Last week, FHA announced 11 significant changes to the Distressed Asset Stabilization Program (DASP), a federal program that sells pools of severely delinquent, FHA-insured mortgages to investors.
The buyers are responsible for resolving the delinquent mortgages (a process known as loss mitigation), through steps including like mortgage modification, short sales, and foreclosure. FHA began selling these non-performing loans (NPLs) in 2012 and has sold approximately 100,000 to date. Most of these NPLs are 36-48 months delinquent and underwater, meaning the property is worth less than the amount owed on the mortgage.
Over the years, FHA has tweaked the program in response to feedback from housing advocates to provide more protection for vulnerable homeowners seeking to avoid foreclosure. Most of the current 11 changes will help that cause, but 1 may have the unintended consequence of significantly reducing nonprofit participation.
The Good News
Let’s start with the positives. Most of the changes are sensible policies that will better serve homeowners and their surrounding communities:
- Making principal forgiveness the first option for investors to consider, rather than foreclosure
- Limiting sudden interest rate increases on modified mortgages
- Prohibiting investors from walking away from problem properties
- Notifying delinquent borrowers that their loan can be sold
- Releasing performance data
- Releasing demographic data
Other changes are aimed at increasing nonprofit and local government participation DASP, which has so far been dominated by private equity firms and hedge funds:
- Preferential bidding for nonprofits
- Establishing a goal of selling 10 percent of assets to nonprofits and local governments
- Streamlining direct sales to local governments
- Targeting loans sales based on nonprofit and local government interests (i.e. offering smaller, geographically targeted pools)
These steps should be applauded. We want to encourage more participation with local community development partners, especially as many of these loans are located in underserved and vulnerable neighborhoods. Nonprofits (including New Jersey Community Capital’s ReStart program) have been far more effective at realizing positive neighborhood stabilization outcomes (NSOs) than the market average. Qualifying NSOs could include: mortgage reperformance, sale to rental tenant, gift to local government, or sale to a nonprofit that has been designated a Neighborhood Stabilization Program sub-grantee (state/local governments are the grantees). The DASP program offers a subset of its loans through special “NSO pools” that require a minimum of 50 percent of loans to acheive an NSO. Our ReStart pools are projecting up to 80–90 percent.
These changes are good, but still not enough to encourage widespread nonprofit participation. While a handful of nonprofits and local governments are doing great work (including Hogar Hispano, National Council of La Raza, and others), the reality is that most such groups don’t have the capital structure, risk tolerance, or capacity to purchase big pools of loans and handle all the loss mitigation work. Public sector capital can constrain allowable uses and have less risk tolerance compared to more market-oriented approaches, plus local governments might not be willing to foreclose on a non-responsive owner, limiting disposition options. Finally, the speed of these transactions can strain even the highest capacity organizations. Typically, purchasers have a window of 30-60 days to perform due diligence on a pool of hundreds or even thousands of mortgages.
Most nonprofits are much better positioned to acquire and rehab properties from larger investors, rather than capitalizing and acquiring pools of NPLs and managing the loss mitigation process themselves.
That brings us to the problematic change. Under the new rules, an investor in an NSO pool would only receive “neighborhood stabilization outcome” credit for selling a property to a qualified nonprofit after the nonprofit disposes of the property according to an NSO plan. Typically, this involves selling to a homeowner or placing the unit into their rental portfolio. In many cases, rehab work will need to be completed first. Any of these plans can take some time.
This delay in receiving NSO credit is a big deal. One of the main ways investors have hit their 50 percent NSO outcome requirement has been sales to nonprofits. Investors needing NSO credit are motivated to work with nonprofits and have sold properties at discounts in many cases. However, the proposed change will make this avenue less attractive to investors and will likely reduce their collaboration with nonprofits.
So why the change? Some advocates have voiced concern that investors could use nonprofits as conduits to set up their own transactions, prioritizing profit over community stabilization. FHA made the change to ensure that positive outcomes were achieved. However, it’s not clear that this is a widespread problem and the change may have unintended consequences. Most nonprofits (especially those working through the Neighborhood Stabilization Program) have strong track records of community stabilization and mission-alignment and are not likely to be held captive by investor interests.
We should continue to strengthen policies that encourage nonprofit and local government participation on both the front-end (NPL pool sales) and the back-end (REO acquisition and rehab) in order to better serve vulnerable families and communities.
(Photo credit: Garry Knight via flickr, CC BY 2.0)