A local battle over home foreclosures in Nevada has put the federal government in a tricky spot.
Attorneys for the Federal Housing Finance Agency, which oversees mortgage giants Fannie Mae and Freddie Mac, sought last month in at least two cases to block Nevada homeowners associations from foreclosing on residents who owed the associations money and whose mortgages are held by Fannie. The foreclosures extinguished the Fannie liens, and Fannie is unable to recoup what is owed on the mortgages.
FHFA is preparing to argue those cases violate the Housing and Economic Recovery Act of 2008 — the law that created FHFA and gave the Treasury Department authority to place Fannie and Freddie into conservatorship — and it is seeking an exemption that may prove controversial, according to attorneys tracking the case.
FHFA Director Mel Watt in testimony on Capitol Hill on Tuesday reiterated his concern over the liens, warning that his agency will pursue recourse aggressively.
The issue surfaced last year after the Nevada Supreme Court and the D.C. Court of Appeals ruled in favor of the homeowners associations. The Nevada case especially alarmed lenders in 22 other states where similar statutes stand but are rarely ever used.
Homeowners associations, seeking repayment for unpaid community and condo fees, have sought tens of thousands of dollars in unpaid dues by foreclosing on properties and selling them at huge discounts to market value. The values of the mortgages wiped away from the banks are sometimes several hundred thousand dollars per loan. Lenders were astonished to learn that their first liens were in fact not superior. The associations are calling their payment order a "super priority lien."
The Nevada legislature reconvenes next week, and its two chambers will have 120 days to attempt to rectify the issues raised by the state Supreme Court decision. It is unclear whether attempts to provide lenders with relief will have enough support to pass a vote.
"After the crisis, people started walking away from their fees, and suddenly there were dozens of people in communities not paying their condo fees, and assessments had to go up," said Roger Winston, managing partner at Ballard Spahr, which has been involved in more than 250 individual cases in Nevada.
The FHFA has its own legal agents preparing for a fight. It has hired Arnold & Porter in Washington to represent the agency, according to copies of motions filed in federal court in Nevada. Elliot Mogul, an associate at the firm, declined to comment regarding the cases, but local attorneys say the firm may soon file motions in more cases.
In October, Watt met privately with Nevada bankers at an industry gathering in Las Vegas. The FHFA director promised he would use the agency's powers to halt the foreclosures to protect Fannie Mae from any losses, according to Steve VanSickler, vice chairman of the Nevada Mortgage Lenders Association. VanSickler also serves as chief credit officer of Silver State Schools Credit Union, which has seen two of its mortgages wiped out by homeowners associations. Together, the loans were worth $250,000.
"Watt said that unless changes are made in Nevada, FHFA will no longer buy loans in common interest communities," said VanSickler, adding that such a scenario would be "devastating" not just for those communities, but also for the state's real estate market, which sells some 70% of its mortgages to a federal mortgage company.
The Mortgage Bankers Association has previously argued that a lender pullback or higher fees charged to loans could have a chilling effect on available credit in Nevada and any other jurisdictions that give super-lien powers to homeowners associations. JPMorgan Chase, which lost a big case in D.C. against a condo association, said in an email to American Banker: "This situation puts distressed borrowers at greater risk of losing their homes even where they have worked out a mortgage modification with their lender."
All eyes are on the Fannie and Freddie, Moody's analyst Yehudah Forster said. "If there is going to be mass shift in operational lending, [guidance] is going to come from them," he said in an interview.
In December the FHFA outlined its position to defend Fannie and Freddie mortgages by claiming them as its own. It is seeking the same kind of exemption now granted to mortgages insured by the Federal Housing Administration.
An exemption for FHFA would be a "home run" for Nevada bankers, according to Michael Brooks, a partner at Nevada law firm Brooks Hubley, which represents title insurers and advises the California Mortgage Bankers Association.
But an exemption could be controversial, multiple legal experts agreed. It revives thorny issues regarding Fannie and Freddie's conservatorship. The nature of the conservatorship was and remains hotly controversial. In question now is whether it would really be in the best interest of Fannie to write off its past as an independent entity, even though it may not have much choice in Nevada.
"It's a head-scratcher," Brooks said in an interview. "FHFA's assets may not be sold without the agency's consent, but does that really mean Fannie and Freddie's assets are FHFA's? If I am the trustee of a trust, I don't claim the trust's assets as my own."
According to a senior government official speaking on the condition of anonymity, attorneys representing FHFA have intervened in at least six cases in Nevada, and there may be more on the way in Washington where the D.C. Court of Appeals ruled against JPMorgan. "When you are in conservatorship and the taxpayer is on the hook, Congress decided for [the Federal Deposit Insurance Corp.] and for FHFA, that no one can take action without obtaining consent of the conservator," the official said.
It may take a year or longer for decisions on the motions pending in Nevada, attorneys say.
At the state house in Carson City, the industry is scraping up lawmaker support to address its biggest grievances; everything else — decisions to alter underwriting practices or reform servicer best practices — is in a state of limbo. If negotiations in the newly elected state Senate and Assembly fail, attorneys for the industry say they are prepared to litigate.
But that is not the ideal solution, according to VanSickler, who on behalf of the Nevada Mortgage Lenders Association has helped forge a working group that includes state senators Scott Hammond, a Republican, and Aaron Ford, a Democrat.
"No, it does not appear that we have broad support," VanSickler said when asked about the probability of a bill's passage. The switch in control of the Assembly from Democrats to Republicans may hurt the legislation's prospects.
Last week, at a final meeting before the legislature convenes on Feb. 2, industry representatives met with Sen. Hammond and an aide for Sen. Ford at the offices of the Greater Las Vegas Association of Realtors. They agreed to three priorities for a new bill: a requirement that homeowners associations notify lenders of foreclosure efforts, a requirement that opening auction bids start at fair market value to prevent fire sales, and some way for bankers to recoup losses on their mortgages.
Banks have complained that they are losing their mortgages because they are not receiving notice of foreclosure. The issue of associations giving notice to lenders is the biggest problem in current statutes, according to Moody's Investors Service, which describes the super priority liens as a credit risk to mortgage bond investors. Without notice, lenders say they do not have a chance to settle delinquent bills on behalf of the indebted tenant. Homeowners associations and other residential groups argue the responsibility, or blame, should rest with the mortgage servicers. The industry counters that the servicers are not receiving notice of delinquencies. Anecdotes have circulated about banks trying to pay delinquent dues, and homeowners associations simply refusing to take their checks.
"In some states a notice may not be required unless a servicer makes their own filing," said Forster at Moody's. "From our perspective the biggest risk is if the servicer does not get notice of HOA foreclosure."
The Senate working group has agreed to share any forthcoming bill with FHFA director Watt's office in Washington before it goes for a vote in Carson City,
Other states may be less vulnerable because of state laws that close the gaps that are paining lenders in Nevada and D.C. Jon Skarin, head legal counsel at the Massachusetts Bankers Association says homeowners associations must provide notice in his state, and that has helped to avoid the same kind of controversy.
"I can't think of many cases when a condo association actually ends up going through foreclosure, though they do have that right," Skarin said.
Additional pressure is flowing in from investors who are unexpectedly facing the risk of cash flow disruption in mortgage-backed securities backed by Nevada-sourced loans. This month rental home manager Progress Residential had to set aside $1.6 million in a bond issuance to reserve against homeowners-association delinquencies for up to a year.
Kroll Bond Rating Agency described the reserve to guard against possible losses, but other credit experts are unsure if lenders can really count on reserves or escrows as a defense.
"You can't just add HOA assessments to escrow," Ballard Spahr's Winston said.
Federal law says that borrowers with loan-to-value ratios under 80% must give permission for escrow. In addition, many argue that homeowners-association payments follow a far more irregular payment timeline than other kinds of regular dues.
Banks' costs are piling up, too. The number of homeowners-association lien sales has dwindled down to almost zero, according to Brooks, not because the associations are any less aggressive, but because banks have rushed in to pay off all of their borrowers' unpaid association fees. The only question other question, he said, is whether this may happen in other states.