Abstract
The loss on a distressed mortgage depends not only on economic and financial conditions but also on the value of the property and how it is transferred to a new owner. Using data from Fannie Mae, we investigate the differences in loss experience across alternative mechanisms for disposing of property (real estate owned or REO, deed in lieu, short sales, and foreclosure sales) from 2003 through 2017. In general, losses are lowest for short sales and foreclosure sales. But these lower losses depend on the overall distress level of the market. The more distressed the market is, the smaller the relative gains associated with these alternative approaches, as compared to traditional REO sales. In contrast, in markets with rapidly increasing distress short sales have lower losses relative to traditional REO sales. We use a variety of matching techniques to address selection issues associated with REO properties and find that the lower loss severities associated with non-REO sales remain.
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Notes
On June 16th, 2016, the Financial Accounting Standards Board (FASB) issued the Current Expected Credit Loss (CECL) impairment standard, which changes the calculation of the Allowance for Loan and Lease Losses (ALLL). These new rules were scheduled to take effect for all banks in 2022 and Security Exchange Commission (SEC) registrants in 2020. In March of 2020, FASB delayed the implementation of the CECL standard by 2 years and included a 3-year phase in of any capital requirements.
In this discussion, we use the term lender generally to refer to the credit guarantor of the loan.
A deficiency judgement is a court ruling that a borrower must cover the shortfall when property sale proceeds do not cover the outstanding debt. Deficiency judgements are typically only available in recourse states (see Ghent and Kudylak 2011 for more details).
Foreclosure laws vary by state. In judicial foreclosure states, lenders have to initiate legal action through the court system, while in non-judicial states, lenders do not have to use the court system to foreclose. See Mian, Sufi and Trebbi (2015) for more details.
For traditional REO and DIL-REO sales, we refer to this date as the disposition date; for foreclosure and short sales, it is referred to as the liquidation date.
Foreclosure timeline related property taxes (or HOA fees) are calculated as
property taxes (or HOA) *fcl_months/(fcl_months+disp_months), where fcl_months measures the number of months between the last paid installment date and the liquidation date, and disp_months represents the number of months between the liquidation date and the final property disposition date.
For market mortgage rates we use the 30-year fixed mortgage rate for 30-year, 25-year, and 40-year fixed mortgages. We use the 15-year fixed mortgage rate for 15-year, and 20-year fixed mortgages. We use the 5/1 adjustable rate mortgage (ARM) rate for 3/1, 5/1, 7/1, and 10/1 ARMs.
For traditional REO and DIL-REO sales, the holding period is calculated as the difference between last payment date and (REO) disposition date.
Disposition related property taxes (or HOA fees) is calculated as
property taxes (or HOA fees) *disp_months/(fcl_months +disp_months). However, this formula does not apply to either foreclosure sales or short sales.
The spike in the distribution for negative loss rates (e.g. gains) is due to the category including all negative loss rates.
While our sample is based on Fannie loan data, other sources show a similar pattern for the broader industry. For example, Zhang (2019) presents evidence of a relative decline in the REO share of distressed sales and a relative increase in the short sale share of distressed sales from 2009 to 2014 using a comprehensive set of property transactions.
Mahalanobis distance between covariates for unit i and unit j is defined as:
$$ M\left({X}_i,{X}_j\right)=\sqrt{{\left({X}_i-{X}_j\right)}^T{S}^{-1}\left({X}_i-{X}_j\right)}, $$where Xi, Xj = vectors of pre-treatment covariates for unit i and unit j, respectively, and S is the covariance matrix between Xi and Xj.
We use the ratio of Fannie’s REO properties over all properties in a particular state for the measure of distress. We include this measure in levels as well as growth rates over the 12 months prior to property disposition. See Table 2 for more details.
Since there are traditional cutoffs for DTIs in underwriting standard around 0.36 and 0.45, we test an alternative specification using spline coefficient estimates around those points of interest. Using the full sample, we find that the DTI-spline coefficient estimates do differ from one another(with a smaller negative effect on severity for the highest portion of the DTI spline above 0.45 versus the lowest portion below 0.36) but have no impact on the primary coefficient estimates of interest (disposition type impact).
In another test, we examine how DTI impacts various components of loss severities. The results (available from the authors upon request) indicate that DTI primarily reduces the losses associated with the sale of the property. The reason for this impact is unclear. But it is clear that DTI reveals something about the borrower or their interaction with the lender that leads to a better sale price of the distressed property. A discussion that breaks down loss severity into different components is provided later in the results section. We also run additional specifications that do not include DTI, which yield almost identical results for the effects on severity of alternative disposition types.
We provide a full set of coefficient estimates in Appendix 2.
It includes the regular primary mortgage insurance revenue as well as servicer payment due to mortgage insurance rescission.
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Acknowledgements
The authors would like to thank participants in the American Real Estate Society 2019 annual meetings as well as Lily Shen for especially helpful discussion and comments on earlier versions of the research. The authors are solely responsible for the views expressed in the paper, and these views do not represent official positions of Fannie Mae or any other employer. All remaining errors are our own.
Availability of Data and Material (Data Transparency)
The data is not available to the public. We use propriety individual loan level data.
Code Availability (Software Application or Custom Code)
We use standard econometric techniques all available in SATA. The code is not available to the public and covered the Non Disclosure Agreement that all non-Fannie Mae authors signed to gain access to the data.
Funding
No direct financial support was provided by any institution. Fannie Mae provided access to propriety data to conduct the research.
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Appendices
Appendix 1 Matched Sample Comparisons
Appendix 2
Appendix 3
Appendix 4
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Biswas, A., Fout, H. & Pennington-Cross, A. Mortgage Losses under Alternative Property Disposition Approaches: Deed-in-Lieu, Short Sales, and Foreclosure Sales. J Real Estate Finan Econ 66, 603–635 (2023). https://doi.org/10.1007/s11146-020-09785-2
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DOI: https://doi.org/10.1007/s11146-020-09785-2