DIAGNÓSTICO DE LA EMPRESA PASTEURIZADORA QUITO S.A.

When workout plans and modifications are unsuccessful, or when servicers determine that a workout is no longer an economical choice, there are two routes a failed loan can take: REO and write-offs. Servicers take property into REO (real estate owned) portfolios when they determine that doing so will minimize investor losses. Since a prerequisite for such determinations is that the property has sufficient value to justify the expenditures associated with the foreclosure process, they tend to be relatively higher-quality homes. For very low-value homes or those properties associated with other negative characteris- tics (e.g., court cases, code violations, liability issues), the lender simply writes off the loan to avoid compounding investor losses with expenses such as property taxes, insur- ance, and a variety of maintenance costs, including city ordinance requirements. In this case, title legally remains with the borrower (although the borrower is often unaware of this and has vacated the home), making it difficult later for municipal authorities or neighborhood groups to deal effectively with the vacant property.

One REO specialist interviewed for this report described the process through which loans reach REO as follows. At ninety days past due (DPD) the company conducts an initial evaluation to determine whether there is sufficient value in the home to initiate foreclo- sure proceedings. (At most institutions foreclosure proceedings and workout efforts pro- ceed simultaneously due to the length of the foreclosure process and the imperative to

foreclose as quickly as possible when the loan cannot be saved).39 In rare cases where value is insufficient at this early stage, the company ceases further recovery efforts, in some cases releasing the lien but leaving the borrower in title. This value estimation is repeated periodically as the foreclosure process unfolds (with the same possible outcomes as at 90 DPD) and a final time prior to the foreclosure sale. If a determination is made not to take the property to REO, the company can avoid assuming title by writing off the as- set and not bidding at the sale.

REO is costly because it requires servicers to arrange for the repair, maintenance and re- sale of the property. They must also stay current on property taxes. This requires that large national servicing firms maintain a large network of vendors to perform these ser- vices. The challenge and cost of assembling and policing these networks is substantial and is one reason why servicing is amenable to economies of scale.

It is worth remembering that the loan and the servicer typically have been bleeding cash on behalf of the trust for months, if not longer, by the time properties enter the REO port- folio. In addition, the fact that a vacant property may continue to lose value can add fur- ther costs until the property is sold. In addition to cost to investors, there can also be negative impacts for vulnerable neighborhoods. Servicers often have little incentive to engage in the time-consuming and costly process of conducting a thorough rehabilitation, especially since housing markets in the neighborhoods where foreclosures concentrate are often weak. Though some do so in cases where the costs are offset by anticipated higher sales value of the rehabbed unit, many rationally ‘paint and patch’ in order to turn the property around as quickly as possible.

This has several neighborhood impacts. First, the failure to fully rehab a home may pose problems to the new owners, especially lower-income borrowers who may lack the re-

39 _{Moody’s (2001) servicer evaluations describe this process as follows: “Moody’s believes that better ser-}

vicers pursue both early settlements and foreclosures simultaneously. That way, if early settlement efforts are unsuccessful, the foreclosure process is already underway and costly delays may be minimized. Addi- tionally, many servicers incorporate the foreclosure process into their efforts as a way of impressing the seriousness of the situation on a borrower.”

sources to address any needed structural repairs. Second, since potential owner-occupiers may shy away entirely from purchasing an REO property in poor repair, many are sold to investors who rent them in a shabby state to tenants at whatever rate the market will bear. In either of these scenarios, the property can and often does deteriorate further, and in doing so drags down property values in the rest of the neighborhood as well.

If anything, the neighborhood impact of write-offs is worse and the legal issues associ- ated with intervention even more complex. When a loan is written off, in some cases the borrower remains in the home. In such cases the home is already in poor and potentially unsafe condition as evidenced by the fact that the servicer determined that the interest of the trust is best served by relinquishing claim to it. Often, however, the borrower has al- ready left the home and is unaware (and most likely not interested in the fact that) he or she holds title. The home, now a ‘walkaway,’ does not go through the foreclosure process and hence sits in limbo, deteriorating. Those agents interested in ameliorating its negative impact on the neighborhood (community groups, municipalities, and others with proper- ties in the area) have no way to take control of the property, since state laws governing title transfer and foreclosure procedures were not designed to handle cases such as these. In some cases municipal ordinances permit or mandate the demolition of such buildings, but otherwise it is difficult to do anything about them.

In order to take control of the ‘walkaway’ problem, some community-based organizations and cities are exploring legislation allowing the creation of nonprofit corporations formed especially to take these properties through foreclosure in order to free up title. These enti- ties would then hold title to the unit, which they could transfer to existing CBOs who would then take responsibility for rehabbing the properties and ensuring that they reenter the housing stock in a structurally robust state and with a capable owner-occupier.

The complexity of issues involved in the foreclosure/REO/write-off process is central to the impact of failed loans on vulnerable neighborhoods and industry bottom lines. Prob- lem properties are not only sources of large losses to investors but are also magnates for illicit behavior that depress surrounding property values. Streamlining and rationalizing

these processes is essential in order to shorten the period of deterioration and vacancy and make it easier to transfer these properties into the hands of actors seeking to improve or remove them for the sake of the neighborhoods of which they are part.