For Yves Smith, wherever he is.
Back on July 8th, Naked Capitalism ran an intriguing article entitled “Banks Outbidding Private Equity Funds at Foreclosures, Believing They Can Beat Them at the Pump and Dump Game,” which suggested banks were bidding up for properties in FL after foreclosures. The post was based on a July 6th, 2013 article in the Herald Tribune by Josh Salman, “Big lenders bidding to keep homes.”
“In some cases, lenders this year have bid up to 600 percent more than a property's worth to retain foreclosures — one of the primary reasons the acquisition costs for competing real estate investors also has spiked in recent months,” Salman reported. “In the 12 months ending June 1, 4,865 foreclosures were auctioned in Sarasota and Manatee counties. Lenders outbid third-parties to keep 3,754, or 77 percent.”
The Tribune report seemed pretty well-researched and convincing, but when I ran this article by several of my colleagues at Carrington and in the industry, as well as lawyers and realtors who work with foreclosures in FL, I got a torrent of comments and information that leads me to a different conclusion. In fact, when lenders are “bidding for REO” they are just setting the “reserve” above market levels to cover most or all of the debt owed on the property. Banks can’t actually outright buy REO.
When a lender is bidding above the distressed market for REO in a judicial state like FL, the properties just revert to REO rather than going to a third party buyer. With all due respect to Mr Salman, this is one of those strange cases in the mortgage industry’s legacy loan saga where we should probably be cheering for the big banks and other lenders. After all, the banks represent investors with secured interests in foreclosed homes via their investment in mortgage notes. It is the investors in mortgages, public and private, who are the biggest victims of the subprime crisis.
Let’s get into some basics of the mortgage and real estate trade. A key term to address is the concept of “auction” and foreclosure (FC) in the context of different states. In general, there are two kinds of states for the purpose of foreclosure, judicial and non-judicial.
First there is the concept of a property being “Sold at the FC Sale” a/k/a “being sold at Auction” or “being sold at the FC Auction.” This is not to be confused with the process of selling homes using an auction platform such as www.auction.com, Hudson & Marshall or Williams & Williams Auction in REO, and in the past year in the Short Sale space.
The operational concept of the FC Auction Sale, which is often done on the steps of the courthouse in non-judicial states, is that someone is appointed by the county will stand outside and “call” the sale. There are hard money investors who stand around and bid on the property. There is little formality to the process and, in fact, often there can be some degree of collusion between the guy calling the sale and the various bidders. Suffice to say that it is not an auction.
The other concept to understand is that about 18/24 months ago, www.auction.com started participating in the “calling” of the auction process in several non-judicial states. The idea of getting Auction.com into the mix was that it removes the concept mentioned in the previous bullet point so that the “potential” for conflicts in the FC sales is eliminated. So for example:
o Auction.com would post the properties for scheduled for FC sale on their web-site (with strict instructions that the home was not to be approached and/or entered). What this did was increase the exposure of the property and ultimately increased the bid/ask price. Fannie and BofA were the first to start this program with Auction.com, which “calls” the FC sale in CA in about 40 counties as well as AZ, TX and WA
o Due to the increased activity for the purchase of properties (local investors or institutional shops such as Blackstone), servicers have seen 70% of what goes to FC sale go to Third Parties (hence fewer REO properties). Also, bank and non-bank servicers will now see anywhere from 90% - 100% of a value obtained for an asset. NOTE: These are “drive-by” valuations, which means today we’re likely seeing properties sold above market value in many cases.
OK, so now we understand what’s going in the Western/Trustee states with the use of Auction.com. Next let’s talk about FL.
o FL is a judicial state vs. CA, TX, AZ and most of the states west of the Mississippi, which are non-judicial states for foreclosures.
o Since FL is a judicial state, there is no “calling” of the FC sale at the courthouse steps. The FC sale is a judicial process that would not allow for the “on the steps of the courthouse” production handled by a trustee in a non-judicial state.
o The judicial FC sale is basically a jump ball type of situation where the court holds a sale for the foreclosed property. This means that the secured creditor (represented by a bank or non-bank servicer) must set a high enough “reserve” to retain control of the property or it goes to a third party at a discount.
In order to utilize an auction platform model, the public “auction” would need to take place after the judicial FC sale in FL. Fannie, BofA and Homeward all have used the Auction.com FL FC model in judicial states. It generally goes as follows:
o Subjects in FL go to FC sale and properties are bid FULL DEBT. The property reverts back to the bank. Note that the bank hasn’t actually paid for the house. The bank is already carrying the debt and the lender has a final court FC order in hand.
o The idea is that, once the bank re-establishes control over the property for the FC process, IT WILL BE SOLD immediately. By bidding the debt, the property can then be sold using a public auction platform that allows for a true fair market sale. The property goes under contract to the highest bidder and closes in 15-30 days.
o Each week, for example, Auction.com will hold an on-line auction of those assets that recently went to FC sale. There is about a 10 day period between the FL FC sale and the time that the sale is confirmed. In a post FC sales in a judicial state, the assets then are reviewed for bids the same way that they would if it were at the FC sale in a non-judicial state.
o The Auction.com model is technically more like an REO sale since it’s post the FC but does not have to have the property going down the path of evicting, marketing; meaning no excessive time delays.
Now some thoughts/comments from both the Naked Capitalism and the Tribune articles:
o The bank does not use the FULL DEBT bid to outbid Blackstone. It’s to make sure the bank gets fair value. If another bidder ends up winning in the process and covers the lender’s unpaid balance, that’s great. Part of REO-to-rent model is the get it at a good price, after all. ;)
o Part of why home owners complain about competition from institutional buyers is that the market is strong and the bid/ask is tighter than it was in the past. Pent up demand + limited supply = housing rebound, at least for now. You can be sure a realtor would rather buy a FC property in a judicial sale w/o a banking making a cover bid than on on auction platform.
o The Tribune article acts like by not allowing the investor to purchase at the FC sale, the lenders are cutting people out of the process. Just the opposite is true. By putting the house on an auction website, you would think more people would see the asset and be aware of the sale.
o There is mention that the investor will fix up the home and the banks will not. – This is actually true in that once the property goes into REO, banks are unlikely to put money into, simply because you don’t need to as there is strong buyer demand.
o The article mentions that banks are turning down offers from investors at the FC sale presumably to take them into REO. He is correct based on the process mentioned above. That same investor can still make an offer when the property is listed on the auction website, for example. Again, remember that we are maximizing the sale proceeds for an investor, whether Uncle Sam or a private investor in the mortgage note.
o When selling a home at the FC Auction, it is likely if not a certainty that it will be an investor who purchases it and not an end-user. End users are not informed as to the FC auction process. If it is put in the MLS, however, then you have a true "market exposure" on the property where all can see it, institutional and retail. The question for the seller of REO is this; will you get more by putting the property in the MLS and getting true market saturation and if so will that amount off-set the commissions and time that is needed?
Lastly, I don’t think Salman is entirely wrong in his comments, but he doesn’t fully understand the process or the business drivers behind the FL FC process followed by banks and other sellers of REO. Banks are NOT looking to hang onto the REO property Think about servicer liability and the state AG settlement, for example. Lenders now have an explicit duty of care to the borrower and they have a fiduciary responsibility to their investor on the loan to execute the REO sale optimally.
Banks like the use of an auction website because it exposes the asset to the market fully. An auction demonstrates that the bank/servicer is doing everything it can to increase the marketability of the property, reduce the timelines and reduce the overall loss given default. That is why you see banks “bid” the FULL DEBT on a property in FC sales in judicial states like FL.