What Should the Government do to Address the Inventory of Foreclosed Properties?

Economists calculate that the decline in home prices has cost American homeowners approximately $7 trillion in home equity. Compounding this problem is the fact that the inventory of homes available for sale remains high and there is potential for a significant volume of “shadow inventory” to hit the market. Intervention is necessary to support the fragile recovery in the housing market and to prevent further declines in home values. What steps must policy makers take to prevent the loss of additional trillions in home equity?

The abundant supply of homes available for sale presents opportunities for first-time homebuyers and “move-up” buyers as affordability is at an all-time high. Many, however, are hesitant to make a move as they wait for values to reach “bottom.” Action is necessary now to establish a balance in the supply and demand for residential housing in America.

Public/Private Partnerships
Federal Deposit Insurance Corporation and the Residential Trust Corporation (FDIC/RTC) experience demonstrates that structured public/private partnerships can be successfully used as a vehicle to convey a large volume of assets of varying types and levels of quality to private-sector ownership and management, in a relatively short period of time, by appealing to a diverse group of investors who intend to employ geographically-targeted asset disposition approaches.

Applying FDIC/RTC experience to Enterprises and Federal Housing Administration (FHA) Real Estate Owned (REO)

As the strategy applies to the Enterprises and FHA, structured transactions would require joint ventures or partnerships between the Enterprises and FHA and private sector entities which are designed to facilitate the disposition and management of distressed real-estate assets.

The Enterprises and FHA make available for bulk sale all one-to-four unit single family homes and condominium REO inventory (properties may be tenant-occupied or vacant at the time of disposition). Bulk buyers are asked to construct custom REO pools (“Pick and Choose”) based on their specific investment objectives.

Once the investor completes the “Pick and Choose” process, the Enterprises and FHA forms an entity (to date, all Limited Liability Corporations or “LLCs”) to which a custom REO pool is conveyed. Under the structured transaction partnership program, the Enterprises/FHA act essentially as a passive participant or limited partner (LP), with a private-sector investor who is responsible for managing the assets and acting as the general partner (GP).

In exchange for contributing REO assets, the GP conveys a shared percentage of cash-equity (50/50 split, for example) ownership back to the Enterprise and FHA. The remainder of the purchase price is then financed through issuance of tax-free Housing Recovery Bonds. These notes would be issued by the LLC as payment to the Enterprise/FHA for the assets conveyed to the LLC by the Enterprise/FHA.

Planned use of properties, with a focus on maximizing returns under strategies tailored to local economic and real estate conditions.

Once assets are purchased by private investors, the use or disposition of those assets will be at the discretion of the buyer’s investment objectives within the constraints of Agency objectives. For example, in the hardest hit localities, where buyer uncertainty is most intense, it would be more appropriate to incentivize long-term ownership through “Rent to Hold” and “Lease to Own” structures. However, in areas where sales comparables are not greatly distorted by an oversupply of distressed assets, the Enterprises/FHA would better meet the stated objective of improving loss recoveries (ultimately improving overall execution as the program evolves) by incentivizing bulk investors who intend to “Rehab and Sell” real-estate assets to first-time home buyers and baby- boomers looking to downsize their housing needs.

Steps taken to ensure that the properties are well maintained and managed during the period they are rented or otherwise held off the market.

One potential option is for the Enterprises and FHA to partner with municipalities who designate dedicated coordinators or teams to inspect properties. In that scenario, states/municipalities would focus on aggressive code enforcement and nuisance abatement, as well as making it easier to reclaim properties by amending receivership and eminent domain laws to make them more effective for the current crisis.

Given the large number of REO properties, many of which have been on the market for extended periods, prompt rehabilitation is critical to maintaining a marketable property. HUD and FHA could also consider allowing investors to utilize the “old” FHA 203(b) and 203(k) programs – which were generally successful but ended in the late 1980’s -for the rehabilitation of single-family homes. Historically, these programs offered a practical solution for homebuyers looking to purchase a home in need of repair.

After a reasonable “first look” offer to owner-occupants, these FHA fixed rate 30 year mortgages could be made to investors to buy up the existing inventory. Individual investors, municipalities, and nonprofits represent a unique and underserved class of prospective homebuyers that require financing. Providing these groups with financing, especially rehabilitation financing like offered through the 203(k) program, would go a long way towards soaking up the excess inventory in the housing market. These investors are capital constrained and more inclined to creating bridges to occupant ownership over time through such mechanisms as “rent to own” programs. Without some sort of bridge or path to occupant ownership the Administration risks creating massive  absentee ownership that could lead to
more blight and damage to communities.

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FDIC Invites Comments on Stress Test Rules

The Federal Deposit Insurance
Corporation (FDIC) has issued a notice of proposed rulemaking (NPR) for
comment.  The NPR would require the
larger of the banks it regulates to conduct annual capital-adequacy stress
tests.  The tests are one requirement of
the Dodd-Frank Wall Street Reform Act and will affect FDIC-insured banks and
savings institutions with assets of more than $10 billion.  The FDIC currently has 23 financial
institutions meeting that criterion

The proposed rule focuses on capital
adequacy and defines a stress test as a process to assess the potential impact
on the bank of economic and financial conditions (“scenarios”) on the
consolidated earnings, losses, and capital of the covered bank over a set
planning horizon.  FDIC said that these
stress tests would be one component of the broader stress testing activities
conducted by the banks which should address the impact of a broad range of
potentially negative outcomes across a broad set of risk types with impacts
beyond capital adequacy along.  These,
however, are beyond the scope of the proposed rule.

Under the NPR each covered bank
would be required to conduct the test annually using the bank’s financial data
as of September 30 of that year.  Where
the parent company structure of the covered bank includes one or more financial
companies, each with assets greater than the $10 billion threshold, the stress
test requirement applies to the parent and to each subsidiary meeting the threshold,
however the FDIC will coordinate with other regulatory agencies to minimize
complexity or duplication of effort.

As proposed, FDIC would provide each
covered bank with a minimum of three sets of scenarios representing baseline,
adverse, and severely adverse economic and financial conditions and each bank would
use these scenarios to calculate the impact on its potential losses,
pre-provision revenues, loan loss reserves and pro forma capital positions for each quarter end within the
planning horizon.

The NPR also describes the content
of the reports institutions are required to publish, and the timeline for
conducting the stress tests and producing the required reports.

FDIC Acting Chairman Martin J.
Gruenberg said, “Both the FDIC and the institutions being tested will
benefit from the forward-looking results that the stress tests will provide.
The results will assist in ensuring an institution’s financial stability by
helping determine whether it has sufficient capital levels to withstand a
period of economic stress.”

The FDIC’s proposal will be
published in the Federal Register with a 60-day public comment period.

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First Round of Pilot Rental Initiative Completed with 2,500 Homes Sold

The first round of winners has been
selected to purchase foreclosed real estate from Freddie Mac and Fannie
Mae.  The Federal Housing Finance Agency
(FHFA) announced today that 2,500 single family homes had been awarded to successful
bidders under a pilot initiative to convert real estate acquired by the two
government sponsored enterprises (GSE) through foreclosure into rental property. 

Successful candidates for purchasing properties
from the GSE’s real estate portfolio (REO) had undergone several steps in a
qualification process before being permitted to bid on the houses which they had
to agree to hold and rent for a period of time before reselling. 

The properties were offered in sale
pools which were geographically concentrated in various locations across the
United States.  The GSEs, FHFA and other federal
agencies involved, Departments of Treasury, Housing and Urban Development,
Federal Deposit Insurance Corporation and the Federal Reserve, had several
goals
for the program.  They hoped to
relieve the GSEs of the costs and administrative burdens of managing thousands
of foreclosed properties, alleviate the blight imposed on communities by large
number of vacant and possibly deteriorating properties, increase the rental
stock, while at the same time not flooding the market with distressed
properties.

 FHFA described the response to the pilot
initiative as “robust with strong qualified bidder interest.”  Some 4,000 responses were received to the
initial “Request for Information” issued by the program sponsors last February,
however beyond announcing that the awards had been made FHFA released no
information on the names or even the numbers of successful bidders.

“FHFA
undertook this initiative to help stabilize communities and home values in
areas hard-hit by the foreclosure crisis,” said Edward J. DeMarco, Acting
Director of FHFA. “As conservator of Fannie Mae and Freddie Mac, we believe
this pilot program will assist us in achieving our objectives and help to
maximize the benefit to taxpayers. We are pleased with the response from the
market and look forward to closing transactions in the near future.”

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Regulators Tell GSEs to Assist Military with Short Sales

Both Freddie Mac and Fannie Mae will be offering additional
consideration to military personnel who may be facing problems with their
mortgage
due to service related orders. 
The two GSEs were directed to address
mortgage servicer practices that pose risks to home owning service members and
to ensure compliance with applicable consumer laws and regulations. The “guidance” came from regulators the
Federal Reserve, Consumer Financial Protection Bureau, Federal Deposit
Insurance Corporation and other regulators.

The guidance pertains to risks faced by homeowners
who have received Permanent Change of Station (PCS) orders, that is have been
ordered by the military to relocate to a new duty station or base.  Such orders are received by about one-third
of active-duty service members each year.

PCS orders are non-negotiable and carry short, strict
timelines.  Homeowners with such orders,
however, are still obligated to honor their financial obligations including
their mortgages.  In the current
environment, with so many homes underwater, these service members may be unable
to sell their homes and obtain sufficient funds to pay off the mortgage debt
and may have to continue mortgage payments while making rent or other housing
payments in their new location.

Under the new guidelines, receipt of a PCS will be
treated as a hardship
for the purpose of qualifying for a short-sale even if the
homeowner is current on the existing mortgage. 
Military with PCS who complete a short sale will be exempt from
deficiency judgments from Fannie Mae and Freddie Mac and relieved of any
request or requirement to contribute cash to the sales proceeds or to sign a
promissory note for any outstanding balance as long as the property was
purchased on or before June 30, 2012.

In addition to holding PCS order, the homeowner must
have a mortgage owned or guaranteed by Fannie Mae or Freddie Mac to be eligible
for the program.  The status of the
mortgage can be current or delinquent.  Freddie
Mac and Fannie Mae were instructed by regulators last year to treat PCS orders
as a hardship for purposes of modifications and forbearance.

Paul
Mullings, Freddie Mac’s Interim Head of Single Family Business and
Information Technology said, “Freddie
Mac is proud to support this important new effort to help servicemen and women
when national duty requires them to sell their homes in an uncertain
market.  We look forward to working with our servicers on this new short
sale policy.  Together we can help ease the challenge of relocation for
military families when Permanent Change of Station orders are
received.” 

The Federal Housing Finance Agency
said it would provide final guidance by September 30 and the short-sale reforms
would be effective 60 days later.

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FHA Expected to Announce New Bulk Sales Agenda

The Federal Housing Finance Agency (FHA)
is expected to announce before the close of business today a new bulk sale
program
to liquidate some of the reported 700,000 delinquent loans they
insure
.  According to The Wall Street Journal, the agency may
be planning on selling as many as 5,000 distressed loans each quarter over an
unspecified period of time.

Bulk sales were used on a large scale by
the Resolution Trust Corporation and the Federal Deposit Insurance Corporation
during the savings and loan and banking crises of the 80s and 90s and FDIC
continues to use this mechanism to clear the assets of failed banks.  Lenders and guarantors such as Freddie Mac
and Fannie Mae generally shy away from these sales because of the deep
discounts needed to move the loans.  Even
the “good” loans such as are sold by the FDIC because they are too costly and time
consuming for the institution to manage are discounted substantially; seriously
delinquent loans go for pennies on the dollar. 
 

The Journal
states that FHA is considering bulk sales in an effort to reduce its growing
portfolio of distressed loans
and to avoid the costly process of foreclosure,
but also because its own rules limit ways in which the mortgages can be
modified, leaving little room for aggressive loan modifications like those done
by Freddie Mac, Fannie Mae, and proprietary lenders.  Once sold these strictures disappear and the
investor can take more drastic steps to bring the loans back on line.

Bulk sales can be hugely profitable for
investors, but in this case the sales may also allow some homeowners to stave
off foreclosure by cutting better deals than would have been possible with FHA.  The Journal
quotes FHA’s acting commissioner Carol Galante as saying “There will be an incentive for a modification that isn’t able
to be done under the current system. It will be cost-effective for the
FHA….It will be better for the communities.”

Investors
also face some restrictions that work for the benefit of homeowners and the
marketplace.  They can’t foreclose for
six months after buying the loans and must agree to hold back from sale at
least 50 percent of the homes backing the loans for at least three years.

Galante
told the Journal that FHA was trying to minimize the impact of any vulture
investors who buy hoping for a quick foreclosure, eviction, and resale.  “We are trying to change, frankly, the
behavior of who’s interested in buying these notes,” she said.

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