Rating Agencies Should Rate Foreclosure Timelines
When Wall Street turns real estate mortgages into commercial mortgage-backed securities, those securities must first be given a rating. To do that, rating agencies scrutinize an exhaustive list of data points for each loan included in the transaction. That review includes, among many other things, the loan documentation, the collateral, valuation, estimated likelihood of default, sponsorship, and whether the borrower structure adequately protects the loan from bankruptcy risks. For anyone trying to close a securitization, the rating agency process can feel like an extended and very detailed proctological exam.
In rating any loan, the agencies also ask: If that loan went into foreclosure, how much of a loss would the holder of the loan, the securitization trust, incur? The loss would start with the direct cost of prosecuting the foreclosure. It would also include the lender’s expenditures during foreclosure to pay real estate taxes and insure, preserve, and secure the collateral. The longer the foreclosure takes, the more these expenses would pile up. Although loan documents require borrowers to reimburse everything, the typical borrower in foreclosure probably has no money. That’s part of why the loan went into default.
During foreclosure, the collateral for the loan often deteriorates, producing indirect costs to the lender even if the lender does some maintenance.