As the result of a massive settlement negotiated between states and lenders that is almost complete, major changes are in the offing that will significantly change the way lenders, especially the largest banks, service defaults and foreclosures. For investors, especially those who invest in major foreclosure markets in states in participating, the settlement will have a significant impact on foreclosure prices and inventories.
More than 40 states will sign onto the settlement, which may be finalized this week. At this is being written (Tuesday, February 7), several major states have yet to agree to the deal. California is the largest hold out, along with New York and Nevada. A major sticking point is the amount the $25 billion settlement for not going far enough to punish lenders but the odds are good that an agreement will be reached. With or without California, the deal is likely to move forward and become the largest industry settlement since a multi-state deal with tobacco companies in 1998.
In return for immunity from prosecution by the states signing the agreement (but not immunity from suits brought by individual borrowers), lenders will pay $25 billion to finance loan modification and homeowner relief efforts and they will overhaul their mortgage and foreclosure servicing procedures.
Roughly $17 billion of the total settlement would be spent on various types of loan modifications for homeowners. Rather than paying that amount in cash, lenders would receive a series of credit toward that amount based on a complex formula that would assign different levels of credit to different types of modifications. Decisions about which loans to modify would be left to bankers. But the overall impact of $17 billion in reduced loan balances would be far too small to help revive the housing market. There are currently some 11 million borrowers with an average shortfall of roughly $65,000 — or a total of $700 billion — in “negative equity,” according to the latest data from CoreLogic.
Another $5 billion would be set aside to help support state foreclosure relief programs. Another $3 billion would be applied to a program to refinance mortgages at lower rates. Borrowers would have to be at least 60 days late on their mortgages as of a date that’s yet to be determined. They would also have to be underwater, meaning they owe more on their home than it’s worth.
The program would apply largely to the relatively small universe of home loans owned outright by the five lenders, including Bank of America, JPMorgan Chase, Wells Fargo, Citibank and Ally Financial (formerly GMAC). Loans held by government-controlled Fannie Mae or Freddie Mac — some 60 percent of the 31 million home loans outstanding — would not be covered in the deal.
However, the settlement’s impact on the foreclosure processing will transcend these five banks. In addition to the financial penalties, the draft settlement includes 40 pages of standards governing future loan servicing and foreclosures. The standards are expected to be tougher than past ones and should improve consumer experiences. Servicers will adopt them industry-side, in hopes their liability will be reduce. The new standards will break the post Robo-signing scandal logjam for all servicers by clearing the way for them to move forward with standardized foreclosure processing procedures that will be faster and easier to implement.
The impact on pending foreclosures would also be very small. As many as 100,000 borrowers could be helped by the settlement, a fraction of the 2.3 million homes in the foreclosure pipeline.
“Based on the numbers alone, this is pretty modest,” said Christopher Mayer, a professor at Columbia Business School told the Washington Post. But he added that the numbers don’t account for the broader impact that the settlement could have on the housing market. Mayer said a deal probably would lead to more industry-wide loan modifications and would help jump-start foreclosures that have languished since reports of flawed and fraudulent legal filings came to light in 2010, causing banks to halt many legitimate foreclosures. “There are no silver bullets,” Mayer said, but the current deal “is an important step forward.”
In light of the size of the backlog in the foreclosure inventory, especially in judicial states (see Foreclosure Update: Happier Days on the Way for Judicial States), expect to see processing speed up. A wave of foreclosures will he going to auction, then back to the bank and into REO status in the coming weeks, just in time for spring home buying season.
In REO-heavy markets, the wave could cause a temporary dip in prices as they expand inventory, creating special opportunities for alert investors. The wave will last through the spring as properties now in default and pre-foreclosure work their way through the pipelines and onto the market. Again, expect the biggest impact to be in judicial states: New York, Illinois, Florida, New Jersey, and Ohio. Banks will want to control the marketing of these properties to avoid disrupting prices, but in light of the fact that many of these homes have been in the pipeline for over a year, they may opt to sell them at a loss rather than suffer further damage and decay.
Perhaps the greatest impact of all is the promise of a smoother, faster-moving, more logical, less paralyzing foreclosure process that will no longer hold hostage entire local real estate markets with logjams of foreclosures stuck in the purgatory of processing.
Photo: Logan Ingalls