TESTIMONY OF DEPUTY ASSISTANT SECRETARY FOR SINGLE FAMILY HOUSING EMELDA JOHNSON

HOUSE SUBCOMMITTEE ON HOUSING AND COMMUNITY OPPORTUNITY

APRIL 1, 1998

Mr. Chairman and members of the Subcommittee, my name is Emelda Johnson and I am Deputy Assistant Secretary for Single Family Housing at the U.S. Department of Housing and Urban Development (HUD). With me today is Paul Leonard, Deputy Assistant Secretary for Policy Development at HUD. I am pleased to be here on behalf of HUD Secretary Andrew Cuomo and want to thank you for the opportunity to testify on the Federal Housing Administration’s (FHA) single family housing programs. I also want to thank the Subcommittee for giving these important issues and the Administration’s current legislative proposal its thorough consideration.

Under the leadership of Secretary Andrew Cuomo, FHA is the strongest it has been in decades, and it is positioned to become even stronger. Secretary Cuomo’s Management 2020 Reform effort is creating new and more effective ways for FHA to conduct its business. Instead of working out of 81 small and inefficient field offices, FHA now does business through four state-of-the-art Home Ownership Centers (HOCs). Working with Freddie Mac, FHA lenders and borrowers now have access to a state-of-the-art automated underwriting system, reducing from days to a matter of minutes, the time needed to approve an FHA borrower for a loan.

HUD’s 2020 Reform is also dramatically restructuring FHA’s loan loss mitigation and property disposition activities, the topics for today’s hearing. In February, FHA opened a new Loss Mitigation Servicing Center in Oklahoma to help boost use of our comprehensive Loss Mitigation Program. And in March, FHA sent a proposed Real Estate Owned (REO) rule to Congress that will revolutionize the way we dispose of foreclosed properties. Using existing authority, this initiative represents a dramatic shift to large scale privatization of FHA’s property disposition program. This rule will allow HUD to manage its single family inventory in accordance with the best private sector practices, to streamline the disposition process and to reduce the time and cost of selling properties, generating significant savings.

Building on accomplishments to date, HUD’s FY1999 Budget proposes further dramatic reform of the property disposition process. Once enacted, HUD’s proposed property disposition legislation will allow HUD to intervene earlier in the loan default cycle and transfer notes to private real estate professionals prior to foreclosure. The new legislation, under consideration in this and other committees, will not only improve FHA efforts at loan loss mitigation and property disposition, it will also further reduce costs associated with foreclosure and disposition, resulting in $525 million in savings.

In short, FHA is streamlining operations, centralizing back-office functions and staff, investing in advanced technology and drawing on private sector expertise wherever possible. Secretary Cuomo is leading FHA into the 21^st Century, and turning it into a state-of-the-art mortgage insurance company.

Even so, in the face of these recent accomplishments, today’s hearing addresses what critics allege to be continued flaws in HUD loan loss mitigation and property disposition efforts. It will feature many of the same voices that have criticized HUD for similar failings over the past decades. While we welcome the opportunity to respond to positive suggestions as to how to improve HUD programs, quite frankly, Mr. Chairman, it is my belief that many of the criticisms reflect a focus on the past, rather than the present and the future. FHA’s critics fail to recognize that within a matter of months FHA will no longer be in the real estate asset management and property disposition business, but will instead turn this function over to private sector specialist.

So while we welcome suggestions for improvement, I think that it is important that I begin my testimony with a detailed discussion of where FHA is today, and our vision for how best to address issues relating to distressed single-family housing in the years to come.

HUD 2020 REFORM: THE NEW VISION FOR PROPERTY DISPOSITION

As part of Secretary Cuomo’s Management 2020 reform efforts, FHA is revolutionizing how it handles single-family loan loss mitigation, real estate asset management and property disposition. Under current legislative authority, FHA already has:

• Moved to Privatize Sales of FHA-Owned Properties: In March, 1998, FHA sent a proposed rule to Congress that will streamline the property disposition process. Modeled after HUD’s successful single family notes sales program, the new procedures will permit FHA to sell blocks of foreclosed properties to private parties specializing in property disposition, a move that will speed the sale of these properties and result in significant savings. Private purchasers of FHA properties will be free of the constraints HUD faces in disposition, such as reliance on a sealed bid sales process and an inability to market properties through computerized multiple listings. FHA is prepared to move forward with bulk sales as soon as the proposed rule takes effect.

• Developed New Loan Loss Mitigation Tools and Created Ways to Increase Use of These Alternatives to Foreclosure: At the direction of Congress, FHA created a new comprehensive set of loan loss mitigation tools, including special forbearance periods, modification of loan payments, balance and/or interest rate, as well as pre-foreclosure sales. These efforts to keep borrowers in their homes, or if necessary encourage owners to sell prior to foreclosure, protect the interests of both homeowners and FHA. HUD is working to increase use of loss mitigation tools by providing training to housing counselors and lenders in loss mitigation options, and by improving monitoring and enforcement of lender activities.

In addition, HUD has pending before Congress new legislative authority for FHA to take notes in lieu of property which will result in increased use of loan loss mitigation efforts and, when needed, further speed the foreclosure and property disposition process.

• Property Disposition Legislation: This new legislation will give HUD the authority to pay claims prior to foreclosure and take back the mortgage note instead of the property. These notes then can be quickly sold to private sector specialists in loan loss mitigation and property disposition. The sale of FHA notes will enhance HUD’s capacity to realize greater recovery against insurance claims, lead to quicker sales of foreclosed properties and reduce any adverse impact foreclosure may have on the surrounding neighborhood. Overall, OMB estimates this innovative legislative proposal will generate $525 million in budget scored savings.

By 1999, FHA plans to be out of the retail property sales business, instead relying on private sector partners, including nonprofit organizations, to perform all loss mitigation and property disposition functions. These private partners will be better able to respond quickly and efficiently to fluctuations in the demand for loan servicing and property disposition that may result from a severe downturn in a regional or local economy.

Under the new system, FHA will continue to work with existing lenders to engage in early intervention at the first indication of borrower distress. HUD is now exploring the potential for adapting risk assessment tools, such as the Freddie Mac/MGIC Early Indicator System for use by FHA. The Early Indicator System represents state of the art technology for assessing the likelihood that a loan in default will cure (e.g. return to making timely payments) or fall further into arrears. Using the Early Indicator or some equivalent system, HUD can help FHA lenders focus resources on those loans that are most likely to cure, and identify the more difficult loans to be turned over to private partners, who will pursue additional loss mitigation efforts and, if necessary, manage foreclosure and disposition activities.

Finally, even as FHA moves to streamline and privatize its loan loss mitigation and property disposition procedures, FHA will continue to hold a small number of properties in inventory in anticipation of possible transfer to local government or nonprofit entities. Building on knowledge gained during a pilot effort with a large national real estate firm, FHA anticipates that any future management and marketing (M&M) activities still required will be done through regional contracts with real estate firms with the capacity to perform all required management and disposition activities.

LOSS MITIGATION

In 1996 Congress authorized a comprehensive new program of loan loss mitigation that protects the interest of borrowers and the financial integrity of the MMI Fund. This new program replaces the ineffective Assignment Program, which often left borrowers deeper in debt and was costly to the Fund. Loss Mitigation offers five alternatives to foreclosure that address a far greater range of borrower problems than could be addressed through the Assignment Program. Perhaps most importantly, the Loss Mitigation Program shifts the emphasis to early intervention in the default cycle, when there is the greatest potential for the borrower to recover from default and remain in their home.

Mr. Chairman, I’d like to take just a minute to describe a few features of the Loss Mitigation Program.

• Lenders Evaluate All Loans in Default. The new program provides lenders both the authority and the responsibility to review and to consider the workout potential of every defaulted loan.

• Lender Evaluations are Mandatory. Though lenders have great latitude in selecting the loss mitigation strategy most appropriate for each borrower, participation in the program is mandatory for all lenders. Lenders are required to document that they have considered all reasonable means to address delinquency. They must inform borrowers of counseling options. They must evaluate the workout potential of each delinquent loan prior to initiating foreclosure. And they must re-evaluate each loan monthly.

• Incentives Encourage Use of Loss Mitigation Tools. FHA offers lenders an extensive set of incentives to encourage use of loss mitigation including cash compensation, other financial incentives and increased authority to use loss mitigation tools. FHA also reimburses lenders for a portion of their costs associated with use of loss mitigation, at a rate that Price Waterhouse described in the 1997 Actuarial Review as "similar to the reimbursement given for use of similar loss mitigation tools used in the conventional market by Fannie Mae and Freddie Mac."

• New Computerized Loan Tracking System Highlights Troubled Loans on the Census Tract Level. FHA’s Neighborhood Watch system, a web-based computer system, is designed to highlight neighborhoods and/or lenders with exceptionally high default and claim rates. After extensive testing in demonstration programs, the system will be launched nationwide in May of this year. It will give HUD the ability to track default and claim rates at the census tract level, which will greatly enhance lenders’ ability to target poorly performing loans for loss mitigation and also help FHA monitors target poorly performing lenders for monitoring review.

• Sanctions Further Reinforce Program Use. Failure on the part of the lender to comply with the provisions of the Loss Mitigation Program may result in the loss of incentive compensation, reduced reimbursement of foreclosure expenses, and curtailment of claimable interest. Furthermore, a pattern of refusal or failure to comply can lead to withdrawal of approval to originate FHA loans.

I want to assure the Subcommittee that FHA is working hard to facilitate the transition from the Assignment Program to the new Loss Mitigation Program. Efforts to smooth this transition and to increase the use of loss mitigation include:

• HUD is investing in training. We sponsored training conducted by the National Consumer Law Center for over 500 HUD-approved housing counselors in loss mitigation policy and procedures. Participating housing counseling organizations facilitate loss mitigation by representing homeowners in financial distress, mediating between the homeowner and lender, and assisting the homeowner in formulating a strategy to avoid foreclosure and achieve debt-free homeownership whenever possible. Trained counselors acting as advocates for their clients will also increase use of loss mitigation by showing how loss mitigation strategies in specific cases both reduce claims and prevent foreclosure.

• HUD is providing more consumer and lender assistance through a new HUD servicing center in Oklahoma City, which specializes in responding to loss mitigation inquiries from homeowners, the lending industry and housing advocates across the country. Since opening in February, 1998, the Oklahoma City Service Center has hit the ground running. It now receives more than 125 calls per day. The toll free number for the Service Center is (888) 297-8685.

• HUD is forcing lenders to help troubled borrowers more quickly by advancing the foreclosure initiation date from nine months to six months from the date of default, under a new HUD mortgagee letter in January, 1998. This will force lenders to evaluate alternatives to foreclosure earlier in the course of a delinquency, which counselors, housing advocates and mortgage lenders all agree is a more likely path to successful foreclosure avoidance than later interventions.

• HUD recently performed rigorous lender performance evaluations in loss mitigation for FY 1997. FHA lender monitors have been trained to evaluate the effectiveness of lenders’ loss mitigation efforts. Lenders’ scores recently were published and those scoring in the top 25^th percentile were given cash compensation, other financial incentives and authority to use loss mitigation tools. This lender scorecard immediately prompted inquiries from lenders about how to improve their loss mitigation performance. These performance ratings will be published annually.

These efforts are already paying off. In the first five months of FY 1998, FHA reported nearly 3,100 new Loss Mitigation cases, with the monthly average number of cases increasing each month. Based on this rapid growth, HUD estimates over 10,000 borrowers will participate in the Loss Mitigation Program by the end of the fiscal year. HUD projects that approximately 5,000 program participants will use non-sale loss mitigation alternatives, such as loan modifications, special forbearance and partial claim, while another 5,000 will use the new pre-foreclosure sales option.

As housing counselors, lenders and borrowers become more familiar with loss mitigation options, HUD expects the number of cases in FY 1999 to equal or exceed assignment cases in previous years, which averaged 12,000 annually.

Finally, it is important to remember that FY 1997 essentially was a transition year when FHA worked on phasing out the Assignment Program, while also implementing the new Loss Mitigation Program. In FY 1997 a total of 12,677 foreclosures were avoided through the two programs. This total includes 7,655 assignment cases and 5,022 loss mitigation cases.

The more than 7,600 cases still in the assignment pipeline in 1997 represent borrowers who had registered to participate in the Assignment Program as of November, 1996, when FHA launched the Loss Mitigation Program. As the pipeline of assignment claims declines in FY 1998, HUD anticipates lenders will be freed up to work on more loss mitigation claims.

Even greater increases in loss mitigation volume will come from approval of the Clinton Administration’s FY 1999 property disposition proposal. The new approach will ensure the full potential benefits of loss mitigation are achieved by moving the decision to a private entity with even greater economic incentive to prevent foreclosures, where possible, and reduce costs to the insurance Fund.

PROPERTY DISPOSITION

After several successful demonstration projects with private partners, HUD recognizes that private real estate professionals, including nonprofit organizations, can often service loans, pursue loan loss mitigation and, if necessary, manage foreclosure and property disposition more efficiently. Now we’re acting on this belief by taking aggressive measures to privatize FHA’s property disposition program

The REO rule currently under pre-publication review by Congress, will streamline FHA’s property disposition process. Using existing authority, the new program will enable HUD to sell blocks of foreclosed properties to private parties specializing in property disposition. These private entities are expected to sell the properties to new homeowners more quickly, reducing the period that homes are vacant. HUD estimates this new rule will result significant savings.

FHA is prepared to move forward with the first bulk sale of properties as soon as the proposed rule takes effect. This sale will launch FHA into the future, toward large scale privatization of its property management and disposition process. Furthermore, FHA can use this existing authority to conduct not only multiple sales of existing inventory, but to sell the right to a future pipeline of foreclosed properties, further speeding the transfer to private real estate professionals who can more quickly dispose of properties. Ultimately, FHA will use these sales to transfer the vast majority of properties to private parties, effectively eliminating much of the need for REAMs and other existing contracts.

In addition to this rule, we can do more to boost the use of loss mitigation and to speed the disposition of foreclosed properties. President Clinton’s FY 1999 budget proposes dramatic reform of the property disposition procedures. It asks Congress to grant FHA the authority to pay claims and obtain mortgage notes prior to foreclosure. This will enable FHA to intervene earlier in the borrower default cycle and sell the mortgage notes to a private third party, who will handle all loan servicing, loss mitigation and if necessary, foreclosure and disposition activities. Under this approach, the private third party will own the note, and ultimately the property, if it goes to foreclosure. Since the new note holder will have its own money on the line, it will be motivated to take action quickly and effectively.

The new approach has numerous advantages:

• Property Disposition Reform Will Save Taxpayers Millions of Dollars. OMB estimates this new approach to property disposition will generate savings of approximately $525 million. The Congressional Budget Office (CBO) estimates savings in FY 1999 will be $400 million.

• Property Disposition Reform Will Further Enhance Loss Mitigation Efforts. Following acquisition of a mortgage note, the new note holder in many cases will actively pursue loss mitigation, since keeping the family in the home often makes financial sense for all parties. This belief was confirmed by HUD’s experience with several prior sales of assignment notes. Private sector purchasers of assignment loans had great success in turning defaults into re-performing loans, by getting borrowers back on track making regular payments and avoiding foreclosure altogether. Key to this success was the ability of the new note holder to refinance the loan at less than full value, an option that FHA lacks the authority to pursue.

• Disposition Reform Will Speed the Sale of Foreclosed Properties. If the borrower is not capable of meeting future loan payments, the private third party entity will pursue foreclosure and sale of the property. With the most up-to-date technology and the flexibility to shift trained professionals around the country to meet the often unpredictable and erratic demand for servicing and disposition services, HUD’s private sector partners will be much more efficient than FHA.

• Disposition Reform Will Reduce HUD Staffing Needs. By selling notes prior to foreclosure, HUD will own, manage and dispose of far fewer properties. Therefore, the number of staff required to manage FHA’s REO operation is expected to drop by more than half.

This new approach simply will provide one additional tool available to FHA for performing loan loss mitigation, property management and disposition activities. It will complement existing disposition processes available under existing authority, such as individual competitive sales, direct sales to nonprofit organizations and government agencies, auctions or bulk sales. No single procedure will ever be right for all locations or economic conditions. Availability of a number of different tools will allow FHA to match its disposition program to the local market and maximize the return to the Fund. Further options will enhance FHA’s ability to adapt to different market conditions.

REAL ESTATE ASSET MANAGEMENT (REAM)

Finally, I’d like to address concerns raised by GAO in a recent report on improvements needed in HUD’s oversight of REAM contractors. The report highlights several suggestions for improving HUD’s oversight process. We welcome these suggestions, and already have taken action to follow through on many of them. First, I would like to remind members of the Subcommittee that with the implementation of the new REO rule, HUD will within a matter of months be substantially out of the business of property management, marketing and disposition.

I also would like to encourage the Subcommittee to judge the HUD property management and disposition efforts by the results. Over the last 12 months ending February 28, 1998, HUD sold 61,317 properties. The average time a property remained in our inventory over this period was approximately six months. And the rate of recovery based on acquisition cost (the recovery amount as a percentage of the costs of paying the insurance claim plus all capitalized expenses) was more than 64 percent.

Moreover, the rate of recovery based on acquisition value (the recovery amount as a percentage of the appraised value of the property at the time of HUD acquisition plus capitalized expenses) was more than 83 percent.

Overall, the rate of recovery for HUD’s disposed properties, whether measured as a percentage of acquisition cost or value, compares favorably with private industry standards. HUD admittedly takes longer to sell properties than the private sector (six months as opposed to four months) but much of this difference reflects delays associated with requirements that FHA hold a portion of its inventory for sale to local government or community based nonprofit organizations, a practice that will continue under the proposed property disposition reforms, as it reflects FHA’s mission and continues to be a Department objective.

By implementing a new REO rule, FHA is taking steps to reduce the time properties are held in portfolio. Nevertheless, it is significant to note that FHA’s current recovery rate and average time properties are held in portfolio are near industry standards.

We also realize that private sector real estate firms have many advantages over FHA in managing and disposing of properties. Private firms have the ability to move staff and resources around the country to respond to the fluctuating demand for loan servicing, property management and disposition that results from regional downturns in specific real estate markets. That is why we are taking aggressive steps to get HUD out of the property management and disposition business. Following the proposed bulk property sales, the private purchasers will be responsible for all property management and disposition activities, greatly reducing the work required of HUD property management and disposition oversight staff.

However, the transition to this new system will occur over a period of months. And even after it is adopted, not all FHA properties will be transferred to private partners. Some properties may be retained to meet FHA’s public purpose goals in property disposition. So we recognize the need to improve the existing system of property management and disposition.

To meet immediate property management and disposition needs, FHA will be more broadly implementing a new marketing and management contract format to improve current practices until privatization can take hold. This type of contract combines the property management and property disposition functions under one contractor instead of separating them.

Mr. Chairman, we know this approach works. A pilot program with Golden Feather Realty Services, Inc. using this contracting method in Maryland, Louisiana and Sacramento, California has proven to be successful. During FY 1997 the pilot contractor was able to dispose of properties significantly quicker than HUD in all three sites. For example, in the Maryland State Office, the turnover rate under the pilot was reduced from seven months to four months; in the Louisiana State Office the rate was reduced from 7.8 months to five months. In the Sacramento office, where the economic conditions are poor, the turnover rate decreased from 5.4 months to 4.7 months. This resulted in properties returning to private ownership much more quickly. In addition, at two of the sites, the average sales price under the pilot increased and the average FHA profit per property sold increased or remained constant.

Over the next several months, these contracts will be made available to HUD field offices where the REO workload exceeds the staffing level necessary to perform required functions. Furthermore, FHA will use these contracts over the long term to manage the relatively small percentage of foreclosed properties that will continue to be held within the HUD portfolio to address FHA’s public purpose objectives.

Finally, HUD also has taken action to immediately address several of the concerns raised by the GAO report, including the following:

• HUD is conducting risk assessments of all REAM contractors coming up for renewal.

• HUD is issuing cure letters to all poorly performing REAM contractors in Massachusetts and Illinois. A cure letter detailing several deficiencies was issued to Countryside Agency, the sole contractor in Massachusetts, on March 24, 1998. The contractor has ten days to respond. This letter is an initial, formal step to begin laying the foundation for termination of the REAM contract if deficiencies are not addressed. Similar cure letters for several REAMs contractors in Illinois are being prepared and will be mailed within thirty days.

• HUD is hiring more contract REAM monitors in both Massachusetts and Illinois. These outside monitors provide a quick means of complimenting HUD staff efforts to effectively monitor REAM contractors.

• HUD sent swat teams of senior headquarters and field office quality assurance staff to inspect the condition of FHA-owned properties, assess the status of HUD’s REAM monitoring and gather information on HUD contractors. The Boston swat team, which was led by a counselor to the FHA Commissioner, found that many of the deficiencies identified in the GAO report already have been addressed. The team reported that the REAM contractor has shown improvement since the time of the GAO audit, as a result of hiring a new manager who is coordinating property management activities in a much more effective manner than had previously been the case.

• Staff of the Atlanta Homeownership Center reviewed the Chicago office's REAM operations, examined files and reviewed all REAM contractors’ performance. The HOC center staff identified three "high risk" contractors, and re-organized Chicago REO staff into geographical teams to perform follow-up monitoring. All three "high risk" contractors also will receive cure letters within thirty days. In addition, the swat team prepared a work plan to facilitate the REAM contract renewal process. This plan includes comprehensive evaluations of all REAM contracts, prior to any contract renewal.

HUD’s new Home Ownership Centers (HOCs) are primarily responsible for general oversight of all procurement and administration of REAM contracts in the future. HOC staff also are responsible for supervising all REO staff in HUD field offices. And, headquarters staff, under the direct supervision of the Deputy Assistant for Single Family Housing, is responsible for overseeing HOC activities.

CONCLUSION

Members of the Subcommittee, I would like to conclude my remarks by reiterating that I believe FHA is heading in the right direction. The results of several years of focused, cooperative work by HUD and Congress to strengthen FHA’s MMI Fund are paying off. The Fund now has an economic value of $11.3 billion, a more than 318 percent increase over the value in 1990, $2.7 billion, when Congress passed the Cranston-Gonzalez National Affordable Housing Act. And the Fund’s capital ratio is 2.8 percent, well above the Congressionally-mandated target of 2.0 by the year 2000. We have come a long way toward restoring FHA to fiscal health.

But we can do more to improve FHA’s operations and enhance the Fund’s ability to serve borrowers not well served by the private sector. Secretary Cuomo is committed to fundamentally changing the way FHA does business. Under his leadership, FHA is aggressively using existing authority to take significant strides toward privatizing FHA’s property disposition program. And if Congress approves our request for new authority to pay claims prior to foreclosure, we plan to revolutionize the way FHA pursues loan loss mitigation and property disposition. With this new authority, FHA will largely get out of the retail property disposition business, and will rely instead on private sector real estate specialists with the expertise, flexibility and access to advanced technology necessary to most effectively pursue loan loss mitigation and property management and disposition.

Thank you for this opportunity to testify.