Recent reports regarding Ally Financial formerly GMAC Mortgage suspending foreclosures due to process failures have implications that extend well beyond Ally.
Foreclosure processes across the industry will come under greater scrutiny, and longer time lines and higher costs will undoubtedly result. It is also becoming clear that chain of title is not being maintained for many properties due to lax underwriting and rushed liquidations. This will have long-term implications for liquidity in distressed property markets. We recommend differentiating between deals from integrated originator/servicer platforms versus conduits.
The market was confronted last week with reports that Ally Financial had suspended foreclosures in 23 states. The company later issued a statement indicating that the reports were not true, and new foreclosures were continuing in the ordinary course of business. However some existing foreclosures were affected by a procedural issue. The problem was that Ally Financial employees were signing affidavits (presumably lost note affidavits) related to foreclosures without verifying the affidavit information as required. One employee testified that he signed up to 10,000 such affidavits a month!
While Ally Financial appears to be downplaying the problem, we believe that this incident is an important reminder of the risks associated with the judicial foreclosure process, given both the lax origination practices in place during the period of high-volume mortgage origination and the challenges associated with high-volume foreclosure. Clearly these issues are not isolated to Ally Financial alone. While Ally states that they have found no instances where the data in the affidavits is not correct, this is certainly not true for all servicers in all instances. There have been any number of news reports of foreclosures that have been delayed or halted due to bad data/documentation. A recent example: In August, a Florida judge found that WaMu and its law firm “committed fraud on this court” by misrepresenting a loan as owned by WaMu that was, in fact, owned by FannieMae.
We think there are a couple of broader implications here for securitization investors. Above and beyond the risk of delays and increased expense in individual judicial foreclosure cases, which can increase loss severity, lies the threat of more activist intervention by courts, regulators and local and state government. The Florida attorney general is investigating several law firms with large foreclosure practices, and Representative Alan Grayson of Florida has asked the Florida Supreme Court to halt all foreclosures in the state in light of the attorney general’s investigation. Attorney generals in other states have expressed strong interest in the events in Florida and are launching investigations of Ally. The risks of moratoriums, class-action suits and other large-scale impediments to liquidation have increased. This may also be an area the new federal Consumer Protection Financial Bureau will want to get involved in.
The other problem this event highlights has not received as much scrutiny, but will be a growing concern. It’s clear that severe damage is being done to the chain-of-title for residential properties. The Florida Sun Sentinel reported that Bank of America foreclosed on a property in Florida, to the great surprise of the owner, who had paid cash. A prior owner’s Countrywide foreclosure proceeded despite the fact that the current owner had purchased the home from B of A in a short sale. While this is (hopefully) an extraordinary example, the multiple, rapid changes of ownership that occurred during the housing boom, together with the widespread use of lost note affidavits as a substitute for full diligence have created a situation whereby it is much more difficult to obtain clear title. This is becoming evident to title insurance companies. It may be that real estate investors who plan to flip properties that they obtained in distressed sales are in for a rude awakening when prospective buyers cannot obtain a mortgage due to title issues.
That will not be a positive for home prices.
Given these concerns, we see increased relative value in bonds that are backed by loans from an integrated origination/securitization/servicing operation that has not been disrupted by the financial crisis. Mortgage loans that were originated retail, and did not change hands before being placed with a servicer are much more likely to bear up under the scrutiny of foreclosure processes that will be coming.
In our view, the sentiment that “the worst is over” that has helped drive the rally in non-agency MBS can lead to complacency. While the mortgage crisis may be entering a new phase, it is not over, and its unprecedented nature can continue to produce unforeseen consequences.