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Analysis of Judicial Vs Non-Judicial Foreclosures

S&P report compares impact in states with judicial foreclosures

March 7, 2011

By staff

Foreclosures in judicial states take longer, give borrowers more leverage over lenders and cause more losses for investors in residential mortgage-backed securities, according to a ratings agency analysis. The study considered recent foreclosure litigation.

The report, Residential Foreclosures: A Stately Matter, identified two types of states: judicial and non-judicial.

In judicial states, which number 21 plus Washington, D.C., borrowers have a better chance of negotiating a loan modification due to the cost of the foreclosure process, according to Standard and Poor's Ratings Service, which issued the analysis. In addition, foreclosures took roughly twice as long in judicial states -- though the longer process gave borrowers more time to cure delinquency.

"The presence of judicial hearings for foreclosures may incentivize a lender to pursue strategic alternatives to foreclosure and work closely with a borrower to return a mortgage to a performing status, such as through loan modifications," the report stated -- adding, however, that there was little empirical evidence to support this in the analysis.

S&P noted that the majority of non-agency issuance from 2000 until 2007 was in non-judicial states.

The report said an 18-month roll-rate analysis indicated that around three times as many homes remain in foreclosure in judicial states.

Loan-loss severities were typically lower in non-judicial states, where servicers have the upper hand, and the difference has widened during the past two years. The New York-based ratings agency noted a high degree of correlation between longer foreclosure timelines and higher loss severities.

Foreclosure litigation might have a bigger impact on foreclosure timelines in non-judicial states, and this may narrow the difference between the two types of states.

"In our view, all else equal, RMBS bonds with exposure to asset pools with a higher concentration of loans in judicial states will likely have higher and more back-ended losses relative to pools with a higher exposure to non-judicial states," S&P stated. "This can adversely affect front-pay discount bonds and could be advantageous to premium or subordinate credit IO type bonds, which, in our view, could benefit from the continued interest proceeds."

As far as the impact from recent problems with foreclosure affidavits and from challenges to MERS' legality, the higher thresholds for foreclosures in judicial states likely means less impact from these issues. The report identified the Massachusetts case Ibanez v. U.S. Bank and the New Jersey case Bank of America v. Janett Alvarado.

In another case cited, In Re: Ferrel L. Agard, Case No. 810-77338-reg, the Eastern District of New York's ruling "seems to indicate that a court will not revisit the legality of a foreclosure once a state
court issues a judgment of foreclosure."

The judge in the New York case also stated that "MERS did not have
authority, as 'nominee' or agent, to assign the mortgage." S&P said the judge's statement contrasted a recent decision from the Kansas Bankruptcy Court in the case In Re: David Michael Martinez, Case No. 09-40886, in which the court said MERS does have the authority to assign a mortgage as an agent for the servicer.

It also contrasted a
decision from the Court of Appeals of California, Fourth District, Division One, in Jose Gomes v. Countrywide Home Loans Inc., No. D057005, which upheld a lower court's ruling and concluded, "Gomes's first and second causes of action lack merit for the independent reason that by entering into the deed of trust, Gomes agreed that MERS had the authority to initiate a foreclosure." S&P said this case is particularly significant because California is currently the largest foreclosure state.

Modification activity was not significantly different between the two types of states, S&P said.

The re-default rate for non-agency loan modifications was 80 percent with 24 months.

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