This week Bruce Norris is joined once again by Sean O’Toole, founder and CEO of ForeclosureRadar.com. Sean has been an experienced trustee sale investor, buying over 150 properties, both residential and commercial. He also has a very intensive tech background that he has brought to ForeclosureRadar.com.
In the last segment Sean and Bruce had just started touching on the term shadow inventory. Originally it meant the lenders had foreclosed on inventory and were sitting on it. Sean said he still thinks of it as how the bank originally coined it of being the bank-owned homes, and they were the first to say there was no more shadow inventory and those bank-owned homes the banks appeared to be sitting on in late 2008 are largely gone now. However, it has been pretty universally extended to also include those in the foreclosure process and still not bank-owned. It also even includes those who have not been making their payments. From there, he has even heard a few, which he does not agree with, extended to the people who are underwater or even to those who would want to sell their house today if prices at 2006 levels.
What most people will ask is if there is a ball-turning behind the scenes that could emerge and affect the pricing, which Bruce believes to be a valid concern. Bruce wondered if there was some inevitability about the process that they will eventually own it, or are they now really going to concentrate on every other way to dispose of it by selling several houses to someone who is going to keep them as rentals. He wondered what Sean’s take was on what percentage would be solved without the process of a trustee sale. Except for the word “solved,” Sean thinks we are going to see every possible effort to not go to trustee sales. We will probably see these REO rentals or even deed-in-lieu rentals where they tell the person to give them the deed to their house in exchange for renting it back to them. We will probably see every possible scene in the book to keep business going from foreclosure.
Unfortunately, it is an interesting thing where you have Occupy Wall Street and others all rallying against foreclosure. What they do not realize is they are helping the banks. Foreclosures hurt the banks; and foreclosures are the best thing ever, especially in California for the consumer. You get to completely walk away from the debt with a seven-year hit on your credit in most cases. It is a brilliantly pro-consumer thing, and it has been turned on its head by some activists to be anti-consumer. Sean thinks this is absolutely the trend; we have seen this trend since September of 2008 when Paulson announced TARP. Every government action, every program we have seen since then including robo-signing and the attorney general’s statement, have been specifically designed to provide cover to the banks to allow them to continue to trickle this out, manage their losses, and manage their balance sheets.
Bruce does not know if there is much that is new. For instance, with deed-in-lieu, this has been around for several years, and you could probably count them on not too many hands the ones that have actually been accomplished. Bruce thought originally this was probably a reasonable way to do it, but it has been received by the occupant with a yawn. Bruce wondered why this is the case. Sean said it was not only a problem with the occupant, but early on it was a problem with the lenders. When you have a deed in lieu, you take the risk for any junior debt. What most of the big banks are maybe now figuring out, which is just a suspicion on Sean’s part, is that if he were Bank of America and there was a first and a second, then he has sold off the first mortgage to some investor. He would hold the second mortgage himself as a portfolio loan. If he takes a deed in lieu, it certainly hurts the investor because it does not go through the foreclosure process and wipe out the second. However, it leaves the second mortgage holder in a much better position. So a deed-in-lieu with a rental and some sort of scheme that says someday the second mortgage may be worth something if we hold onto the property long enough and finding a way to make it all work on the books is pretty brilliant. Sean thinks we may see a renewed push there. We just saw Bank of America announce that they are going to start a deed-in-lieu to rental program, which they have previously resisted.
Bruce said he has a portfolio of loans at his business, and he uses the term that The Norris Group is the servicer. However, he said they would never think of doing something without the expressed permission of the person who is actually the owner of the loan. In some cases it seems the servicer has more power than the people who actually own the loan. This is why if you are an investor it is so important to carefully choose your servicer. This is a testament to why people choose Bruce and not others.
Bruce said his thoughts sometimes are, “So what, you’re a servicer. You can’t do a thing without calling the person who is the benny.” He said this thinking is naïve, but he is being honest. It sounds like somewhere in the contract they have been given an awful lot of authority to act on behalf of the benny. This is an interesting scenario where you are acting on someone else’s behalf for your interest. This is kind of a scary scenario. Sean said he has only dug into the attorney general’s settlement a little bit, but he has talked to others who have. One of the things that really surprised them and is leading now to some investor lawsuits is there are things in the settlement where the servicers have agreed to put the investors in a worse position than their own portfolio seconds. Part of the settlement agreement was to give seconds a bigger share in the names of helping homeowners. However, it sure seems like a bank bailout by any other name.
Up until recently, everyone has been against reducing principal. There have been a couple million loan mods, but really very few of them have dealt with principal reductions. All of a sudden, even that seems to be on the table as well. Sean thinks if they were really seriously talking about principal reductions, they would change the rules around market to model and the rules around allowing lenders to leave these things on their books for extended periods of time, which is basically back to the way things used to be. If they could not play games and they had to take losses, then they would probably realized principal balance reductions likely lead to lower losses. However, they lead to losses all the same.
There is a tough double-edged sword because for every loan that is currently delinquent, there are another three to four folks who are underwater. If you make that too easy, those other three to four who are underwater but still paying may want the same deal. Sean thinks this leads to a banking collapse similar to 2008 if not worse. Sean believes this is the queue reason DeMarco at FHFA has been pushing back against that. It is the start of a slippery slope. Sean thinks it is getting more press, but he does not know if we will see any more of them in reality.
Bruce said it reminds him of the $8,000 tax rebate because right before that there was a $7500 tax loan that was not a rebate. You have an interest-free loan; so if you have gotten the $7500 no-interest loan and a month later the program changed, instead of feeling grateful you are now feeling you got cheated. There are $2.2 million loan mods looking at this going, “Hey, we didn’t get any principal reduction.” The first two million problems are people who have already gotten the loan mods. Sean said he has always called that first set of loan mods the most exotic loans ever made. Here you are taking loans that already never should have made it in the first place, and a lot of them get converted into these ridiculously low 2% interest rates, interest only for five years or some other incredible terms. Some of the early loan mods especially have to be some of the most toxic loans on the planet, and they will probably start blowing up as we hit the five-year mark on those. This is probably one reason why the foreclosure problem is going to extend.
Sean said he used to talk about when the pay option ARMs or the five-one interest only were carefully tracked when these things were going to hit their reset dates. Everyone has forgotten about reset dates because they never panned out to matter as much as people thought. The things with reset dates were the ones the banks were most aggressive about fixing. However, they fixed them by tacking another five years onto an already bad deal in a lot of cases. Sean thinks this is still a ticking time bomb. Coming back to shadow inventory, there is no question there is a lot of distress. The only thing he tries to remind folks of is with the length of the foreclosure process, even if they got to work on it now and went through the foreclosure processes as fast as possible, by the time these things hit the market and they deal with the evictions, you are talking a minimum of a year. There is no sign of this at this point, so there is no possibility of a wave of foreclosures hurting the market in any way, shape, or form for at least twelve months. There is just not the inventory there that they could put back on the market that quickly.
The loan mods that were done in the first year are over 70% delinquent already. Their total percentage of current loan mods for the entire history is 49%. Half of these are late. So if this was a loan program, it would be hard to call that a success at 50% default. There should not have been any surprise here. You cannot take a toxic loan, make it more toxic, and think you have fixed it. This is one of the things people believe to be true and what Sean said to be true, but lenders will also loan to people in foreclosure much earlier than the 7-year time period mentioned. When somebody is in foreclosure, it is going to be on their credit history for seven years. However, this does not really prevent them from getting a loan for seven years. Sean said on the upside for the real estate market, the folks who were foreclosed on early in 2008 are getting to be four years into this. Some of those folks are probably tired of being renters by now, realize that interests are awfully low, or may be starting to reach a point where they can qualify to be homeowners again. Sean thinks this is actually a potential source of strength for the market in the next couple years.
Bruce interviewed FHA a couple years ago, and he asked her specifically how long it takes after a foreclosure bankruptcy before she would consider someone for a loan. Her answer was six months, which really surprised Bruce. He thought this is certainly not the street answer. Sometimes there are overlays on top of programs, but if that program actually does exist where FHA would actually say they will look at that as early as six months, then they really should think about not knocking off the overlays since it would probably be a safe loan at this point. If the government had not outlawed everybody but big banks making loans and getting a decent return on their money, then Sean said he personally would take any dollars that he had and loan to strategic defaulters. These are people who made financially smart decisions; and if he is comfortable with current asset values, he would make a loan to anybody with a pulse. Even if they did not perform, he could rent the property and get a better return than he would probably get on the interest rate on the loan. He could certainly find somebody else to take over the loan. Sean said anybody with a pulse would be given a loan when prices were ridiculously high. Now, the prices are at a point where you are taking no risk by making a loan to anyone with a pulse, so they won’t do it.
Bruce and Sean had the privilege of going back to Washington D.C. and sitting in front of what seemed to be pretty intelligent people. You just wonder how the decision process is flawed where the people sitting in front of them could have influence and make the same decisions Bruce and Sean had talked about. It seems like there are roadblocks to common sense. Sean said he came back from this trip more depressed than he had been in his adult life. Bruce said the only reason he came back a little bit better than that was because he always realized there would be room for private money. Unfortunately, they continue to make lending money privately as illegal as possible to help out their handful of friends at the banks. Fortunately, they have not done this for loans to investors, and hopefully this stays true. When you look at things as a business owner, one of the scariest things is you feel like things could change at the drop of a hat for all the wrong reasons. Everything that is real should have foreclosures going up, and the reality is 2012 is probably going to play out as Sean expected with a quantity getting into the marketplace with less inventory.
Sean said in February they saw fewer foreclosure sales than any month since September of 2007. The number of people underwater and in the foreclosure process is not dramatically different from when we were near our peak in foreclosure sales that was three times as many. Clearly the only difference between then and now is the policies around foreclosures. He would love to say these policies were helping people with principal balance, loan mods, and more short sales. However, this is not the reality.
Sean also tracks a couple other states besides California. Bruce said he does not know the rules of Nevada, but he had read something that it is almost outlawed to have a foreclosure. They are the negative equity capital of the country, so Bruce wondered what has changed here. Sean said it has not only changed here, but it appears those changes are coming to California. This is important to understand as Bruce’s business model could change pretty radically if this happens. The fundamental issue is the laws we have around mortgages or deeds of trust are what we really use. If Sean buys a house and receives a mortgage, he gives his ownership of the house in trust to a trustee. They have the power to sell the house if Sean does not make his mortgage payments. This is how the foreclosure process works in California and in Nevada. Within that, there are these loose terms in the law that say that there is a beneficiary for the deed of trust who one could assume was the lender or even the note holder. It is not that specifically spelled out in the law. Somebody who benefits from receiving the stream of payments is allowed to foreclose.
What they have done in Nevada is they have retroactively changed the law to say that you must prove that the beneficiary actually holds the underlying note and all of the paperwork such as assignments and transfers have to be shown up front before the foreclosure can occur. The whole point of the foreclosure process is if somebody tries to foreclose on you and you can prove that you have made your payments, you have the opportunity to come forth and stop the sale. If the trust deed does not agree with your proof, you can avail yourself with reports and get an injunction to stop the sale. There is plenty of time for this, but instead they have now switched that burden of proof from the homeowner to show that he has made his payments to the bank to show that they actually have the power under the deed of trust to collect in a way that was never previously specified. What this has done is it has brought a complete halt to foreclosures in Nevada. There are still some foreclosures, but they are all Homeowner Association liens, which are not subject to the laws or for loans that are outside of the timeframe. There is a timeframe to which the law applies. It has really brought a complete halt to the foreclosure process there, and if those laws pass in California then he would expect the same thing to happen here.
What is interesting about this entire scenario are the unintended consequences going forward for who is going to make a loan next in Nevada. The government is always going to be crazy enough to make a loan, even if they cannot collect since they have the taxpayer to fall back on. It was only a few months ago when Nevada had 3,000 homes being sold at foreclosure a month. That is 3,000 escrows, realtor commissions, cleanout crews, and homes getting cleaned up and put back on the market rather than sitting in foreclosure with an owner who is not going to continue to make repairs. The question is why they would continue to make repairs on something they know they are going to lose. Sean believes they are going to deal with pretty significant economic impacts a few months out in addition. They don’t need any further pain in their economy, and they are probably going to deal with significant blight as homeowners. Homeowners just stop bothering to take care of these properties.
Ronald Reagan had a good quote. He said, “The nine most dangerous words in the English language are ‘I’m from the government and I’m here to help.’” Bruce kind of wishes they would leave the industry partially alone at this point. But what Sean was talking about is kind of a scary scenario. It affects people’s lives that have had business models that they thought were going to work, and then all of a sudden they are dead in the water. The world has changed. When most of these laws were written around mortgage notes and foreclosures, these laws are not ten but eighty years old. These things have been around forever. The whole robo-signing situation drives Sean nuts because what they are saying is the person does not have personal knowledge. Sean does not rely on looking everything up. If he has his computer system where he has been tracking his invoices, accounts, and bills, he relies on this. He does not remember every bill he paid over the last year or every detail, so he needs his computer.
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