OCC Issues Foreclosure Guidance - Part II

In yesterday's newsletter, Part I of this two-part series, I outlined the role of the bank as owner and servicer of foreclosed property, as described in the recent guidance issued by the Office of the Comptroller of the Currency (OCC) with respect to a bank's obligations and risks related to foreclosed property. (See OCC 2011-49)

A bank's obligations with respect to foreclosed residential properties may differ depending upon the bank's role in the foreclosure. For instance, a bank may be (1) an owner of the foreclosed property, or (2) a servicer and/or property manager, or (3) a securitization trustee.

Additionally, there are specific obligations when lenders release a lien securing a defaulted loan rather than foreclose on a residential property.

In today's newsletter, Part II or this two-part series, I outline the role of the bank as trustee of a securitization trust, and also releasing a lien rather than foreclosing.

For detailed information and guidance, please consult with us or a regulatory compliance professional.

In this Newsletter
Safety and Soundness
Bank as Trustee of Securitization Trust
Releasing a Lien Rather Than Foreclosing
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Safety and Soundness

As a matter of safety and soundness banking practices, banks should have robust policies and procedures in place to address risks associated with foreclosed (or soon to be foreclosed) properties.

Acquiring title to properties through foreclosure - either for the bank or as servicer for another mortgagee - results in new or expanded risks, including operating risk (which may include market valuation issues), compliance risk, and reputation risk.

Banks should be sure they have identified all the risks, and have policies and procedures for monitoring and controlling these risks. In each risk management consideration, it is critical to establish and implement policies and procedures, and bank management and the Board of Directors should consider, at a minimum, the role of the bank in foreclosure procedures and obligations.

Bank as Trustee of Securitization Trust

The securitization trustee is primarily responsible for holding a lien on the trust assets for the benefit of the investors who purchase securities issued pursuant to the securitization and administering the trust in conformance with requisite agreements.

The trustee's duties and responsibilities are established by a PSA, trust agreement, or indenture. These agreements direct a securitization trustee to perform various complex administrative functions. Such functions usually include ensuring the timely receipt of payments from the servicer, calculating payments, remitting payments to the investors, circulating information to investors, monitoring compliance, and determining if an event of default is triggered.

As permitted by the PSA, the trustee should work with the servicer to ensure the performance of its responsibilities. The securitization agreements may require a trustee to appoint a successor servicer or to take over servicing in the event the original servicer fails to perform its duties or defaults. These agreements generally do not grant the trustee any powers or duties with respect to the foreclosure or with the maintenance, sale, or disposition of foreclosed properties. Instead, these responsibilities typically reside with the servicer.

Nevertheless, to the extent a servicer undertakes foreclosure actions in the trustee's name as the secured party, a bank trustee should be aware of potential reputation and litigation risks. (See my comments in Part I, relating to reputation risk.)

Additionally, if the securitization agreements require a bank trustee to act as a replacement servicer until a successor servicer is appointed, the bank trustee would also be exposed to credit risk.

Releasing a Lien Rather Than Foreclosing

At times, lenders may release a lien securing a defaulted loan rather than foreclose on the residential property.

This decision is often based on financial considerations when the bank or servicer and/or investor determines that the costs to foreclose, rehabilitate, and sell a property exceed its current fair-market value. When this decision is made after a bank or servicer has initiated foreclosure, the borrower may have already abandoned the property or discontinued the care and maintenance of the property, increasing the chance of a blighted property in the community.

Because the decision to release a lien is typically a financial decision, banks and servicers should ensure that their valuation of the property provides the best information practicable, while complying with investor requirements, before initiating foreclosure and subsequently deciding to release the lien. While the financial risk must be considered, banks and servicers should also consider the potential for reputation and litigation risk arising from their position as a prior mortgagee or servicer of a now-abandoned property.

If the decision is made to forego foreclosure and release the lien, the bank or servicer should notify, or attempt to notify, the borrower of the decision. Borrowers should be notified that (1) the mortgage holder is not pursuing foreclosure and has released the mortgage lien, (2) the borrower may continue to occupy the property, and (3) the borrower is obligated to maintain the property consistent with all local codes and ordinances and to pay property taxes and the debt owed. The bank or servicer should also make appropriate notifications to the local jurisdiction when it makes the decision to release a lien in lieu of foreclosure.

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Office of the Comptroller of the Currency (OCC)
Foreclosed Properties
Guidance on Potential Issues
With Foreclosed Residential Properties
OCC 2011-49
December 14, 2011

* Jonathan Foxx is the President and Managing Director of Lenders Compliance Group

OCC Issues Foreclosure Guidance - Part I

The Office of the Comptroller of the Currency (OCC) is providing guidance to banks on obligations and risks related to foreclosed property. Issued on December 14, 2011, this guidance highlights legal, safety and soundness, and community impact considerations. It primarily focuses on residential foreclosed properties. (See OCC 2011-49)

A bank's obligations with respect to foreclosed residential properties may differ depending upon the bank's role in the foreclosure. For instance, a bank may be (1) an owner of the foreclosed property, or (2) a servicer and/or property manager, or (3) a securitization trustee.

Additionally, there are specific obligations when lenders release a lien securing a defaulted loan rather than foreclose on a residential property.

Furthermore, understanding the requirements imposed by Fannie Mae and Freddie Mac (GSEs) or the U.S. Department of Housing and Urban Development (HUD) on servicers is particularly important.

I will analyze the OCC's guidance as it relates to the aforementioned three roles of the bank in foreclosing on residential properties.

This is a two-part newsletter. I will offer a brief overview of the OCC 2011-49 bulletin pertaining to guidance on potential issues with foreclosed residential properties. Today, in this first part, I will outline the role of the bank as owner and servicer of foreclosed property. Tomorrow, in the second part, I will outline the role of the bank as trustee of a securitization trust, and also releasing a lien rather than foreclosing.

For detailed information and guidance, please consult with us or a regulatory compliance professional.

In this Newsletter
Safety and Soundness
Bank as Owner of Foreclosed Property
Bank as Servicer of Foreclosed Property
Library

Safety and Soundness

As a matter of safety and soundness banking practices, banks should have robust policies and procedures in place to address risks associated with foreclosed (or soon to be foreclosed) properties.

Acquiring title to properties through foreclosure - either for the bank or as servicer for another mortgagee - results in new or expanded risks, including operating risk (which may include market valuation issues), compliance risk, and reputation risk.

Banks should be sure they have identified all the risks, and have policies and procedures for monitoring and controlling these risks. In each risk management consideration, it is critical to establish and implement policies and procedures, and bank management and the Board of Directors should consider, at a minimum, the role of the bank in foreclosure procedures and obligations.

Bank as Owner of Foreclosed Property

Obligations and Actions

• In acquiring title to foreclosed properties, banks assume the primary responsibilities of an owner, including providing maintenance and security, paying taxes and insurance, and serving as landlord for rental properties.
  • Banks should communicate with localities, including homeowner associations, about specific requirements with respect to foreclosed residential properties (i.e., localities may have requirements about certain aspects of upkeep, such as lawn mowing, property maintenance, and security, et cetera).
  • In the absence of these actions, banks should be aware of potential nuisance actions or the exercise of local receivership powers to seize properties.

• For FHA-insured mortgages, the bank must ensure compliance with property and preservation guidance issued by HUD to preserve the insurance claim and obtain reimbursements for allowable expenses.

• Following foreclosure, the bank must record its ownership interest in local land records.

• Banks must comply with the other real estate owned (OREO) appraisal and accounting requirements.

• Banks should maintain appropriate insurance on the property.

• Some localities may require registration of foreclosed properties, properties in foreclosure, or vacant properties. Banks should be aware of and comply with such requirements.

• The Protecting Tenants at Foreclosure Act of 2009 (PTFA) provides tenants with protections from eviction as a result of foreclosure on the properties they are renting.

• When a bank takes title to a house after foreclosure, it must honor any existing rental agreement with a bona fide tenant and must provide 90 days' notice to the tenant prior to eviction whether or not the tenant has a rental agreement.

• State laws may impose additional requirements that are not preempted by the PTFA.

• Additional potential requirements with respect to rental properties include:

• reviewing the lease to determine if the property can be shown to prospective purchasers; and

• returning any security deposit upon termination of the rental agreement.
  

Plethora of Languid Foreclosure Prevention Programs

Keeping foreclosures down and homeownership up has been the stated goal of policy makers for the last few years. The record shows that nearly all of the promulgated programs have failed to provide much relief to lenders or borrowers. And even if there were a chance for them to succeed, the obstacles to their viability are daunting.

I think a brief review of such programs is in order.

My list is not meant to be complete, but it is indicative of the success of presumptive remedies to the foreclosure crisis.

The Land of Cockaigne

I don't think many Americans ever really bought the 'spiel' about "a car in every driveway," "a chicken in every pot," "a salary for every able-bodied person," and "a house for every citizen." But it's not as though they weren't given plenty of reasons to pursue the so-called American Dream - at least the homeownership version. Presidents and their Administrations have equated owning a home with being as American as Apple Pie. Congress followed the narrative and fortified the burgeoning real estate industry with seemingly infinite funds boosted by and through the GSEs. The Federal Reserve did its part. But it was all trumped-up! Unsupported by the fundamentals of economic theory, dream-thinking nevertheless entrenched itself.

In the 13th century, a French poem described the "pays de cocaigne," which is Middle French for "The Land of Cockaigne." A fair translation of the poem portrays Cockaigne as a country where "the houses were made of sugar cakes, the streets were paved with pastry, and shops provided goods for nothing." (My translation.) Later, in the 16th century, the Dutch artist Pieter Bruegel the Elder depicted Cockaigne as an imaginary land of self-indulgent luxury and idleness, a utopia of gluttony, complacency, instant gratification, and physical excesses, where the lowly and beleaguered peasants could finally be free of their oppressive, daily struggles to survive.

In effect, Cockaigne was a medieval peasant's dream. But it was a chimera!

This is not to say that the modernized version of Cockaigne, perhaps our own American Cockaigne, was meant to curry the favor of people who were gluttonous or complacent in return for their votes. It is not to say that Americans are peasants in the fashion of medieval peasants. And it is not to say that we should run away from our dreams. But living a dream has consequences. 

So, let's take a look at some of those consequences. Let's see how foreclosure prevention programs have fared in mending the harm caused by our own version of Cockaigne.

The "Job's Bill"

The Obama Administration has proposed a plan to provide $15 billion to fix foreclosed and vacant properties. The idea is to provide a means to revitalize communities blighted by foreclosures. It would also offer a boost to construction jobs. Is there anybody reading this who actually believes that this bill, at least in its current form, will receive even a scintilla of Congressional approval anytime soon?

Converting Vacant and Foreclosed Homes to Rentals

The Administration has asked for proposals to convert foreclosed houses into rental properties. This would reduce the oversupply of foreclosed properties and reduce the demand causing rising rents for existing rentals. As far as I know, no politically viable proposals have been publicly announced. However, some statistics indicate that benefits could be outweighed by adverse consequences.

Principal Reduction

In effect, this approach asks banks to adjust the total amount owed on a mortgage, based on the post-bubble value of a home. However, this could lead to strategic foreclosures and perhaps an incentive for borrowers to take out riskier loans. I get that this remedy is supposed to be a way to deal with the $800 billion overhang, that is, the amount that borrowers owe above the value of their homes.

These so-called "underwater" mortgages are being just left out there dangling away! It seems to me that principal reduction could work, given the right methodologies. For instance, most mortgages are either owned or guaranteed by Fannie and Freddie, so the overall public could benefit through principal reduction.

However, here's the nasty secret: the FHFA, the regulator overseeing Fannie and Freddie, will not even consider principal reduction, because it would adversely impact the GSE's bottom line. Even after being bailed out, the GSEs are $141 billion in the negative. So, a decision to keep the losses off the books leads principal reduction into a dead end.

Bailout Money

At least President Obama recently admitted that his Administration had not made "enough progress" on dealing with the foreclosure crisis and he is "going back to the drawing board." This is how many years since the bubble burst? Going "back to the drawing board?"

With what money? After all, $30 billion in unused bailout money from the previous foreclosure programs cannot be used to fund new programs.

Making Home Affordable

This program was supposed to encourage servicers to lower mortgage payments. Political pundits labeled it the "homeowner bailout."

It began in the spring of 2009 and was meant to assist four million homeowners who were facing foreclosure. But MHA is a major malfunction. Servicers were thrown into backlogs, improperly processed cases, made numerous errors, all while regulators did very little to prevent this debacle. As of August 2011, as I have reported previously, only about 816,000 homeowners had received loan modifications through MHA - which is less than 25% of those who applied for MHA assistance!

Here's yet another nasty secret: the government is expected to spend about $7 billion of the $46 billion in bailout funds that were set aside to help homeowners. Consequently, nearly $30 billion meant to address the foreclosure crisis may instead be used to pay down the deficit. Yes, that would be those same $30 billion I mention above, meant to address the foreclosure crisis, and will instead likely be spent to pay down the deficit.

Home Affordable Refinance Program

This is the program that permits homeowners to refinance their mortgages at lower interest rates. It is another program from 2009. With much fanfare, the Administration estimated that five million homeowners would be served. As of June 2011, just 838,000 homeowners had refinanced through the program.

But where is this program going? The FHFA stands in the way, since refinancing is deemed to be more risk to Fannie and Freddie, which happens to own or guarantee about 5 million mortgages that are underwater.

President Obama has stated that he would increase the number of homeowners in the program. How is that supposed to happen, given that the FHFA's professed mission now is to further protect Fannie and Freddie from taking on any new risk?

Emergency Homeowners' Loan Program

The basic concept of this program is to loan money to jobless homeowners so they can avoid foreclosure. I fail to see how this is a solution at all to foreclosure. At best, maybe it postpones it. As promulgated in 2010 and commenced in June 2011, the program consists of $1 billion and is supposed to affect 30,000 families, by offering interest-free federal loans of up to $50,000 to qualifying homeowners. Essentially, to be qualified for this program, the borrower must have lost income because of unemployment or a medical condition. To date, only 10,000 to 15,000 of the 100,000 applicants have actually qualified for these loans.

But here's the catch: there is a deadline of September 30, 2011 for lending out money to eligible homeowners before the unused funds are to be returned to the Treasury. So, the application period has now expired. At this point, it is estimated that only half the allotted funds will be spent.

States Foreclosure Prevention Programs

The notion of giving funds to states to remedy the foreclosure epidemic goes back to February 2010, when the Administration promised almost $8 billion to finance "innovative" programs. The money was supposed to go to the states that had the worst foreclosure problems.

But reports issued in July indicate that only $478 million of the government's $8 billion had been actually loaned. I have read several reports that some of these states have failing programs due to burdensome enrollment procedures. In Arizona, for instance, 4,000 homeowners were to be assisted through principal reduction. But recent news reports indicate that Arizona only approved three homeowners for this remedy. And, again, banks and the GSEs do not want to participate in principal reduction, a particular feature of that state's "innovative" program.

Bankruptcy Protection

I seem to recall that candidate Obama expressed a willingness to permit bankruptcy judges the power to lower mortgage payments. The modern vernacular calls this a "cramdown." Banks were against cramdown from the start. Members of Congress, particularly some Democrats, tried to pass legislation permitting cramdown. But the legislation was defeated. And, anyway, President Obama's very own economic advisers rejected it. At this point, the Obama Administration has virtually abandoned it as a remedy.

Cockaigne Redux

Pieter Bruegel the Elder lived during the time of the famed Dutch Revolt. There is much symbolism in his painting, "The Land of Cockaigne." That symbolism, according to some authorities, refers to the failure of leadership, the effects of complacency, and the proclivity of the people to become dependent on their formidable abundance, while being unwilling to take risks that would bring needed systemic change.

I wonder: is the American Cockaigne a dream from which we refuse to wake up?