Less than four years ago, short sales were such a rarity that the industry, for the most part, didn’t bother to track them. But in 2011, short sales accounted for 7.8% of all sales, and 28.7% of distressed sales, based on national sales data from CoreLogic.
This year, it is possible, if not likely they will top 300,000, as
While short sales frequently produce a better economic and societal outcome than foreclosures, even their strongest advocates acknowledge the limitations of these transactions. These include difficulties of completing short sale transactions, the prolonged approval process, and the growing potential for fraud. CoreLogic, in its 2011 Mortgage Fraud Trends Report, estimated that fraudulent or suspicious short sales could be costing the lending community as much as $375 million a year.
So the conundrum the industry is grappling with is accelerating short sales while simultaneously detecting and preventing the growing incidence of fraud these transactions may produce.
Best Practices
Recently, members of the CoreLogic National Mortgage Fraud Consortium asked the team to conduct the Mortgage Fraud Prevention Best Practice Benchmarking Study. While that study examined fraud prevention across the entire mortgage origination and servicing continuum, it also examined what servicers and risk managers are doing to curtail fraud in short and real estate owned sales.
Last fall, CoreLogic deployed their fraud and risk strategists to conduct on-site visits to several national lenders and servicers surveying fraud prevention processes that were then summarized and benchmarked against industry peers. Five national mortgage lenders, representing $132 billion in annual loan value and over 600,000 mortgage originations, participated in the study.
CoreLogic analyzed, summarized and compared the data provided by these participating members to create an effective benchmarking summary with cross-lender comparisons and best practice fraud prevention recommendations for improved risk mitigation.
The Risk Management Perspective
The survey results found, perhaps not surprisingly, that one’s position in a servicer’s operation often shapes his or her views on the trade-off between risk and reward on short sale transactions.
For example, the fraud and risk managers interviewed collectively agree that while short sale inventory is increasing, so is the inherent risk in these transactions. Because risk managers are typically very familiar with short sale fraud schemes and the accompanying red flags, they tend to view them with a more cautious eye.
In response to this emerging threat and in an effort to minimize potential losses from suspicious short sale transactions, this group indicated that they advocate the use of predictive short sale monitoring tools. They also lobby within their respective institutions for stronger risk mitigation policies and procedures, such as the use of an “arm’s-length affidavit,” escalation reviews of LLCs, trust and cash transactions and scrutiny of high risk geographic areas such as California, Arizona and Florida.
The Servicing Management Perspective
While fraud and risk managers tend to focus on the risk of short sales, asset and liquidation managers in the same organizations gravitated to the rewards of short sales. According to the May MarketPulse Report, the average short sale is at a discount to current market value of roughly 10% percent compared with a 30% to 40% discount for a completed foreclosure and REO sale, indicating the investor’s losses are usually lower on a short sale. The interviewed asset and liquidation managers also argue that short sales have less reputational risk for the servicer than foreclosures, and can frequently give the borrower a more dignified, and in some cases, economically beneficial exit strategy.
From an asset and liquidation manager’s perspective, short sales should be encouraged and the processes streamlined, while new policies that could throw additional obstacles into a transaction should be avoided. The key to protecting their companies, and investors, from additional fraud-related losses, they say, is establishing accurate, supportable fair market values for short sale properties.
The mortgage fraud prevention best practices study found that definitions of fair market value for short sales and how they are arrived at could differ from servicer to servicer. But most servicers arrive at a fair market value by using a combination of valuation tools such as BPOs, distressed AVMs and collateral risk assessment tools, as well as analysis of nearby sales and surrounding market trends.
The servicers that participated in the study reported that they do not rely heavily, or at all, on the unpaid principal balance, the initial origination appraisal or the results of a single valuation tool.
Be Prepared: New Fannie and Freddie Guidelines Are Here
In June 2012, Fannie Mae and Freddie Mac, at the direction of their parent, the Federal Housing Finance Agency, implemented new guidelines designed to streamline and accelerate the short sale process. And most industry observers expect this will create a significant upward spike in short sales. The guidelines initially focus on two of the major complaints about short sales: timelines and customer communications.
Now servicers of GSE mortgages will be required to review and respond to requests for short sales within 30 calendar days of receipt of a buyer’s offer. The newly implemented June guidelines will also mandate weekly status updates to the borrower if the short sale remains under review after 30 calendar days. Servicers will also be required to inform borrowers of final decisions within 60 calendar days of receipt of an offer.
By yearend, Fannie and Freddie are expected to announce other enhancements to the short-sale process, including borrower eligibility evaluation, simplified documents and payments to subordinate lien holders in an effort to provide additional tools that will help prevent foreclosures, keep homes occupied and help maintain stable markets and communities.
Risk managers believe that the greater emphasis on short sales and the new faster timeframes for decisions will create new opportunities for “flopping” distressed properties and reduce the time that servicers will have to scrutinize deals.
Steps You Should Consider
Love them or hate them, it is indisputable that short sales will be, for the foreseeable future, an integral part of most servicers’ loss mitigation repertoire and a major factor in the real estate and housing finance markets. Given that fact, along with the evolving landscape of short sales and the limitations of practices currently being used by servicers, the following are several “best practices” suggestions for servicers to consider as additional support to existing risk management and FMV policies.
Risk mitigation policies should include the following:
• Implementation of predictive short sale monitoring tools.
• Fraud red flag training for short sale and REO negotiators.
• Require an “arm’s-length affidavit” on the seller and buyer side of the transaction.
• Scrutinize cash transactions, especially when an LLC or trust is involved.
• Apply appropriate escalation policies to high risk geographies such as California, Florida and Arizona.
• Investigate for non-arm’s-length transactions.
• Monitor transactions up to 180 days after close of the short sale.
Strong valuation processes should include the following:
• Use of multiple valuation tools—distressed AVMs, BPOs and Uniform Residential Appraisal Reports.
• Use of appraisal subject matter experts or an appraisal review team for escalation of high-risk transactions or challenging real estate markets.
• Detailed scrutiny of comparables, nearby sales and surrounding market externalities.
Ed Gerding is a senior fraud and risk strategist at CoreLogic. He can be contacted at egerding@corelogic.com.
