foreclosure

PIMCO, which was one of the firms spearheading the putback push against BofA, has put together a useful and rather objective analysis though Executive Vice President, Global Structured Finance Specialist, Rod Dubitsky, titled "Foreclosure Flaws Trigger New Round of Uncertainty." While not surprisingly the baseline case presented by PIMCO is a moderate one, as the asset manager claims the most likely impact is "moderate" it does acknowledge that there is a possibility for substantial complications (although Fannie's recent bail out of BofA pretty much takes cares of that). The two main adverse consequences are "corrupted title" -  a topic beaten to death previously, and, more importantly, "Tax issues relating to RMBS issuance entities" on which PIMCO says "Some have argued that assigning the note for the
mortgage loan so long after closing would run afoul of REMIC rules,
which could subject RMBS deals to adverse tax consequences." Of course, as an escalation of these developments would bring the entire $8 trillion RMBS structured finance industry to a halt, we are fairly confident that as more and more settlements are instituted, that the whole fraudclosure issue will be very soon completely forgotten.

Foreclosure Flaws Trigger New Round of Uncertainty

Rod S. Dubitsky

In early October a contested foreclosure action on a tiny house in
rural Maine lit the fuse of a blast that has reverberated throughout
the markets, spreading renewed fear of a second downturn in the housing
market and potential gridlock in the mortgage market. Specifically, the
contested foreclosure action led to a deposition of an employee of GMAC
Mortgage (a subsidiary of Ally Bank, fka GMAC Bank), which appeared to
reveal that GMAC was cutting corners while executing the foreclosure
process. The deposition led GMAC to freeze the foreclosure process, and
other servicers quickly followed GMAC into the servicer confessional
and likewise froze foreclosures. Further, the 50 state attorneys
general launched an investigation. 

Though many servicers are in the
process of fixing the flawed procedures, and the long-term market
impact of these revelations is uncertain, in our base case scenario we
see moderate risks to housing prices and to residential mortgage-backed
securities (RMBS) investments. Though the story is months old and
several issues have been clarified since the story initially emerged,
much uncertainty remains and many additional challenges have been
raised with the foreclosure process as well as with the securitization
process in general.

A Brief History of “Robogate”

Though there are several complicated threads to
the story, the primary flawed processes employed by mortgage servicers
can be easily summarized: 1) employees of the servicers were attesting
to facts in affidavits that in fact they often didn’t have explicit
knowledge of and 2) contrary to requirements, the affidavits in many
cases weren’t signed in front of a notary. (We note that this should
not imply there are no other broken servicer processes.) As an
affidavit is a sworn statement of fact that needs to be witnessed,
these two shortcuts rendered the affidavits defective. No witness and
no real knowledge of the facts being attested means an affidavit is not
acceptable to the foreclosure court. The media dubbed this trend of
rapid, automated signing of affidavits “robo-signing” and the ensuing
uproar “robogate.”

The secondary thread of the story that seems to
be growing in importance is potential flaws associated with the
mortgage documents and the process of transferring the documents during
the securitization process. The upshot of the latest stories is that
flaws in the transfer of mortgage documents associated with the
securitization could increase the complexity of the foreclosure process
and, in the extreme scenario, jeopardize the economic interest of the
trust in the associated mortgage. Though the document flaws (as
distinct from the affidavit flaws) currently appear to be limited, we
are watching this thread closely to see if the issues are more
pervasive.

Though some of the earlier moratoria have been
lifted, it’s not entirely clear that the servicers’ processes have
improved enough to satisfy the attorneys general and foreclosure
judges. Further, for some servicers who have not imposed a moratorium
and have indicated that their procedures were correct, in some cases
evidence has emerged that calls into question the procedures of even
these “compliant” servicers.

The attorneys general, who have yet to conclude
their review, are rightly concerned over the possibility that
streamlined foreclosure processes either 1) resulted in some
foreclosures that shouldn’t have occurred (though we expect this is
rare) or 2) didn’t give borrowers an adequate chance to resolve their
mortgage payment difficulties (e.g., via a loan modification or other
resolution). However, we don’t believe the attorneys general want to
see permanent gridlock in the
REO (Real Estate Owned – i.e., foreclosed homes) housing market; after
all, many voters buy foreclosed homes and most voters don’t like seeing
empty homes blighting their neighborhoods and failing to contribute
property taxes.

Most Likely Overall Impact Is Moderate

At this point it doesn’t appear the legal right
to foreclose will be severely impaired across a large number of
mortgages, nor will the ability to foreclose likely be subject to
massive or terminal delays. Rather, thus far it appears that servicers
will ultimately be able to execute foreclosures on the overwhelming
majority of mortgages. Most of the problems and flawed procedures, in
short, appear to be fixable, and in our base case scenario we see the
long-term impact on housing prices and RMBS as likely to be moderate.

That said, robogate and its fallout do have
several implications for investors. First, the servicers will be
affected by 1) higher costs (in both the short term, as the backlog is
cleared, and the long term, as staffing needs to be stepped up) and 2)
potential legal liability, as the various infractions may result in
legal action on the part of borrowers or the attorneys general. Second,
potential gridlock in the housing market and further delays in
resolving the housing overhang do pose the risk of an adverse impact on
home prices in the longer term, though the short-term effect could be
positive as distressed supply is pulled from and kept off the market.
Third, RMBS investors will likely be affected as delayed liquidations
result in longer duration and higher losses (due to greater costs,
resulting from the longer timelines). On the other hand, credit IO RMBS
will likely benefit, as the IO (interest only) period will last longer,
thereby increasing the value of the interest component of their cash
flows (a credit IO is a bond that is impaired to the degree that no
principal is expected to be received and the only value is remaining
interest payments). Fourth, we note the foreclosure delay’s impact will
depend on the bond structure, since structural nuances vary across and
within deals.

The final implication for investors is very
difficult to quantify: If borrowers know they have a reasonable basis
to legally contest the foreclosure, the recent revelations may embolden
many more borrowers to do so. Even borrowers who know they can’t afford
the home may choose to contest foreclosure if it increases the free
rent period or if they have hope of improving their financial situation
during the prolonged delay. Borrowers may cite an array of reasons to
contest foreclosure: affidavit irregularities, lost notes, improper
standing to foreclose, misapplied payments, incorrect ARM calculations,
excessive delinquency-related expenses (late fees, inspections, force
placed insurance), failure to offer a loan modification (which is
required in some jurisdictions), or problems associated with the
origination of the loan. In most cases, we believe delay will be the
worst outcome from an investor’s perspective. We believe most
title/note mortgage assignment issues appear to be fixable (at some
time and expense), and more to the point, while some borrowers will
challenge and successfully avoid foreclosure, most borrowers who
challenge are likely only delaying the inevitable (as most such
borrowers simply can’t afford the home). Nevertheless, it’s another
area of uncertainty.

And on a positive note, we have no doubt that
some borrowers were rushed to foreclosure when in fact they may have
had a legitimate ability to pay, and to the extent the foreclosure
timeout can save additional borrowers, that is clearly a good thing.

In PIMCO Advisory, we’re accounting for the
impact of foreclosure freezes on RMBS prices by running delays ranging
from three to 12 months across base case and stress scenarios; the
values of the bonds generally don’t change more than a few points in
the more extreme scenarios. In addition to longer foreclosure
timelines, we are assuming higher loss severity because servicers will
need to advance more delinquent interest while the foreclosure is
pending. One element that is difficult to quantify is whether servicers
will incur substantially more fees that may in turn be passed along to
RMBS investors, thereby adding to loss severity. Though some expenses
will likely be borne by investors, at this point we’re not assuming
much additional loss severity other than that strictly from the
extended timelines.

Further, it’s not clear at this point whether the
delay should only be applied to current foreclosures or whether
foreclosure timelines will become permanently longer as servicers and
courthouses now take longer to process each foreclosure. We are
currently applying our lags to the existing foreclosure and REO
pipeline, while leaving our process for current loans unchanged.
Assuming servicers increase staff to clear the backlog and adequately
fix their procedures, we believe it’s reasonable to assume that
foreclosure timelines will revert to pre-robogate levels (which already
reflected lengthened timelines).

Less Likely but More Dire Consequences Are Possible

Following the foreclosure moratorium, market
participants raised two issues that would theoretically have far more
dire consequences for RMBS investors in particular and the mortgage
market in general. Thus far, the likelihood of either of these
worst-case scenarios appears remote, but they are worth considering.

1. Corrupted title:
   Some have speculated that the legal transfer of the mortgages to the
   trust has been so flawed that investors in RMBS face the risk that they
   don’t even have good title (i.e., ownership) of the mortgages. As a
   result, servicers potentially would have no legal standing to
   foreclose. A mortgage that doesn’t allow the holder to foreclose and
   take title to the property and doesn’t permit the lender to enforce the
   borrower’s obligation to pay is worth no more than kindlin’ wood, as
   the saying goes. Thus far – despite a couple of sensational stories –
   we don’t believe “kindlin’ wood” mortgages are widespread. Yes, there
   was the story of the eight-year foreclosure and the foreclosure on the
   homeowner who didn’t have a mortgage, but stories don’t equal
   statistics. Not that we should dismiss all these stories just yet,
   either; after all, mortgage origination horror stories turned out to be
   the rule rather than the exception. If new information reveals far more
   severe impairment in the note (obligation to pay) or the mortgage (the
   lien on the property), things could get a whole lot worse for RMBS
   investors (as well as other mortgage holders and guarantors, such as
   Fannie and Freddie), but at this point the more extreme outcomes don’t
   appear to be in the cards. However, the situation is fluid and we
   continue to consult with attorneys and are actively evaluating the risk
   of material impairment in the ownership of mortgages.
   
   Relatedly,
   some have questioned the role of MERS (Mortgage Electronic Registration
   Systems), an electronic registry in whose name more than half of all
   mortgages are registered. MERS was established to streamline the
   process of mortgage assignments by having the mortgage assigned in
   MERS’ name so that any time an ownership interest was transferred,
   sellers could avoid the costly county recording process. Some are
   arguing that MERS doesn’t have standing to foreclose (and indeed some
   states have ruled thusly) and therefore foreclosures in its name are
   invalid. Though this may pose a risk, our understanding is that the
   cure for the MERS problem is simply to assign the mortgage to an entity
   that does have legal standing to foreclose (e.g., the RMBS trustee).
   Therefore, we believe that the MERS issue may result in further delays
   to the foreclosure process, but not permanent foreclosure freezes or
   impairments.
   
   
2. Tax issues relating to RMBS issuance entities:
   RMBS are generally issued by an entity called a Real Estate Mortgage
   Investment Conduit (REMIC) that is exempt from federal taxes at the
   entity level provided it satisfies certain requirements. Broadly
   speaking, REMIC rules provide that a REMIC has three months to acquire
   its initial assets and two years to substitute a new mortgage loan for
   a defective one. Some have argued that assigning the note for the
   mortgage loan so long after closing would run afoul of REMIC rules,
   which could subject RMBS deals to adverse tax consequences. However,
   nothing that we have seen so far would validate this concern, and
   opinions published by securitization attorneys recently give very
   little credence to the REMIC tax risks. (For example, see SNR Denton’s
   “Commentary on Transfers of Mortgage Loans to RMBS Securitization
   Trusts,” October 18, 2010, www.snrdenton.com.) 

A press release from LPS' Mortgage Monitor Report shows Foreclosure Inventory Rising for 5th Straight Month

The November Mortgage Monitor report released by Lender Processing Services, Inc. (LPS) shows that the volume of loans moving to REO continued to drop as moratoria further delayed foreclosure sales. While the 90+ delinquency category has steadily declined, the number of loans moving to seriously delinquent status beyond 90 days far outpaced the number of foreclosure starts. Nearly 2.2 million loans are 90 days or more delinquent but not yet in foreclosure.

Foreclosure inventories also continued to rise for the fifth straight month as delinquent accounts are referred for foreclosure, but the sale of foreclosure properties continued to decline. When compared to January 2008 levels, the foreclosure inventory of Jumbo Prime loans is nearly seven times higher; the inventory of Agency Prime loans is nearly six times higher; and the foreclosure inventory of Option ARM loans is approaching five times the inventory in January 2008.

The report also shows that one-third of loans that are 90 days or more delinquent have not made a payment in a year; however, the number of new problem loans declined nearly 5.4 percent from October, which is opposite of the seasonality trend that typically impacts new delinquencies this time of year. Self-cures for loans one to two months delinquent increased in November to a six-month high.

In the month of November, 261,153 loans were referred to foreclosure, which represents a 0.7% month-over-month decline. The total number of delinquent loans is nearly 2.1 times historical averages - and foreclosure inventory is currently at 7.7 times historical averages.

As reported in LPS' First Look release, other key results from LPS' latest Mortgage Monitor report include:

• Total U.S. loan delinquency rate: 9.02 percent
• Total U.S. foreclosure inventory rate: 4.08 percent
• Total U.S. non-current* loan rate: 13.10 percent
• States with most non-current* loans: Florida, Nevada, Mississippi, Georgia, New Jersey
• States with fewest non-current* loans: North Dakota, South Dakota, Alaska, Wyoming, Montana

Charts From The Report

The report is 34 pages long. Inquiring minds may wish to give it a closer look. Here are a few select charts.

click on any chart for sharper image

Delinquent and Foreclosure Rates by Month



Total Delinquency Percent Excluding Foreclosures



Total Foreclosure Percent By Product



Foreclosure Increase Compared to January 2008



Loan Cures



Serious Delinquencies



Foreclosure Starts vs. Serious Delinquencies




While there are some welcome trends in direction, actual foreclosures are lagging. The pent-up need to foreclose is huge.

Moreover, mortgage rates have rising nearly a full percentage point in the last 45 days. This will put a damper on already depressed home sales, making it harder to unload inventory.

Look for months of inventory to soar in the upcoming months with continued declines in home prices. Contrary to what most think, falling prices are a good thing. Home prices need to fall to a point low enough where genuine demand kicks in.

Foreclosure moratoriums are counterproductive and exacerbate existing problems.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

free rental agreement forms

YouTube - DESKTOP <b>NEWS</b>!!

WHHHAATTT?? The internet isn't woking here in the hotel, so today's show is all the news stories that I have saved on my desktop :) MY FACEBOOK: http://Faceb...

Verizon iPhone Finally Arriving Jan. 11?: Apple <b>News</b>, Tips and <b>...</b>

A new press invite from Verizon Wireless is making the rounds, announcing a special media event on Jan. 11 at 11 AM Eastern in New York City at Lincoln Center. The event could be the long-awaited announcement of the iPhone's arrival on ...

Small Business <b>News</b>: Small Biz Funding Fundamentals

Will raising capital your small business be easier in 2011 than it was in 2010? Well, some sources say that funding may be loosening up but be assured that.