13 E-bRM 363 program Buy residential properties free and clear out of bankruptcy for far less than...

© 2013 E-bRM, LLC - CONFIDENTIAL

363 Strategy

© 2013 E-bRM, LLC - CONFIDENTIAL 2

Business Problem• Approximately 2.6 million loans (8.5% of mortgages / $442 billion of unpaid principal balance) are 60 days or

more delinquent or in the foreclosure process. During the month of August 2012, there were 57,000 completed foreclosures.

• The timeline to complete foreclosures has extended significantly, particular in states that require judicial review. Foreclosures in judicial states have aged an average of 654 days and non-judicial states have aged 297 days. This timeline is expected to increase in judicial states.

• The increased timeline to process foreclosures is primarily influenced by limited court capacity, file migration patterns and historically high pipeline inventory levels.

• The longer foreclosure timeline has a direct impact on higher carrying costs of banks / servicers, in particular, exposes such as maintenance, insurance and property taxes. This results in more deteriorating homes, reduced stability in governmental tax receipts, and a lower recovery rate for the lender.

• Federal regulatory oversight, the Consumer Finance Protection Agency, National Mortgage Servicing Best Practice Standards, Attorney General Settlement and various state rules now require servicers to produce and review new documentation that evidence the accuracy of the mortgage transactions.

• Banks lose primary control of implementing current loss mitigation methods (e.g. loan modifications, short sales of properties) once a homeowner has declared bankruptcy.

• Based on lawyer estimates, approximately 35% of foreclosures result in Chapter 7 bankruptcy. A reduction in liquidation timelines for this population could achieve cost savings of approximately $20 to $50 billion.


Value Proposition• The foreclosure timeline in judicial states can be reduced by selling properties pursuant to 363 (f)

of the bankruptcy code. This action, paired with programs that will allow borrowers to stay in their home under a leasing arrangement can help create value amongst all key stakeholders.

• If a homeowner has entered into (or is willing to enter into) Chapter 7 , the purchase of a chapter 7 trustees interest in the property pursuant to section 363 (f) of the bankruptcy code allows the servicer/ secured creditor to receive title from the trustee free and clear of liens. This is the equivalent of a sheriff s deed in a judicial foreclosure; and can be accomplished over a few months.

• When will a residential property qualify for a sale under section 363(f)?• Under USC 363 (t) — a bankruptcy trustee may sell property free and clear of any interest of

an entity other than the estate, only if one of the following conditions are met-1. applicable non-bankruptcy law permits sale of such property free and clear of such

interest;2. such entity consents;3. such interest is a lien and the price at which such property is to be sold is greater than

the aggregate value of all liens on such property;4. such interest is in bona fide dispute; or5. such entity could be compelled, in a legal or equitable proceeding, to accept a money

satisfaction of such interest.


Value PropositionParty Key Benefits Risks / Concerns

Home Owner - Ability to stay in the home under a leasing arrangement at more advantageous economic terms.

- Potential options to buy-back the home after a pre-set period of time

- Potential tax advantage (no cancelation of debt income)

- There are limited grounds to object to the sale under 363, which makes the trustee sale final

- "Rent-free“ period significantly shortened - Uncertainty of the outcome of a new process - Claim of being unduly influenced into entering

into Chapter 7 bankruptcy

Bank - Converting NPLs and REO to cash with the potential regulatory capital relief

- Potential for tax benefits can be evaluated- Maximizes cash recovery in comparison to

going through a full judicial review and avoids expenses associated with maintaining a vacant property.

- Reputational / Headline Risk around creating a program targeting owners in bankruptcy

- Borrower believes they will lose their home and raises objections

- Selling to investors with aggressive or deficient property management teams

RBMS / Investors - Potential to maximize proceeds and reduce expenses associated with servicer advances and servicing costs

- Uneven benefit to investors in different areas of the capital structure as losses will be brought forward

Agencies - Maximize cash recovery in comparison to going through a full judicial review

- Potential to leverage processes being built to support bulk REO sales

- Difficult to process in large bulk sales- Reputational / Headline Risk around creating a

program targeting owners in bankruptcy


Value Proposition (continued)

Party Key Benefits Risks / Concerns

Servicer - Reduces cash-outlay on maintaining the homes over longer time periods

- Creates goodwill for the servicer for creating new options to allow homeowners to stay in their home

- Uncertainty of what trustee will assign if property is sold to another 363 bid

Bank - New source of supply provide to the market- Allows for immediate identification of a tenant

with an incentive to maintain the property- Provides a source of inventory with little capital

investment required- Possibility to have more control over the terms

of the sale if the initial bidder (“Stalking Horse”).

- May require increased due diligence as the home and borrower must be evaluated at the same time

- Concern of being tied to an active bankruptcy case

Bankruptcy Trustee - Potential to maximize money for unsecured creditors

- Opportunity to apply an surcharge to the sale of the home to cover real estate commission and attorney’s fees significantly in excess of the $60 fee for the administering of a no asset case.


Value Proposition (continued)

Party Key Benefits Risks / Concerns

Bankruptcy Court - Recovers money to pay unsecured creditors- Greater distribution to unsecured creditors- With home retention option Chapter 7 becomes

a more viable option for achieving borrower, trustee, and unsecured creditor objectives

- Does not require the votes of creditors for approval of the sale

- Procedures employed in 363 sales are locally driven, and the sales process and strategy can differ considerably depending on the local court district

- Concern that the 363(f) transaction is another secured creditor scheme to take advantage of a distressed borrower

Regulators (Banks / Agency)

- Allows for regulate entities to improve balance sheet more quickly

Regulators (CFPB) - Creates more options for consumers to stay in their home

- Consumers being influenced into bankruptcy without sufficient understanding of the impact

- Buy-Back provisions creating unreasonable terms for lessees


Key AssumptionsArea Assumptions

Homeowner - Has (or is willing) to declare Chapter 7 Bankruptcy. It is estimated that 60% of the borrowers who face foreclosure eventually file for bankruptcy. Of those bankruptcy filings, 60% are Chapter 7.

- Credit counseling services will be provided to the homeowners

Court System - There are no judicial blocks to the sale of the home under Section 363 (i.e. the mortgage holder, investor, bankruptcy trustee and servicer all either do not object to the sale or their objections are not upheld, and the judge approves the rent and repurchase agreement.)

Local Rules and Regulations

- The sale process and strategy under 363(f) can differ considerably depending on the local district. The strategy proposed is based on a combination of deep local market knowledge, strategic local relationships, efficient and comprehensive information gathering techniques and well-developed valuation methodology

Investor Appetite - Investors are able to obtain sufficient information on the borrowers to perform due diligence, and bids for the properties provide an attractive IRR


US GAAP Accounting Impact• Defaulted loans in foreclosure or bankruptcy are considered TDRS and specific impairment is assessed at the

loan level, based on estimated FMV of the underlying collateral and carrying costs through time of sale; - Sec 363 strategy potentially shortens the carrying period to sale, therefore reduces carrying costs and associated loan loss reserves.

• Repossessed collateral (Other Real Estate Owned asset — OREO - ASC 360 Properly, plant and equipment) also require significant costs to preserve and prepare the property for sale, including securing the property, maintenance, insurance and real estate taxes. OREOs are initially recorded at the fair value of the asset less the estimated cost to sell and the excess of the loan over the fair value (net of cost to sell) is charged to the Loan loss reserve account.

• Accounting impact of servicing costs before and after foreclosure presented below:

• MSR P&L impact is expected to be neutral to positive. Generally servicers either receive no fees for delinquent loans, or the fees (which would be paid upon the sale of the home or the re-performance of the mortgage) are insufficient to offset the additional cost of servicing a delinquent loan.

Costs include in impairment calculations

Costs expensed as incurred (often included in impairment calculation when Basel II approach is used)

Pre-foreclosure costs (mortgage loan servicing) Post-foreclosure costs (OREO servicing)

Costs to sell Delinquent property taxes (OCC guidance June 2012) Costs to sell

Legal fees, Appraisal fees, Internal / external collection costs, Property management / maintenance fees, Legal fees, Insurance premiums, Property taxes


Bank Economic Impact• The following example displays the potential reduction in economic loss and potential to reduce loss reserves

by successfully reducing the liquidation timeline for a single loan:


Tax Implications• Tax Accounting and Implication:

• There are two method of Tax Accounting for Mortgage Loans

• 1. Mark to Market

• 2. Conformity with Books

• If the tax accounting conforms with the book accounting, taxable income will increase with the release of the reserve and a DTA could be reduced

• Requires understanding of Banks’ Method of:

• Reserve

• Book Accounting

• Potential Additional Tax Considerations:

• Timing of Recognition of Gains and Losses

• Debt Forgiveness for Homeowner under 363

• Tax Basis of Real Estate Property


Sales Process Flow1) Homeowner declares Chapter 7. Bankruptcy Trustee will begin the

process of liquidating homeowner's assets to fulfill outstanding debts, Homeowner has the desire to remain in their existing home

2) Transaction facilitators identify homeowners who have filed for Chapter 7 and will begin discussions with the Debtor’s Attorneys to propose a 363(f) sale to the homeowner

1) 363(f) The trustee may sell property free and clear of any interest of an entity other than the estate, only if one of the following conditions are met:

1) Applicable nonbankruptycy law permits sale of such property free and clear of such interest;

2) Such entity consents;3) Such interest in a lien and the price at which such

property is to be sold is greater than the aggregate value of all liens on such property;

4) Such interest is in bona fide dispute; or5) Such entity could be compelled, in a legal or equitable

proceeding, to accept a money satisfaction of such interest.

3) ) Transaction facilitators have developed automated processes to facilitate the sale of the property, including: a) monitoring bankruptcy filing and data assembly, b) automated tools to calculate the property valuation and recommended bid price, and c) automated borrower rental risk scoring

4) Transaction facilitators and the holder of the mortgage (e.g. servicer, servicer on behalf of trust, bank) agree on a selling price for the house.

5) The deed to the house passes from Homeowner to Investment Vehicle, and consideration passes from the investment vehicle to the current holder of the mortgage.

6) Homeowner has the ability to lease back the property with the option to purchase the property at the end of the lease. Credit counseling services are also offered to the homeowner.

7) Steps 1 through 6 are repeated for each 363(f) sale until the investment vehicle is fully invested.


About UsE-bRM – professional services, risk

management and project management, licensed software solutions for mortgage industry

Reach out to us for a Demo or more information

Richard Ellis PMP PRM CSM PMI-ACP

http:/www.e-brm.com

[email protected]

Date post:	15-Jan-2015
Category:	Real Estate
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