I recently took part in a discussion where the topic was the ability of a lender to call a loan; in that specific instance, a businessman's line of credit. This discussion covered the reappraisal of mortgaged real estate. In a changing market, a lender may want to gauge the change in the degree of risk (lenders may require additional collateral or may reduce the line of credit if the value of the collateral becomes less than the loan amount), and also touched upon "due on sale" clauses.
A typical mortgage deed might contain something like the following (which is the actual text from an actual mortgage):
"18. Transfer of the Property or a Beneficial Interest in Borrower. As used in this Section 18, "Interest in the Property" means any legal or beneficial interest in the Property, including, but not limited to, those beneficial interests transferred in a bond for deed, contract for deed, installment sales contract or escrow agreement, the intent of which is the transfer of title by Borrower at a future date to a purchaser.While the likelihood of foreclosure on a residential property due to the above clause is currently not very high because there are so many foreclosures clogging the market, an understanding of what is actually owned and mortgaged is frequently missing in the mind of a typical homeowner.
If all or any part of the Property or any Interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender's prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if such exercise is prohibited by Applicable Law.
If Lender exercises this option, Lender shall give Borrower notice of acceleration. The notice shall provide a period of not less than 30 days from the date the notice is given in accordance with Section 15 within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by this Security Instrument without further notice or demand on Borrower."
The popular view of a piece of residential real estate is a plot of dirt with a house on it. While it is true that these items are useful, the actual real estate is something different. Some definitions are in order.
estate : A right or interest in property. Defines an owner’s degree, quantity, nature, and extent of interest in real property. There are many different types of estates, including freehold (fee simple, determinable fee, and life estate) and leasehold. To be an estate in land, an interest must allow possession (either now or in the future) and be differentiated primarily by its duration.Typically, when the buyer and seller of a residential property reach a meeting of the minds, the transaction that takes place is a transfer of a fee simple interest in the land and improvements. Theoretically (within the limits imposed by government), the owner of the fee simple interest may sell off all the materials that make up the improvements, and/or all the dirt, rocks, water, oil, or other minerals within the bounds of the property to the center of the Earth and still have the fee simple rights to the empty space left. He would have sold all the "stuff" that was on his real estate, but not the actual real estate itself.
freehold estate : An estate or possessory interest in land that lasts for an indeterminable length of time, such as for a lifetime or forever. Examples include fee simple (also called an indefeasible fee), defeasible fee, and life estates. The first two continue for an indefinite period and are inheritable by the heirs of the owner. The life estate terminates upon the death of the person on whose life it is based.
fee simple estate : Absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat.
leased fee interest : A freehold (ownership interest) where the possessory interest has been granted to another party by creation of a contractual landlord-tenant relationship (i.e., a lease).
leasehold interest : The tenant’s possessory interest created by a lease.
Source: Appraisal Institute, The Dictionary of Real Estate Appraisal, 5th ed. (Chicago: Appraisal Institute, 2010).
This is one of the hardest concepts to pound into the heads of real estate appraisers, their lender clients, and the borrowers against the real estate. What is being appraised for a mortgage loan is not the dirt and sticks (although they play a part in determining what is available for quiet enjoyment of the real estate) but the market value of the bundle of rights that belong to the mortgagor. In fact, the FNMA/FHLMC forms used to report the appraisal clearly identify the Property Rights Appraised at the very top of the first page. In most cases, the lender is loaning money on the fee simple interest.
This creates some interesting potential problems for the mortgagor. Note that the lender reserves the right to call the loan if any interest in the property is sold without the lender's prior written consent. Let's look at some scenarios.
Pitfall #1. Big Bean Gas Company is aggregating parcels for a drilling unit, and strikes a deal with a group of owners in a subdivision for rights to the shale gas under their lots. Selling the rights to any possible underlying gas is a reduction of the fee simple interest in the property; under clause #18 in the mortgage above, it could trigger an acceleration of the loan payback, including a demand for immediate payment in full.It is vital to remember that when a person mortgages real estate, he is signing a deed which gives most of his rights in the estate to the mortgagee in the event that a default situation occurs. It is a sale with a right of redemption. The mortgagor retains the rights to possession and quiet enjoyment of the estate, but those rights are only on loan from the new owner, the mortgagee, until the terms of the mortgage are complete. The rest of the rights to the estate may belong to the lender, and if the mortgagor attempts to take those rights back without the mortgagee's approval, it could be a trespass which could forfeit the entire estate to the mortgagee in foreclosure. When you borrow money, and grant a mortgage deed to the lender, be sure to carefully read the terms of that deed.
Pitfall #2. Joe Homeowner wants to move but can't sell his home due to the poor real estate market. He can, however, rent it out. He finds a perfect tenant, and signs a one year lease. The tenant now has a leasehold interest; the fee simple interest has been diminished (even if only for 12 months), and if the lease was entered into without the prior written consent of the mortgagee, acceleration is possible.
Thursday, July 25, 2013
Saturday, February 9, 2013
I've long been a gadfly to those who think that cheap money, Quantitative Easing, and all the other Voodoo Economic Spells by the Fed Magicians are the solution to America's financial woes. It just does not make sense to me that anyone could possibly think that devaluing a currency can have positive future effects. Hence I was taken a bit by surprise by a recent article in the financial section of the Beacon Journal which not only shared my concern about the direct valueless money was taking us, but also put forward a clear warning of a possible side effect that had escaped my attention : the future impact on the secondary mortgage market. In Scott Burns' blog post of 9/8/2012 Building the Next Financial Crisis, One Loan at a Time he concludes,"What’s worrisome here is what’s going to happen to the market value of all these mortgages when, and if, interest rates return to more normal levels. When that happens, the institution holding the mortgage will be holding a loan whose market value is far lower than it’s face value. Suppose, for instance, mortgage rates rise to 5 percent over the next 5 years. At that point a 3.5 percent 30-year mortgage that is new today will have a term of 25 years and an outstanding balance of $179,768 but its market value will be $153,627.As mentioned, THAT was something that had not occurred to me. What is unsaid is that the disaster is unescapable. The Fed's low rate policy cannot be maintained forever. Even without any substantial economic recovery inflation has begun to attack the daily budgets of American households and businesses. The day will come when rates will have to be allowed to rise in order to attract government bond buyers.
That’s a loss of 14.5 percent, a loss that would wipe out the equity of most lenders. If mortgage rates rise to 6 percent over the next 5 years, the market value of the mortgage will be $139,390. That would be a loss in market value of 22.5 percent.
The same holds true for shorter-term loans such as the 1.99 percent auto loans that are becoming common . Were interest rates to rise quickly to 5 percent, every $1,000 of new 1.99 percent five-year car loan would sink in market value to $928. That’s a loss in market value of about 7 percent, enough to threaten the solvency of the lender.
Note that we’re not talking financial Armageddon and runaway inflation here. We’re just talking about a return to interest rates that are on the low side of what we’ve seen over the last 50 or 60 years. Indeed, for some readers this will be a case of “deja vu all over again”— rising mortgage rates would be a replay of what was experienced in the 1970s, an event that culminated in the thrift crisis, destroyed the thrift industry and produced a financial crisis that paralyzed the real estate industry for years.
Can we find a silver lining somewhere in this dark cloud? You bet. First, let’s not fret about our financial institutions; they already own Congress and can take care of themselves. The silver lining is for younger families: higher future interest rates amount to a major wealth transfer. Lenders will lose, borrowers will gain. Younger households may be able to recoup some of their losses from the last decade as home prices rise and the true value of mortgages declines."[Red italics are mine.]
On that day the collapse of the secondary mortgage market will regain front and center position. Woe on that day to the investor who has a portfolio heavy in financial stocks. Why do I not share Burns' optimism about the banks escaping again? Congress has heretofore shown no will to reign in the Fed, but in the face of a second banking collapse, it will not provide easy bailouts to that sector as it did in 2008. The mortgage derivative market is a house of cards built from worthless Federal reserve paper, and there is a hurricane brewing in the Sea of Inflation.
Wednesday, February 8, 2012
A common instruction in an engagement letter in these times might include wording such as:
"Please provide both the current market value and the disposition value based on a 9 month market period for the fee simple interest."
As compliance reviewers, my colleague, Richard Rexroad, SRA, and I have noted on numerous occasions what appears to be total confusion among the ranks of appraisers as to what exactly is meant by "disposition value". Certainly, the definition of disposition value is easily found for, and cited in, their reports, but the summary statements that include their opinions of disposition value may be of marginal use -- or worse, no use at all -- to the client.
To try to ascertain the resources available to appraisers for reference on the subject, a search was made of all media in the Appraisal Institute's Lum Library using the keywords "disposition value". The search returned one resource, Appraisal Institute Special Task Force on Value Definitions, June 1992 by Schultz, Featherston, Gibbons, LeGrand, and Parson. That work proposed definitions of disposition value and liquidation value, both of which appear to have subsequently been defined following their proposal. No further modern references could be located in the Lum Library.
Perhaps the best starting point for the discussion would lie in examining the Assignment Type and Intended Use of the report. After the highjacking of the URAR form by Fannie and Freddie in 2005, and the hardcoding of the Intended Use ("The intended use of this appraisal report is for the lender/client to evaluate the property that is the subject of this appraisal for a mortgage finance transaction."), most residential appraisers gave no further thought to that matter. For the most part, the assignments were for either purchases or refinances; no other discussion of the intended use was needed.
With the increase in inventory of REO properties and the periodic need to analyze the value of the collateral with a view toward asset disposition, lenders holding residential properties in their portfolios have been ordering large numbers of appraisals for the purpose of collateral analysis rather than mortgage finance. The AI Reports forms (which would be a much better choice for the task) have been ignored by the lending community. Appraisals for collateral analysis have been ordered, almost without exception, on the FNMA 2005 series of forms, most likely because that is what the lenders are most familiar with.
Because the FNMA/FHLMC forms are intended to be used for mortgage finance rather than disposition of the asset, the change in Intended Use is in direct conflict with the hard-coded statement in the report, and very few residential appraisers (even among those holding various designations from professional associations) have seen fit to add language in the addenda to the report which will supercede the hard-coded verbiage.
[Note: The forms do state that "Modifications, additions, or deletions to the intended use, intended user, definition of market value, or assumptions and limiting conditions are not permitted.", and then two exceptions are cited. However, that restriction applies ONLY to the use of the form for a FNMA/FHLMC mortgage transaction. The GSEs cannot prohibit the use of the form for other purposes; the key to their USPAP-compliant use in such situations is to adequately provide overriding verbiage in an addendum regarding the intended use, intended user, definition of value (and the source of the definition), assumptions, conditions, limitations, and certifications. ]
This discussion does not purport to address all forms of deviation from the hardcoded verbiage in the FNMA/FHLMC forms, but appraisers using those forms for other than a mortgage finance transaction need to keep the above factors under consideration.
When the assignment stipulates that the purpose is in the nature of collateral analysis for disposition of the asset, the client will frequently request either a disposition or liquidation value opinion along with the current market value opinion. In doing so, the client is first looking for the present value of the asset as though it had been offered on the open market at competitive terms with all other properties comparable to it. The typical exposure time for the subject must be analyzed and reported for the current market value. In that analysis, the appraiser will also be analyzing the market supply and pricing trends of competitive homes; all these factors are supposed to be summarized on page 1 of the FNMA report form.
Development of current market value is a straightforward process for most residential appraisers. Their major concern with the neighborhood market trend information is to develop adequate adjustments for the comparable sales, based on their distance in time from the effective date of the report. When the assignment adds the requirement to develop an opinion of disposition or liquidation value, however, there will be an application of the trends to the stated marketing period along with additional consideration of the motivation of the seller.
An examination of the definitions of these values is in order:
Market Value Disposition Value Liquidation Value 12 CRF 323.2(g) Dict. of RE Appraisal (4th Ed) Dict. of RE Appraisal (4th Ed) Consummation of a sale as of a specified date. Consummation of a sale will occur within a limited future marketing period specified by the client. Consummation of a sale will occur within a severely limited future marketing period specified by the client. Competitive and open market under all conditions requisite to a fair sale. The actual market conditions currently prevailing are those to which the appraised property interest is subject. The actual market conditions currently prevailing are those to which the appraised property interest is subject. The buyer and seller each acting prudently and knowledgeably. The buyer and seller each acting prudently and knowledgeably. The buyer acting prudently and knowledgeably. Assuming the price is not affected by undue stimulus, buyer and seller are typically motivated. The seller is under compulsion to sell, the buyer is typically motivated. The seller is under extreme compulsion to sell, the buyer is typically motivated. Both parties are well informed or well advised, and acting in what they consider their own best interests. Both parties are acting in what they consider their best interests. The buyer is acting in what he or she considers his or her best interest. A reasonable time is allowed for exposure in the open market. An adequate marketing effort will be made in the limited time allowed for the completion of a sale. A limited marketing effort and time will be allowed for the completion of a sale. Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto. Payment will be made in cash in U.S. dollars or in terms of financial arrangements comparable thereto. Payment will be made in cash in U.S. dollars or in terms of financial arrangements comparable thereto. The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale. The price represents the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale. The price represents the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.
Standards Rule 1-2 requires that the appraiser identify the Intended Use of the appraisal. It seems to be a difficult thing for appraisers to ask clients, "What do you intend to do with my opinion?", yet that is critical to understanding how the problem must be approached. The appraiser cannot render a useful opinion of value without understanding the motivation of the participants in the market. We seem to clearly understand that a market value opinion will be used to make a decision regarding underwriting a mortgage loan. Sadly, there seems to be a failure to understand why a client would request a disposition or liquidation value; the client assumes we know, and we assume they understand what we are about to deliver.
Let us step into the shoes of the lender with an asset which needs to be sold. The lender first wishes to know what his collateral is worth today -- the current market value. That value assumes that the subject has been on the market for its reasonable exposure period. In studying that exposure period, the appraiser will note the change in the market from the beginning of the exposure period to the effective date of the appraisal; that market change information will be critical in making adjustments to the comparable sales.
Unfortunately for the client, he is holding the subject in his inventory today, without a sales contract. He realizes that in order to get a contract, he will have to market the property. He has certain parameters for market time. Let us assume that the market is slow and the reasonable exposure period for the subject might be 6 months. The client knows that it will take time to sell the subject; acting prudently (see the definition of disposition value) he is willing to extend the market time to a maximum of 9 months, and orders a disposition value based on a 9 month market period. What is he telling us he wants? Have we really learned the definition of the value type?
Perhaps the client tells us his intent is to know what the property will be worth 9 months from now by asking for a disposition value based on a 9 month market period. That is a prospective value opinion which the appraiser will need to develop by adjusting the current market value for any anticipated change in the market over the 9 month period, as well as his knowledge, perhaps gleaned from anecdotal evidence in talking with sales brokers, of typical discounts in the subject market when properties sell under compulsion. Similarly to forecasting in a relocation appraisal, the 9-month disposition value thus arrived at gives the client a far end of a range (current market value is the near end) within which he can hope to sell the property during that time period. If an offer comes in within that range, the client now has a tool he can use to judge the acceptability of the offer. As the 1992 Task Force noted, in a declining market, the disposition value opinion would probably be lower than current market value, but in a rising market, it possibly could be higher.
Development of a liquidation value opinion would follow the same general pattern, with a subtle difference -- the factor of extreme compulsion to sell, coupled with the facts that the marketing effort would be limited and the seller might not be acting prudently. In such a situation, the place to turn for the anecdotal market conditions would be the auctioneer who specializes in absolute auctions with no reserve. Such an opinion would need to be formed with the mindset that the specified market period for the subject would anticipate an absolute auction at its termination, with a view toward informing the client that any offer he received within that time period which fell into the range would likely be one to which serious consideration should be given.
Nevertheless, regardless the trend of pricing in the marketplace, the anecdotal evidence will be crucial to the development of either type of value. There simply is not enough reliable statistical information readily available to the average residential appraiser for this purpose. The subjective nature of anecdotal data should not be viewed as lacking validity; the decisions behind the motivation and actions of the typical seller in disposition or liquidation scenarios are similarly subjective and valid. The appraiser is not being misleading as long as full disclosure of the kind of data source is made.
What is not valid, and is indeed unethical, is to postulate an opinion of value without understanding the intended use of the appraisal, or acknowledging the conditions explicit in the definition of that value.
Thursday, August 4, 2011
On Tuesday, after the nefarious Beltway Bozos passed the largest debt increase in American history -- a 16.78% increase which the greedy spenders will utilize to its fullest extent -- the stock market reacted with its sharpest loss in months. I said then that worse was to come; that the Asian markets at midday were down about 2%, foreshadowing a continuing Wall Street decline.
Wednesday morning the slide from Tuesday afternoon continued until the afternoon, when the tide turned and the market began to rise. The Dow clawed its way back to +26 for the day, and I began to wonder what had happened. I think I know.
Wednesday afternoon the heaviest volume came from heavy buying of Standard & Poor's industrial fund. That fund deals mainly in the 500 top industrial stocks on the exchange (most people have at least heard of the S&P 500). When money is pumped into the S&P 500, the fund managers must deal with it; they buy industrial stocks. This creates a feedback mechanism, driving the market ever higher. This feedback is enhanced by computer trading, since the computers are not programmed for fear.
All you need is a catalyst, and it is my belief that the catalyst was the Fed's private member banks -- a sinking stock market was the opposite of what their political masters needed, so they began buying to shore up the market. Without doubt, the need for a "sucker rally" was also a powerful motivator. The industrials rose on the coattails of that buying.
This morning the outlook was a bit bleaker. The Asian markets did not follow Wall Street; they continued to drop. Standard & Poors was the top loser of the day in terms of volume. Apparently the rallyers from Wednesday also got cold feet, and the sell-off began again in earnest. Traders wanting to retain relative liquidity are moving to cash in anticipation of rising interest rates. This is putting a strain on the banks, which, while paying minimal interest, are still being hurt by having to hold funds which they dare not place in the market.
It is no wonder that instead of paying interest, banks are starting to charge large depositors a fee for holding their cash, as announced by BNY Mellon today. "The northern lights have seen strange sights...", but we are about to fall down the rabbit hole.
I have digressed. Today, the Dow dropped over 500 points, down 4.31% in a single day. At this writing (10:30 PM Thursday here, 10:30 AM Friday in Hong Kong), the Hang Seng is down over 4%. It could rebound, but the threat of a weekend, and worries over the U.S. unemployment figures pointing upward, make an Asian rebound very tentative.
So, to the geniuses in Washington, I say, the worst possible thing you could have done to our economy was to increase the President's credit card limit. Prove me wrong. I'm waiting.
Tuesday, August 2, 2011
There are some stunned people this evening who were jubilant that the House and Senate and President came together on a deal that would hopefully avert default. They were expecting that the stock market would rise and everyone would be cheerful about the wonderful new future we faced.
But -- the market tanked. It lost 265 points, over 2%, for the day. This may seem counterintuitive to government figures, public employees, and newscasters, but there is a very logical reason for what happened. Unless I have misread what appears to be an obvious reaction, I predict that the next few days may show that it will continue to happen. In fact, as I write this, the Asian markets (on which the sun has risen and which are already in tomorrowland)are down over 2% -- a harbinger of tomorrow's Wall Street adventure.
What the Washington Klutzes have done over the past several decades has been the steady erosion of the worth of the US dollar. In order to score political points by artificially generating an "economic recovery", the gummint, through the evil genies at the Federal Reserve, has held interest rates at levels that are artificially low. My question for some time has been, "If it costs nearly nothing to borrow a dollar, then what is that dollar really worth?"
The panic over possible default was engineered by the Administration, the Fed, and the lapdog press, with the overt participation of the folks who make their living through usury -- the bond traders. In the last hours of the panic, there were those who moaned that if the US gummints credit limit was not increased, the gummint would not be able to pay its creditors.
That fiction ignored the fact that the President, via the Secretary of the Treasury, has the responsibility of prioritizing spending. He has put a high priority lately on bombing Libya, but such a low priority on such things as Social Security and Medicare as to threaten that those latter checks might not go out if he didn't get his way.
The usurious bond traders were particularly worried. If the credit limit were capped at the current rate, there could be no new borrowing. Because they make their money on the commissions from bond sales, capping the credit limit might cap their incomes. They needed an influx of new borrowing.
There are unintended consequences to every evil under the sun. The US dollar, already weakened by the stupid Quantitative Easing policies of the Fed, is about to get even weaker. Currency inflation has one side effect that the markets understand, and that is, that when money is devalued through printing, interest rates must rise.
When interest rates are held artificially low, and stock dividend yields outpace bond interest, stock prices rise due to higher demand. That was the scenario during the rounds of Quantitative Easing, and the reason for the interest in the stock market over the past year. I expect that this scenario is ending. Cheap money is risky money. Risk-takers demand higher compensation for higher risk, and interest rates are about to rise.
Classically, when interest rates rise, and their rate of return begins to exceed the rate of return for stocks, the market flees stocks and buys bonds. When savvy investors realize that everyone else in the marketplace will sooner or later get the same idea, panic selling sets in. Nobody wants to be the last guy to trade before the market hits bottom.
I have been wrong before, and am willing to concede that I may not be entirely on the right track. I will, however, predict that the stock market is in for a decline to a sustainable level, at say around 8500, maybe a little lower. That will be caused by an expectation that cheaper money will be seen as higher risk with higher returns, with the gummint selling economic snake oil in an effort to charm bond buyers. This will lead to a drawdown in capital invested in plans to expand operations and payrolls, with an accompanying depression of the employment figures.
The American people elected new Representatives who promised to hold to Tea Party principles. Instead, those Representatives appear to have been eating the Washington Establishment's magic mushrooms.
Friday, October 15, 2010
I've been too busy to publicly express my perspective on the economy lately but several items are making me curious as to how much manipulation the markets can handle before they correct themselves. The future, as presented by the US government and its monetary master, the Federal Reserve, appears quite well, and "market analysts" seem to be predicting a gradual strengthening which supposedly began when the "recession" ended over a year ago.
I have often spoken out against the use of statistical correlation with regard to attempting proof of a concept. Correlation, however, allows visualization of a composite picture of events. Such correlation helps to avoid tunnel vision, where fixation on a particular goal blinds the observer to other inputs. The analysis of correlated events will then provide a view with more depth perspective, and add "color" to a "black and white" picture.
The Fed has embarked on a course of Quantitative Easing (QE). QE is another term for printing money without increasing its backing. It "eases" the ability of member banks to lend money at low interest rates, and consequently, devalues the currency in which the money is issued.
I have a question for the wizards : if interest rates are at a historic low, and yet the lenders are having difficulty interesting businesses in borrowing more (because the businesses appear wary of overextending themselves), what are the banks going to do with the additional currency? Will they, themselves, take the opportunity to purchase additional assets at low interest rates?
A related area is the trend in consumer prices. If the Consumer Price Index has risen for the past 3 months at only fractions of a percent, this is perceived as a sign that inflation of the currency is under control. However, when the index rate for July and August combined was only 0.3 percent, yet the increase in August alone for fruits and vegetables (at the peak of harvest when prices should fall) was 0.4 percent, does this indicate that the composite index is understating the inflation of the core items which affect the largest numbers of consumers?
Another area being watched is the trend in retail sales. One prediction which I saw, credited to JP Morgan Chase, was that retail sales would be up 0.6 percent in September, but if autos are excluded, would be up only 0.4 percent. Question : if retail sales are measured by dollar expenditures, and they roughly parallel the rise in consumer prices, does this indicate that they are in reality flat or even slightly negative?
A third area being considered is the report on business inventories. The prediction (again attributed to JP Morgan Chase) is that the government will announce business inventories up 0.6 percent in August. This has been interpreted to mean that confidence is increasing. In view of the rise in consumer prices, coupled with the increase in retail sales roughly paralleling the price increases, could it also mean that perhaps people have stopped or slowed their buying?
I don't know. I confess to being an amateur in matters of complex macrofinances. Nevertheless, there is something smelly that the newspaper has been wrapped around. Looking at only one part of the data could make me hopeful. Correlating the data makes me skeptical.