Dispose Distress Early to Minimize Loss Severity
September 17, 2019
A new study of distressed property dispositions between 2003 and 2017 by Fannie Mae and academic researchers finds loss severity on nonperforming loans is lower when properties are disposed of early, before a lender takes ownership.
“Losses tend to be lower when the lender does not take ownership of the property,” according to early findings from the study provided by Hamilton Fout, director of Economics for Economic and Strategic Research at Fannie Mae. “The earlier the creditor is able to dispose of the property the less they lose because of better maintenance of the property, for example.”
Fout and study co-authors Arnab Biswas with the University of Wisconsin Stout and Anthony Pennington-Cross with Marquette are also working on publishing a paper that will provide a more in-depth treatment of findings from the study to shed light on an area of loan servicing that has not been well-explored in academic literature, according to Fout.
“There is not a great understanding about what’s driving severity,” he said. “Loss mitigation strategy matters.”
REOs experience biggest losses
The specific distressed property disposition strategies analyzed in the study were short sales (SS), deeds-in-lieu of foreclosure in which the distressed owner deeds the property directly to the lender (DIL), third-party sales at foreclosure auction (TPS), and sales of real estate owned by the lender (REO).
To measure loss severity, Fout and his co-authors looked at record-level default data from Fannie Mae between 2003 and 2017 for which a disposition outcome was available. The loss severity calculation accounted for all disposition-related costs incurred by Fannie such as foreclosure costs, property maintenance costs, sales costs and interest carrying costs. These combined costs were subtracted from the property sale proceeds and then divided by the outstanding mortgage balance at the time of default.
This initial loss severity calculation found that loss severity was highest for REO dispositions (63 percent) followed by deeds-in-lieu (60 percent), short sales (46 percent), and finally third-party sales at foreclosure auction (32 percent). Fout and his co-authors dug beyond those initial findings, however, taking steps to control for factors that may have influenced the results. These factors included loan type, loan-to-value ratio, borrower credit score and debt-to-income ratio, as well as a property’s owner-occupancy status.
“Controlling for borrower, loan and market characteristics, as well as sample selection, we find that REO loans experience the greatest losses followed by TPS, SS and DIL,” the study concluded.
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