Distressed loans move through a sort of funnel of default. There are really two types of default: non-payment and technical default. Each quarter lenders report the levels of default or distress that they’re experiencing to the FDIC. We use the reports filed directly from the banks to the FFIEC. The data at the FFIEC is then retrieved and compiled by he FDIC for regulatory purposes.
Lenders report the following balances:
- Past 30 days overdue
- Past 90 days overdue
- Non-Accrual loans
- Other Real Estate Owned
More broadly speaking though there are really 3 categories;
- Up to 90 days late
- 90+ Days Late and Non-Accrual
- OREO or Other Real Estate Owned (REO)
There are different opportunities through these stages and there are a range of motivations, tactics, and strategies on the lender side in how the these stages are dealt.
When a loan is in non-accrual it is facing the most scrutiny by regulators and by the bank’s own committees. This is the period during which a bank is most likely to sell the loan.
This is also the period during which short-sales are negotiated. When loans owned by the bank are in default they may not sell the real estate because they don’t own it.
In order for the bank to take possession of the real estate they need to foreclose. I’m often asked whether why a bank won’t sell the property to an investor when the loan is in default and the simple answer is that you cannot sell what you do not own. Notes, mortgages, loans collateralized by real estate – give the lender certain rights including, typically, the right to recover their investment through the foreclosure sale.
This doesn’t mean that the lender has the right of possession or control of the property. That means they can’t show it to potential buyers, can’t enter it, can’t put signs on it, none of this. What they can do is work with the owner of the property with a delinquent mortgage to do one of a few things:
- Modify the loan: alter the amount owed, the rate, the amortization
- Sell the property ‘short’ meaning the bank forgives some amount of debt on the property in exchange for the owner working to sell the property
- Deed-In-Lieu becomes REO: if an owner has given up or no longer wants the property the lender may allow the borrower to turn the property over in a “friendly foreclosure” bypassing the auction
- Foreclosure auction sold to a 3rd party: In some states foreclosures sales are more approachable than others. In Massachusetts for example the law is flexible enough that lenders are able to market the foreclosure auction and get acceptable market bids, where states like Texas have laws that all but prevent this entirely by imposing onerous terms of sale
- Foreclosure auction to REO: When a lender goes to a foreclosure auction and “credit bids”, meaning bids without cash but instead with the investment they’ve already made in the property, when the bank is the high bidder they then take possession of the property and it becomes owned as REO.
Next: Delinquency »