Deficiency Judgments-The Next Wave to Hit?

Mortgage loan investors are turning to judicious but more aggressive use of deficiency judgments to wring more value out of distressed portfolios in the wake of the tsunami of foreclosures in recent years.

"Several of our customers have asked us to look at more actively seeking and enforcing deficiency judgments," said Rick E. Smith, president and CEO of Marix Servicing LLC, a specialty servicer in Phoenix, "and we are expanding our internal and vendor-based capacity to improve portfolio performance for them in that way.

"Investment property foreclosures currently are the focus of deficiency judgment attention," Smith added. He indicated that in Marix's portfolio, the average deficiency on non-owner-occupied loans was greater than $100,000, an amount significantly larger than the average deficiency on owner occupied loans, which supports focusing on investment property.

Such a focus makes sense, at least as long as present market and political conditions prevail, but broader use of deficiency judgments in the long term could improve the stability of the housing market.

Given the current government and industry emphasis on preserving homeownership, aggressively pursuing deficiency judgments against cash-strapped owner occupants would seem ill-advised at the moment.

Such borrowers have the sympathy of legislators and the public, and, in any event, may not be able to satisfy a deficiency judgment in the near future.

Additionally, judgments would create significant hurdles to future homeownership by those borrowers, arguably prolonging the housing crisis.

On the other hand, non-occupied property investors are seen as part of the housing crisis problem and not part of the solution.

Such investors are cast as speculators and have the ire of lawmakers. They also are more likely to have the income and assets to satisfy deficiency judgments.

Plus, deficiency judgments against investors are often more readily available under state law than judgments against homeowners.

While the current demonization of investment property buyers is surely inapt in many cases, a morality play starring loan investors and servicers seeking deficiency judgments against rapacious investment property buyers might garner political support for deficiency judgment collection efforts and needed state law changes.

There is a market dynamics argument that greater use of deficiency judgments, across all loan types, should be encouraged.

Such an emphasis will reassure secondary market investors and reduce risk-taking by buyers, at a time when the residential real estate market is suffering from lack of discipline.

State law restrictions on obtaining and enforcing deficiency judgments are a real patchwork, so the ready availability of this remedy should not be assumed.

Some states significantly limit the collectibility of deficiency judgments, even on investment property. However, given present depressed real estate values, there is a large volume of deficiency judgments available as nearly every foreclosure results in a deficiency.

The efficacy of deficiency judgments in reducing defaults has been noted in comparisons of states with and without efficient deficiency judgment regimes.

Further, the almost universal availability of deficiency judgments outside the United States has been cited as a reason for lower delinquency numbers abroad. Using deficiency judgments regularly for default management could influence the loan market and state law.

Lenders and loan buyers might price differently based on availability of deficiency judgments under state law. This could exert pressure on consumer protectionist state legislatures to reduce credit prices for their constituents by making deficiency judgments more available.

Focusing on investment property buyers will not unduly limit collection efforts for some time, as investment loans make up a surprising portion of delinquent loans.

The Mortgage Bankers Association concluded as early as 2007 that "defaults on mortgages where the owner does not live in the house are a major driver of the defaults in [states with the then-fastest rising delinquency rates]."

Homeowners engaging in strategic default, those with the ability to pay but unwilling to continue paying on devalued real estate, may be a subsequent focus of deficiency judgment efforts.

Robert W. Johnson is the SVP/general counsel and CCO of Marix Servicing LLC, Phoenix.