Managing the Foreclosure Process
by Mark J. Huber
Credit Union Advisor, 2007 Fall

In the wake of the subprime mortgage lending crisis, some lenders have found themselves managing mortgage credit risk on the back end of the lending cycle via the foreclosure process. For credit unions, which are driven by their principles to enable and enrich the lives of their members, foreclosure is an unfortunate last resort. However, financial and economic realities can result in unintended consequences for defaulted borrowers, i.e., foreclosure. For both member-based and economic reasons, many credit unions aren’t familiar with the foreclosure process. But, because of this past inexperience and the uncertainty of the ultimate severity of today’s mortgage lending crisis, credit unions should act now to educate themselves and prepare for the foreclosure process.

For starters and to best serve members, proactive management of mortgage credit risk should include understanding where a credit union is at risk (e.g., loan products and/or positions behind exotic loan products), identifying specific member risks, and identifying which members to extend help. Working with members to re-structure a potential at-risk mortgage into a more suitable product is a win-win for the member and the credit union. Inherent in this process is the prospective monitoring of members’ first mortgages to evaluate the credit risk for second mortgages and HELOCs held by the credit union.

After addressing specific member needs, credit unions should be familiar with different foreclosure laws in the state(s) in which they operate. The foreclosure process often varies by state with respect to the type of foreclosure (e.g., a judicial process or deed-in-lieu), timing of foreclosure, required notices, and cost of the foreclosure action.

Credit unions should also be mindful of the added costs associated with carrying foreclosed properties — which are in addition to the cost of a non-performing asset. Extra costs might include eviction costs, repairs to make the property saleable, realtor fees, property maintenance, insurance, taxes, and association fees.

Ultimately, after estimating the potential foreclosure costs, a determination must be made regarding the potential for recovery relative to the credit union’s existing equity interest in the property. Knowing the current fair value of a property is critical to this assessment and may even require discounting recent appraisals in today’s real estate market. Equally important is the determination of whether any tax liens or mechanics liens exist against the property. If a prudent analysis of the aforementioned costs, expenses, claims, and values suggests the credit union’s net recovery will exceed $0, simple math and economics suggest that foreclosure is an appropriate course of action.

Proactive mortgage risk management also includes monitoring a foreclosure pipeline to anticipate the volume of potential foreclosures relative to available resources, namely liquidity and internal staffing needs. Practical questions concerning how many ORE properties can be held/managed at one time should be asked. Then, priority should be given to property foreclosures where the expected net recovery is maximized — relative to liquidity and acceptable risk. Prudent liquidity and cash flow management may favor the purchase of a $100,000 first mortgage to protect a $45,000 HELOC interest over expending $250,000 to protect a $50,000 HELOC. Additionally, such strategy affords the credit union another $150,000 to manage other potential at-risk foreclosures.

In the end, the goal is to have a formalized foreclosure process in which an institution’s management team knows how to foreclose and has an understanding of liquidity needs to know when to buy out first mortgages to mitigate losses. The foreclosure decision process should be factual, absent of emotion, and well documented. If you are not familiar with the foreclosure process, terms, and accounting or believe your foreclosure procedures could be improved, it may be advisable to consult with your professional advisors — namely your auditors and general counsel.