Rating agencies should assess foreclosure times


When Wall Street turns real estate mortgages into commercial mortgage-backed securities, those securities must first be rated. To do this, the rating agencies scrutinize an exhaustive list of data points for each loan included in the transaction. This review includes, among other things, loan documentation, collateral, appraisal, estimated probability of default, sponsorship and whether the borrower’s structure adequately protects the loan against the risk of bankruptcy. To anyone trying to close a securitization, the rating agency process can look like an extensive and very detailed proctology review.

In rating any loan, the agencies also ask: if that loan were foreclosed, what loss would the loan holder, the securitization trust, suffer? The loss would start with the direct cost of pursuing foreclosure. It would also include the lender’s expenses during foreclosure to pay property taxes and to insure, preserve and secure the collateral. The longer the entry takes, the more these expenses accumulate. Although the loan documents require borrowers to pay everything back, the typical borrower in foreclosure probably doesn’t have any money. This is partly why the loan defaulted.

During foreclosure, the loan collateral often deteriorates, causing indirect costs to the lender, even if the lender does some maintenance.

The more complex the foreclosure process in a particular state, the longer it will take, the more it will cost and the more the warranty will deteriorate. Longer foreclosures result in greater losses for lenders.

So one would expect that when rating agencies estimate loss from a hypothetical default, they would try to predict how long a typical foreclosure would take in the state where the property is located, taking into account of that state’s foreclosure law and procedures.

My informal but reliable surveys suggest that rating agencies are in fact paying no attention to these matters. Instead, they estimate the likely magnitude of the loss for the lender based on a generic foreclosure schedule. They do not take into account the actual speed of the actual process in the actual jurisdiction where the warranty is actually located. Agencies ignore specific foreclosure deadlines because it is too difficult to quantify them and assess how they would affect the likely loss of the lender.

In other words, while it is intuitively obvious that slower foreclosures increase lender losses, rating agencies cannot quantify variations and therefore ignore them. These are the same rating agencies that are obsessed with single purpose entity commitments in loan documents, for example if the borrower uses a separate header and has a separate phone number.

If rating agencies included foreclosure times in their ratings, loans in states with slower foreclosures would suffer from drawbacks. Anyone setting up securitization would favor loans from faster states, as these loans could benefit from higher ratings. Over time, this should have some effect on loan pricing in slow foreclosure states. Since these loans should be less attractive to loan originators and the securitization system, they should require the borrower to pay a higher interest rate.

It wouldn’t be good for New York borrowers as New York has one of the slowest foreclosure times in the United States. A foreclosure in New York generally takes between 18 and 48 months. This is true even if the borrower does nothing to defend himself and has resigned himself to the fact that his property is under water, is worth less than the loan amount. The New York foreclosures are proceeding slowly because the state process is quite complex. Unlike most states, it requires the involvement of a judge throughout.

If rating agencies paid attention to foreclosure deadlines as part of the rating process, slow states like New York could eventually find that their inefficiency will indirectly cost their borrowers money. People who set up securitizations – who pay attention to every little demerit in the rating process – might not like the fact that the securitization process devalues ​​New York loans. They could try to do something about it.

If the added cost to New York borrowers were significant, he and other sluggish states could improve their foreclosure procedures. This would reduce the losses suffered by lenders in the event of foreclosure and alleviate the deterioration and local scourge that often results in these proceedings. And such a change in the law could easily include protections for borrowers against abusive foreclosures.

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