Although much has been made of borrowers' decisions to walk away from their mortgage obligations, a different form of abandonment – bank walkaways – has caught the attention of at least one federal entity.
According to a study published last month by the Government Accountability Office (GAO), bank walkaways, which occur when servicers abandon foreclosures, are extremely rare but nonetheless have a devastating effect on the communities where they are located. In total, the GAO estimates that walkaways made up less than 1% of all homes that became vacant between January 2008 and March 2010. Although they happen infrequently, bank walkaways are highly concentrated in a small number of areas. The areas of greatest concentration tend to be economically distressed communities, including Rust Belt cities like Chicago, Detroit and Cleveland.
Walkaways – or charge-offs, as they are sometimes called – are typically associated with low-value assets. The economic reasoning for why a servicer might choose to abandon a foreclosure action, or to not even initiate one at all, is that the servicer does not expect that the proceeds from the sale of a real estate owned property (REO) will cover foreclosure and property-preservation costs.
In other examples, servicers, with investors' blessings, will forgo foreclosure if the principal balance of a loan in default is below a certain threshold and all relevant loss mitigation options have been exhausted. Freddie Mac, for instance, requires reviews for charge-offs on mortgages with balances less than $5,000. Freddie's cross-town sibling-in-conservatorship, Fannie Mae, formally stopped charging off loans in April.
As part of its study, the GAO interviewed six servicers – four large national platforms and two shops that specialize in nonprime mortgages. According to at least some of those servicers, properties valued between about $10,000 and $30,000 are considered charge-off eligible.
‘Based on our reviews of bank regulatory guidance and discussions with federal and state officials, no laws or regulations exist that require servicers to complete foreclosure once the process has been initiated,’ the GAO report states. ‘Therefore, servicers can abandon the foreclosure process at any point.’
Analyzing loan-file data from the six servicers, the GAO found that most walkaways – about 60% – happen before the foreclosure process is initiated. And in those instances, properties are more than twice as likely to be occupied at the time the decision not to pursue foreclosure has been made. But in the remaining 40% of charge-offs reviewed by the GAO, nearly half of the properties – 48% – were vacant at the point of charge-off.
In other words, the later the decision to charge off a loan is made, the more likely it is that the property will be vacant. This trend does not sit well with officials in the cities and counties where bank walkaways are most prevalent. Vacant properties, as has been well documented, promote crime and blight, as well as wreak havoc on cities' tax rolls.
‘Charge-offs are going to be the reality’ in some cases, said Steve Bancroft, executive director at the Detroit office of Foreclosure Prevention and Response, at the National P&P Conference in Washington, D.C., last month. ‘The issue is, how is the process done.’
Bancroft wants to see servicers improve their communication of charge-off decisions to local officials, as doing so could promote the transfer of low-value properties into local hands. His office has piloted several programs in the past year that aim to curb vacancy levels in the city.
Another approach taken by an increasing number of communities is to institute land banks – quasi-public entities that rehabilitate, repurpose or demolish REOs that they inherit or buy from investors and servicers at deep discounts. In its report, the GAO suggests that land banks deter servicers from abandoning foreclosure actions because they provide servicers an additional option for REO disposition.
The land-bank movement is perhaps best exemplified by the city of Cleveland, which also happens to be a bank-walkaway hub. The Cleveland-Elyria-Mentor metropolitan statistical area (MSA) recorded the third-highest level of abandoned foreclosures in the nation during the time period studied by the GAO. Only the Chicago and Detroit MSAs had higher volumes.
‘We're really trying to get to the point where the major banks and servicers understand and recognize the fact that the vast majority of the properties they hold in the city of Cleveland are going to have to be charged off,’ Jim Rokakis, the land bank's chairman and Cuyahoga County treasurer, said at the National P&P Conference.
The objective for Bancroft, Rokakis and other similarly situated city officials is not to necessarily end the practice of charge-offs, but to end the practice of reckless charge-offs – the kind that, more often than not, result in vacant properties.
As part of its report, the GAO recommended that servicers be required to notify borrowers when foreclosure actions are stopped, as well as notify borrowers of their right to stay in their homes until a foreclosure has been completed. In response to this suggestion, the Federal Reserve said such notifications represent a ‘responsible and prudent business decision.’
The GAO also recommended instituting a requirement for servicers to obtain updated property valuations before they initiate foreclosures.
(Please address all comments regarding this article to John Clapp, editor of Servicing Management, at email@example.com.)