Where is the Middle Ground in NPL Sales Guidelines?

The sales of non-performing residential mortgage loans by Fannie Mae, Freddie Mac, and HUD have been a lightning rod for controversy in the last year or so.

The source of the controversy has been housing advocates, civil rights groups, Democratic lawmakers, and other progressives that have organized massive protests over the sales of these deeply delinquent loans to private equity firms and Wall Street investors. Protestors say these firms are concerned only with profiting from the housing crisis and will only push borrowers into foreclosure faster, thus triggering a host of other problems such as community blight and lower property values.

On the other hand, both HUD and FHFA have enhanced their guidelines for non-performing loan sales to achieve the best outcomes for borrowers, which include applying a “waterfall of resolution tactics” before resorting to foreclosure. These loans are years delinquent on the average—sometimes three, four, five, or even more years.

Are the guidelines for the buyers of agency non-performing loans too strict or not strict enough? There are risks attached to both, which makes it necessary to find the middle ground with the least possible amount of risk for buyers of the loans, borrowers, and taxpayers.

Recent research conducted by the Urban Institute indicates that the sales of these loans to investors benefits both the borrowers and the investors. According to Karan Kaul of the Urban Institute, “Private investors have greater flexibility to modify non-performing loans and mitigate losses than HUD or the GSEs, so the sales are a win-win.” Don Mullen, founding partner at Pretium Partners, who has bought up several FHFA delinquent loan pools, “The FHA (Federal Housing Administration) and the FHFA (Federal Housing Finance Agency) have made several improvements to their programs over the years in order to create a process that is transparent and inclusive.”

“Policymakers should do all they can to further improve outcomes for borrowers and neighborhoods while minimizing taxpayer losses. That said, active investor participation is what makes the program successful. Making sure it works for everyone will always require a careful balance of policy considerations.”

Karan Kaul, Urban Institute

Sales of non-performing residential loans has picked up in the last two years. The Urban Institute reported that HUD has sold more than 105,000 deeply delinquent mortgages through its Distressed Asset Stabilization Program, and the GSEs have sold slightly less than 40,000 loans. That makes up about 18 percent of the 820,000 delinquent loans in the HUD and FHFA mortgage portfolios combined.

Kaul suggested four ways to improve these delinquent loan sales:

• Mandatory borrower outcomes—It has been suggested that buyers of these non-performing loans should be required to meet one of many mandatory outcomes, which include reperformance via successful modification, short sale to owner-occupants, conversion to rental property, sale to a non-profit, or donation to a land bank. An adviser at FHFA noted that the agency doesn’t require servicers to meet mandatory outcomes because the circumstances might be beyond their control, which in turn would likely discourage investor participation. Instead, FHFA mandates the overall parameters under which the buyers operate.
• Restrictions on abandoned and very low value homes—Buyers often have to spend a great deal of time and resources rehabilitating a vacant home that has been substantially damaged, and sometimes they end up walking away and cutting their losses—despite the harmful effect walking away has on the neighborhood. This results in investors lowering their bids and taxpayers bearing the cost. Currently, Kaul said, both HUD and FHFA are evaluating ways to reduce the number of notes backed by low-value or abandoned homes, and FHFA recently issued a rule to prohibit investors from walking away from an abandoned property.
• More data transparency—Housing analysts, including those at the Urban Institute, have urged the government to release performance data on the outcome of these non-performing loan sales so that researchers can study them and offer feedback. HUD has released some limited data, but so far the FHFA has not; it will reportedly be released by the end of June.
• Greater partnerships between private and nonprofit sectors—Kaul points out the nonprofits are often better equipped than private investors to conduct borrower education and outreach, because the nonprofits work at the neighborhood level and are mission-oriented. However, nonprofits have a limited capacity to buy loans and manage assets on a large scale, which generally discourages investors from seeking them as partners.

While Kaul believes there is room for improvement, there is risk attached to both tightening requirements too much and having requirements that are too loose. If the requirements are too strict, it could motivate investors to turn to Europe’s distressed sales market and reduce opportunities for U.S. homeowners. If the requirements are not strict enough, it could unnecessarily expose borrowers to undesirable outcomes, Kaul said.

“Policymakers should do all they can to further improve outcomes for borrowers and neighborhoods while minimizing taxpayer losses,” Kaul said. “That said, active investor participation is what makes the program successful. Making sure it works for everyone will always require a careful balance of policy considerations.”