Mortgage lenders are threatening to halt lending on condominiums in Nevada after the state Supreme Court upheld a law allowing homeowners associations to foreclose ahead of first mortgage holders.
On Thursday, the court denied a rehearing of the case, outraging mortgage lenders and servicers.
"Now we are rethinking whether we want to lend in Nevada," said Clem Ziroli, president of First Mortgage, an Ontario, Calif., lender. Ziroli holds first liens on three homes in Nevada, which has one of the highest concentrations of homeowners associations in the country.
"Our collateral has basically been robbed from us," Ziroli said.
Nineteen states give homeowners associations "super lien" priority over first trust deeds held by banks and private label investors, meaning the HOA can collect unpaid dues before a bank can foreclose. (In the other 31 states, HOAs are wiped out by a foreclosure.)
But the Nevada ruling further rankled banks and servicers because they want homeowners associations to be required to go to court for permission to foreclose. Doing so would have given servicers greater certainty about the amount of past HOA dues that need to be settled.
Since Nevada is a non-judicial state where foreclosures do not have to be processed through the courts, the lending industry would have to appeal to the state legislature for a change.
"It is a blatantly bad decision and will ultimately harm mortgage lending in that state," said David H. Stevens, the president and CEO of the Mortgage Bankers Association.
Compounding these issues is that many HOAs have been selling their right to foreclose on properties at auctions in an effort to collect delinquent HOA dues. This has sparked a robust market of bottom-feeding investors eager to seize the homes ahead of banks and mortgage servicers.
Since last month's ruling, prices for HOA liens at auction have jumped dramatically to nearly the market price of the properties, lawyers in Nevada said. Before the ruling, HOA liens typically sold for the value of the HOA delinquency amount, roughly a few thousand dollars.
Fannie Mae, Freddie Mac and their regulator the Federal Housing Finance Agency are concerned about the ruling primarily because they could suffer losses if servicers are not able to foreclose ahead of HOAs.
FHFA said in a statement that it "is reviewing its significant implications for housing finance.
The case involved a Las Vegas home that in 2012 was sold at auction to SFR Investments, a private company that owns 300 properties in the city. SFR bought the home from a homeowners association for just $6,000, the amount of dues that were owed by the defaulted homeowner.
Bank of America is the servicer for private-label investors who held an $885,000 first mortgage on the home. When B of A tried to foreclose in late 2012, SFR filed suit. (The case, SFR Investments Pool 1, LLC v. U.S. Bank, names as the defendant the trustee for the private-label mortgage securitization.)
The court unanimously upheld the HOA's "super lien" priority, stating: "With limited exceptions, this lien is 'prior to all other liens and encumbrances,' on the homeowner's property, even a first deed of trust recorded before the dues became delinquent."
Bank of America said it was "disappointed" that the court denied a review of the case.
"The court's interpretation, that Nevada law does not require judicial foreclosure for HOA actions, sacrifices lenders' and homeowners' interests," the bank said in a statement.
Jacqueline Gilbert, an attorney for SFR who argued the case before Nevada's Supreme Court, said banks and servicers that fight the ruling could depress auction prices for properties, and thus hurting themselves.
"As long as the banks continue to fight, underwriters are likely not going to want to insure title for HOA foreclosure sales unless they know the deed is not subject to some kind of attack," said Gilbert, an attorney at Howard Kim & Associates in Henderson, Nev. "If everyone accepts this is what the law is, the prices will rise to what they would be in a bank foreclosure sale and the bank or servicer would be paid off and the statute will work as intended."
Gilbert said she has 240 pending lawsuits against banks and beneficiaries of the deeds of trusts.
Stevens, at the MBA, said the ruling raises a slew of problems for lenders and title insurers. He said it will be difficult to quantify the risk on loans secured by condos or planned unit developments since an HOA lien could occur years after an insurer has cleared title.
"At a minimum, insurance premiums should go up," said Stevens. "All of a sudden we're adding a whole administrative burden on the lending and title insurance industries to have some supervision over HOAs."
The challenge for banks and servicers now is how to track HOAs and delinquent dues.
Though HOAs are required to notify servicers of a foreclosure action, Ziroli claims the HOAs routinely fail to provide proper notification. (Homeowners and regulators, in turn, have long faulted servicers for failing to notify homeowners of a foreclosure and for adding junk fees during the foreclosure process.)
Matt Martin, the chairman of Matt Martin Real Estate Management, which tracks HOA delinquencies, said banks and servicers have not paid enough attention to the issue. Martin said he has been telling servicers for years that they need to prepay delinquent HOA dues or add the past dues to the balance of a loan if a borrower falls behind on payments.
Banks, servicers and the government-sponsored enterprises "are going to lose hundreds of millions, they are going to get crushed by this," Martin said. "We knew this would happen and we tried to tell banks about this for a long time, and now all of a sudden it's going to cost a whole bunch of money."