I present for your consideration you the strange saga of 4100 Gray Fox Court, a vacant lot in the rarefied confines of ArrowCreek. It was purchased for $448,081 in October 2005 with a $375,360 1st loan from IndyMac, who subsequently sold the loan to Deutsche Bank, who packaged it in MBS. The owner took out a 2nd loan for $50,178 in February 2008 from local contractor Pinnacle Drywall (the connection seems to be the ill fated Highland Place development, which is another saga for a later date).
On 11 April 2008, the owner deeded the property back to Deutsche Bank in an apparently unilateral Deed in Lieu of Foreclosure (3639231).
On 14 May 2008, The HOA filed a Lien for $3,120 in delinquent HOA dues.
On 19 March 2009, Deutsche Bank filed a NOD on the original first loan, rejecting the attempted DIL.
On 9 October 2009, the NOS was filed with a due amount of $434,369.
On 11 December 2009, Deutsche Bank took back the property at a Trustee’s Sale for $88,500 (3865254). Or so they thought. There was another drama going on.
On 31 July 2008, the HOA had refiled a Lien for delinquent dues, this time on Deutsche Bank based on the recorded DIL (3674478).
On 18 December 2008, the HOA filed a NOD. Another NOD was filed on 7 October 2009, with $11,062 now in arrears.
Today, a second Trustee’s Deed was recorded by the HOA, transferring the property to a private 3rd party, with the amount owed and amount paid being $50,400 (3865254). I can’t for the life of me find the NOS, but it may exist.
So who owns this property now, the 3rd party or Deutsche Bank? ArrowCreek HOA was pursuing action against DB, believing that they owned the property. DB says uh-uh, not us, we never took it back. Still, DB was in 2nd position when they (thought) they took back the property, and should have had to pay off the HOA in 1st position to gain title at the Trustee’s Sale. Is the property worth the legal fees it is going to take to sort this all out?
I’m interested in your comments about another trend I have been seeing – banks recording a reduced amount of debt owed at Trustee’s Sales. Where I’ve been seeing this is at really low end properties (Smithridge, DeLucci, Highwood) and at the Grand Sierra. For instance, 506 Smithridge went back to the bank today with a purchase price and amount of debt being recorded as $58,987 (3864964). The amount owing was shown as $164,002 in the NOS. Can the bank still 1099 the owner for the amount of forgiven debt when they record that the debt doesn’t exist? Are the banks so afraid that these loans could be found to be fraudulent that they are playing nice-nice? I haven’t a clue, just another "Huh?" moment. What do you think?
smarten
Well Mike. Your queries are beginning to sound more and more like a law school exam.
The one question you ask that isn’t, is why are lenders making opening bids on their note receivables the subject of trustee’s sales at 20 cents on the dollar? I asked this question some time ago and the responses were that beneficiaries were attempting to attract bids from ANYONE else. That may be the answer here. Or how about this one? The measure of damages for a deficiency action is the difference between the security’s fair market value [“fmv”] and the amount due. Is the lender attempting to run up the amount of a potential deficiency judgment? Or was the sales price actually fmv? Or is the subject irrelevant because lenders allegedly never file deficiency actions after non-judicial foreclosure? Or is the lender just attempting to mitigate the property transfer fees it will be assessed when recording its trustee’s deed? I really have no clue.
PEPB
“Is the property worth the legal fees it is going to take to sort this all out?”
Does the Arrowcreek HOA have any money to pay legal fees?
billddrummer
Mike,
You could argue that the lower bid at the trustees’ sale represents fmv for the property at the time the deed is recorded, especially if no other bids surface.
I would expect the lender to 1099 the borrower for the difference because it would be considered ‘forgiven debt’ and subject to ordinary income tax. (It’s reported on a 1099-C for a cancellation of debt, or a 1099-MISC if the cancellation arose from a foreclosure.)
In the case of a borrower who defaults on a first and a second, at foreclosure, he would receive a 1099-MISC for the deficiency on the first, and a 1099-C for the cancellation of the second, because the second would be considered an unsecured debt after foreclosure on the first, presuming any equity was wiped out at the trustee’s sale.
Lenders aren’t thinking about the transfer fees. All they are concerned about is liquidating the property as quickly as possible. So another motivation for lowballing the bid might be to spur interest in a short-term flip. That way, the lender doesn’t hold the property very long, and everyone can get on with their respective lives. Remember that lenders aren’t set up to own property–they would much rather take their lumps and move on.
The person who defaulted is faced with trashed credit, a big tax bill, and if the lender is sharp, a deficiency judgment.
Martin
I thought that a while back, there was discussion on the blog to the effect that the IRS had adopted some policy that it would not consider foreclosed out borrowers to have imputed income for some limited period of time. Perhaps I am mistaken. Or perhaps it was only in relation to short sales. I think it was Tom who provided this information. Any update Tom? I probably have it wrong, and would appreciate clarification.
Thanks.
Tom
There is another reason why lenders will sometimes prefer to bid-in the property in foreclosure at a fraction of the unpaid debt. They don’t want to pump-up the total of REO assets on their statements. Carry value for their REO column on their books, will be based on the foreclosure sales prices of those properties which are in that category due to foreclosure sales. Having too high of an REO total, in relation to other assets, puts the bank out of proportion. Banks are very sensitive to relationships between asset categories on their statements. They can negatively affect their ability to write attractive new business if they get out of proportion, i.e., are too over-invested in an undesired category like REO property. They can avoid that result but still foreclose by bidding in at a lesser price. They will still own the property, and can sell it later for whatever the market will bear, but in the meanwhile, the carrying value is less, thus helping to keep their total REO a smaller number.
DonC
Martin — The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. This special treatment ends after 2012.
Note that this includes restructuring of debt or debt forgiveness but does not affect state tax treatment. Not important of course in Reno but in CA you would still have a state income tax liability.
DonC
Tom — Great point. But that’s the balance sheet. Does a low foreclose price hit the income statement as a loss equal to the difference between the loan amount and the foreclosure price?
Tom
Don, I don’t think the foreclosure itself is the terminal event triggering the recognition of loss; it is more like a change in form of the asset, from a secured receivable (even if in a non-performing category) to an REO asset. But the balance sheet would be affected by the change in categorization.
Once the REO asset is sold, then there would be a loss recognition to compute. If there were later on some deficiency judgment recovery, that would be a recapture.
That’s the way I am told the banks report these, for whatever it is worth.
billddrummer
To DonC,
That Act does allow the borrower to exclude income from the discharge of debt on their principal residence, but only if the debt was a purchase money first mortgage, or if a refinanced debt, if the refinance amount was less than or equal to the purchase price of the property.
And to Tom,
Good point about banks wanting to limit their investment in REO property. But as far as the accounting on a loan that goes into foreclosure, there are a couple of additional pieces. When a bank determines that a loan will go into default, the bank will charge its loan loss reserve for a portion of the impaired loan balance.
If the loan continues to deteriorate and ultimately goes into foreclosure, the carrying value of the property replaces the outstanding loan balance at the time the trustee’s deed is recorded. The bank will (usually) recognize a loss at that time, but charge it to the loan loss reserve.
When the property ultimately sells, the REO balance is canceled, and the bank will take a gain or loss (usually another loss) against current earnings.
In addition, while the property is on the bank’s books, the bank is responsible for maintenance, insurance, property taxes, utilities, repairs, HOA dues–in short, everything an owner would normally pay, the bank has to pay. Those costs are charged against current income but added to the REO balance for as long as the property belongs to the bank.
Hope that helps clarify the accounting a bit.
DonC
billddrummer – Thanks for the clarification. However, I think the exclusion applies to any debt which is used to build or improve your principle residence so long as it is secured by the home. So it’s not limited to the first mortgage AFAIK. In a sense it mirrors the loans that are eligible for non-recourse treatment in states like CA. IOW a HELOC used for a Disney Cruise wouldn’t be eligible but a HELOC used for a new kitchen would.
There is also a $2M cap ($1M if filing single) if that matters. Like all tax related provisions there are always nuances.
billddrummer
To DonC,
Thanks for the input. I had forgotten the non-recourse piece of the legislation.
inclinejj
Actually If you read a new form Notice Of Trustee sale there is a line that says. something to this effect. Too swamped right now to look it up.
Lender or Beneficary has the right to bid lower then the total debt.
Sometimes the lender opens the bidding very low to bring out the “shark” bidders and the bank is bidding the property up with the shark bidders, other times they may do something like this:
Amount of debt owed: $500,000
Opening bid $232,000.00
If you walk up to the court house steps you could buy the property for $232,000.01
inclinejj
It is possible that the opening bid may be less than the total debt.
billddrummer
To inclinejj,
I’ve done some spot checking, and it seems that the only bids that are close to the total debt are entered by Fannie Mae or Freddie Mac.
Hmmmmm….
Does that mean the government is overpaying for foreclosed assets?
Nah, they’d never do that, would they?
Or would they?
billddrummer
Something else I just thought of–
And would that mean no ‘shark’ bidders would appear? None of them would bid the loan balance on a foreclosing property in an environment of falling values. There would be no upside to flip the property.
So does that mean the balance sheets of Fannie and Freddie will grow with unmarketable REO properties?
And will the government turn around and rent these houses to displaced residents for less than market rent?
Is that what’s happening? Is it?
Can’t be. This is America, land of the free, home of the brave.
GreenNV
The new wrinkle is that the amount of debt is being recorded as less than the actual amount on Trustee’s Sales, not that the winning bid is less than the amount of debt. Maybe it means nothing, but I haven’t seen it happening until recently, and it is happening on a narrow range of properties.
billddrummer
To GreenNV,
Is there any way to tell which properties fall into that category? Is it price? Location? Age of foreclosure action? Something else?
Inquiring minds are seeking the truth.
GreenNV
billdd, I’ve seen at least 6 at Grand Sierra, about the same at Smithridge, a couple at the Belvedere, and a couple up in the Clear Acre / Weidekin area (forget the actual development names, but anything starting with 004 leading the APN).
All condos. All projects that have tanked over 75% from their peaks. I don’t think that’s a coincidence, and I have seen ZERO of these debt reduced filings anywhere else in Washoe. The very narrow spectrum of these filings is what piqued my interest. Something is going on, but I don’t know if it is positive, negative, or just bookkeeping.
inclinejj
I just emailed two mid sized Bank Presidents the same question:
They came back with the same answers:
When the bank funds and closes a loan for example $500,000 it goes on the books as a $500,000 loan. When the borrower stops paying, I don’t recall the exact formula but they have to put the money aside and almost account for the loan to go bad. When the property goes to the courthouse steps lets say the bank opens the bidding at $200,000. The bank gets to write off the whole $300,000 as a loss, due to the fall of values. Now there are different accounting rules, which I didn’t get into, on how if they took the property back for $500,000 plus all the back payments, taxes forced insurance etc etc.
I see your point Bill, this house just went back yesterday. Total debt owed on the Notice Of Trustee’s Sale $518,508.65 foreclosed for $523,008.74. What is the house worth, well the last lowest comp just came in at $405,000. What do I think the house is worth. Between $400,000 and $425,000.
inclinejj
Also I forgot to mention:
Fannie/Freddie are quasi-Government agencies.
Think this way. Why do Fed Ex and UPS make money every year and the USPS has always bled money?
billddrummer
To inclinejj,
In your example, the bank will carry the house on its books at $523,008.74, and add any other charges (power, insurance, taxes) as they are incurred.
When the property finally sells, the bank will book a loss equal to the difference between the carrying value and the sales price. That loss is charged to current earnings.
So in your example, if the house sits on the bank’s books for 3 months and they pay another $1800 in expenses during that time, the REO value becomes $524,808.74. If they sell the house for prevailing value ($425,000, say), then the bank writes off $99,808.74 to current operations as a loss on the sale.
That’s what’s holding up the OREO clearing process. No bank wants to write off any losses against current earnings. As long as the property stays in the borrower’s name, the bank can pretend that the loan will ultimately heal itself.
The big difference in accounting is this: When an impairment in a loan is booked, the bank charges earnings but the funds are placed in the loan loss reserve. When a loss is booked on an asset sale, the charge is DEDUCTED straight from the bank’s capital account.
So the bank will continue to keep the loan on the books, perhaps charge the loan loss reserve as the NODs and NOSs are filed, but not pull the trigger on the foreclosure itself for months, maybe longer.
IMO, that’s why shadow inventory is so high. It’s not really inventory of the lenders, so much as it is inventory of the nonpaying resident (read squatter).
inclinejj
They also booked Option Arm Interest that was added on to the loan amount as “income” talk about creative accounting 101.
Also even more troubling:
Fed Pulls Plug; World Does Not EndBy Alyssa Katz Mar 31st 2010 @ 1:30PM
Filed Under: News, Economy
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A A A Tomorrow is the big day – the day the Federal Reserve pulls the plug on its purchases of mortgage-backed securities. Since December 2008, the Fed has kept the mortgage-backed securities market going by buying $1.25 trillion in securities issued by Fannie Mae, Freddie Mac and Ginnie Mae that no one else wanted. The massive program has helped keep home loan interest rates low during the financial crisis.
The securities — comprised of residential mortgages bundled to diversify risk — have long greased the wheels of the housing market. But after the subprime meltdown, investors viewed mortgage securities as unacceptably risky.
Starting tomorrow, private investors have to step back up to the plate to buy up the $1.5 trillion in mortgage-backed securities likely to be produced this year. Will they? Or will the government withdrawal leave a vacuum in the housing market that could push interest rates higher, as some fear?
“We will be watching the end of the Fed program very closely,” said Mark Fogarty, editor of National Mortgage News. “We have heard predictions both ways — that the end of the program will cause a big bump in interest rates and that it will have little effect at all.”
So far, investors seem to be warming up to the idea of putting their money into mortgages again. Strict screening of borrowers and cautious lending under Fannie, Freddie and Ginnie means that mortgage pools are once again safe bets, and private investors are currently buying more than two-thirds of the securities. Prices of short-term securities are competitive with other investments, and have stabilized since the Fed started its buying program, a sign that investors now trust them.
And the federal wind-down has been orderly. It has signaled its intent to end the program, and has been steadily reducing its purchases since the beginning of the year.
As a result, the market has not been jolted, says Fogarty. Private bond investors seem to be picking up the slack for the Fed. Average interest rates for 30-year home loans have stayed under 5 percent, near its historic low point recorded at the end of last year, according to the Freddie Mac Primary Mortgage Market Survey for March 25.
“There has been a relatively liquid and stable market for Freddie Mac securities throughout the capital crisis,” says Freddie Mac spokesman Michael Cosgrove. “What’s important is that there is liquidity in the market and there have been investors that have been stepping up to buy.”
There’s still unfinished business to deal with, however. The Fed still has that $1.25 trillion in securities on its balance sheet – far more than it spent bailing out AIG and other credit insurers. One-fourth of all Fannie and Freddie securities are now the Fed’s property. (Fannie and Freddie themselves hold another 25 percent.) Some conservative economists have expressed concern that when the Fed tries to unload all that debt, it risks increasing inflation. (For a paper by Stanford University economist and monetary policy expert John B. Taylor on the topic, check out this pdf).
But overall it’s pretty hard to find the bad news here. Interest rates are likely to go up a quarter of a percent at most, much lower than many had predicted. The Fed has been generating tens of billions in income off these investments. And while inflation poses all kinds of problems for an economy, it also has a silver lining, because mortgage payments may end up taking less of a bite out of a household’s income.
Bendix Anderson contributed reporting to this story.