (CWCOT) has a direct correlation to the FHA mortgage market. Foreclosed FHA loans fall into the CWCOT realm in various ways. The CWCOT program through the U.S. Department of Housing and Urban Development (HUD) has existed for upwards of 30 years but only recently has experienced resurgence in viability following the downturn of the foreclosure crisis. The program encourages third parties to buy assets at the courthouse steps instead of servicers having to convey the assets to FHA asset managers.
With the goal being to slash the number of properties in HUD’s inventory, programs nationwide—like that of auction company ServiceLink Auction powered by Hudson & Marshall—offer brokers, agents, and investors an opportunity to access these newly foreclosed properties. Surging initiatives like these assist servicers by reducing loss severity and operational expenses related to the post-foreclosure process, all the while helping reduce the number of properties servicers must convey to HUD.
The entire process can be simplified in three easy steps. First, a property goes into default and then goes into a foreclosure sale. Next, if the property isn’t sold at the sale, it reverts to the bank or the servicer. Finally, the property then has an opportunity for a Second Chance sale with an auction vendor.
Second Chance assets sold in the auction format are usually done via public auction in a ballroom or online. The auction environment truly broadens exposure from intimate settings to a full online presence with thousands of prospective bidders. The technology ensures that only properties that are cleared for sale are auctioned; buyers are automatically notified of postponements and cancellations. Investors can search specific areas to locate properties to purchase, and, as a result, the objective of successfully completing sales to third-party buyers and expanding buying opportunities is met.
CWCOT assets go through two main steps in the selling process. First up is the foreclosure sale, or TPS (third-party sale), which is the sale at the courthouse steps. If the bidding instructions for a property were prepared under CWCOT guidelines at the foreclosure sale and it reverts to the bank at that sale, then the property is eligible for a program known as Second Chance. This is when an auction vendor gets involved.
Servicers can use third-party auction vendors to help sell the properties in hopes of ridding the assets from their inventory. HUD wants the properties to sell so servicers don’t convey them back to HUD, which increases HUD’s inventory. HUD typically releases a haircut schedule—a discount on a state-by-state basis—that is applied to the appraisal value done at the time of foreclosure. Now buyers can purchase these properties in most states below market value. In some states, the haircut value increases once an auction vendor is involved.
It is to the seller’s advantage to sell properties in Second Chance with the auction vendor so they can file their claim with HUD and don’t have to worry about getting the property in conveyance condition. Servicers run the risk of conveying a property to HUD and HUD then sending the property back to them because the property isn’t in conveyance condition. In this case, servicers aren’t always able to file their claim with HUD if they’ve already tried to convey the asset. Also, auction vendors will market the property and the servicers don’t have to pay for it. There is an auction fee involved, but the servicers can include that in their claim to HUD.
Why They’re Not REOs
CWCOT assets differ from regular REOs in various ways. While both are distressed foreclosed asset classes, the differences have made the CWCOT program hugely popular.
REO properties are valued after the foreclosure date, typically using recent comparable properties to set pricing. Since there’s no chance of the GSE filing a claim for the property, this asset type is more like a retail property sale than a CWCOT asset.
CWCOT properties have an appraisal completed at the time of the foreclosure sale, and the price for these properties is set using a predetermined amount based on the competitive or noncompetitive state haircut. While both programs sell on an as-is, where-is basis, CWCOT properties are sold with no back taxes or liens and with the foreclosure deed recorded for transfer to the new buyer. Unlike many government-backed REO sellers, CWCOT properties do not have a predetermined timeframe for properties to be flipped, making this program prime for investor clients.
While the REO inventory continues to subside, the prime mortgage market strengthens, and the high number of FHA-backed mortgages becomes delinquent and foreclosed, the CWCOT inventory has, quite contrarily, continued to rise.