The Federal Housing Administration (FHA) is touting a new “severely delinquent note sales” program, the Distressed Asset Stabilization Program, through which they’ll increase their NPN sales by a factor of 10.
“Thousands of borrowers severely delinquent on loans insured by the Federal Housing Administration will have help from a new servicer to explore affordable mortgage solutions or achieve a favorable resolution under an enhanced government note sale program announced today. [June 8th, HUD]”
The FHA started a pilot program in 2010 aimed at selling delinquent note pools to private investors with the idea being that those investors have more flexibility in how they’ll workout the loans.
Keeping homeowners in their homes and maintaining the stability of neighborhoods are just a couple of the FHA’s intentions with this program. Investors, however, are looking for returns. How these two goals will meet should be interesting.
Notes are sold competitively at a market-determined price generally below the UPB.
Here are the rules for the program that we know about today:
- The borrower is at least six months delinquent on their mortgage
- The servicer has exhausted all steps in the FHA loss mitigation process
- The servicer has initiated foreclosure proceedings
- The borrower is not in bankruptcy
- Must delay foreclosure for a minimum of six additional months
- Must try additional steps to help the homeowner avoid default by
- Modifying loan terms, or
- Maximizing shortsale value
- Must take no more than 50% of the loans within a purchased pool in as real-estate owned (REO) properties
- If the servicer and borrower are unable to bring the loan out of default, the servicer must hold the loan for at least three years.
I’m trying to imagine how this will work and what the ramifications of these rules will be on the sales. For servicers this seems pretty straightforward, but for investors? Maybe not so much. (If you have experience buying notes from the pilot program launched in 2010 I’d like to hear from you).
I don’t know if HUD or the FHA are offering favorable loan terms on these pool purchases. If they are, I would imagine this would change the dynamic on these sales quite a bit. With the additional rules imposed, as outlined above, let’s try to dissect the math on these.
First there’s the cost of the workouts, the actual overhead, staff, space, etc. Either you pay these or maybe you’ll outsource to a servicer for a percentage or a fixed fee.
Next, consider the fact that unless you’re all cash for these purchases your vig starts ticking when you close on the pool. So now you’ve closed. Now you’re paying interest on your acquisition funds and paying staff or a servicer to workout the note.
Let’s assume that since the pool of notes you bought is severely delinquent, there are a good number of these that are just not going to be modifiable. How many? It’s hard to say, but if the borrower is six months delinquent and has exhausted all steps in the FHA modification process, let’s guess it’s at something like 70%. I’m ready to be wrong and do challenge me in the comments if you disagree.
So now you’ve modified 30% of the loans and you have the other 70% to deal with.
On the shortsale front you’re going to have to give ample time on market (of course I’d recommend an auction, but then I am somewhat biased) in order to document that you’ve tried to maximize the shortsale value. You’re also probably going to have to offer some incentives, like cash for keys, maybe a seller incentive. There will undoubtedly be back taxes, and although you’ll be offering the property with the seller “as-is,” depending on which state you’re asset is in, you may have costs associated with getting the property up to par. In Massachusetts, for example, smoke detectors and Title V (septic) regulations (getting a plan approved, etc.) are just a couple of items to add to your expense column.
The investor must take in no more than 50% of the loans purchased as REO. OK, let’s hope that my 70% figure (above) is too high. If not what will the investor do?
If there’s no resolution the servicer must hold the note for three years. If you’ve tried to modify the loan and the borrower is unable or unwilling to pay, if they’re further unwilling to play ball on a shortsale, then resolution comes down to a matter of whether or not the investor has exhausted their 50% REO limit, I suppose.
Other issues for investors to consider are the cost of foreclosure and, in the event of a bankruptcy filing on the part of the borrower, the extended legal fees. Finally, there’s a matter of maintenance and marketing costs on homes taken into inventory.
This is a complex equation and I’ve attempted to lay out some of the considerations in making an investment in a transaction with so many stipulations. It makes you wonder what the strike price will be, all things considered–20 cents on the dollar? 30?
The intentions here are no doubt good, but how this plays out will be interesting as private investors try to capitalize on the 20,000 severely delinquent notes per year that start coming to market this fall.
Let us hear your thoughts in the comments section below.