Residential Properties (December 14, 2011), available at

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1 OCC Guidance Regarding Foreclosed Residential Properties 1. OCC Bulletin On December 14, 2011, the Office of the Comptroller of the Currency ( OCC ) published guidance on the obligations and risks associated with foreclosed residential properties that are applicable to national banks and federal savings associations in their roles as (i) an owner of a foreclosed property, (ii) a servicer or (iii) a securitization trustee. In Bulletin , Foreclosed Properties: Guidance on Potential Issues With Foreclosed Residential Properties, 1 the OCC directed such regulated institutions to institute robust policies and procedures to address the expanded operational, compliance, reputational and other risks that arise from acquiring title to properties through foreclosure. The principles embodied in OCC Bulletin reflect legal, safety and soundness, and community impact considerations, but the OCC recognized that an institution s actions may be subject to requirements established by Fannie Mae, Freddie Mac and the U.S. Department of Housing and Urban Development ( HUD ) as well as by separate contractual obligations in private securitizations. The guidance also institutes specific procedural and notice requirements for a decision by an institution to release a lien instead of foreclosing on a property, ostensibly to minimize the risk of community blight. OCC Bulletin complements the OCC s previous directives to national banks in OCC Bulletin , Foreclosure Management: Supervisory Guidance (June 30, 2011), 2 which we analyzed in an earlier memorandum to clients (OCC Supervisory Guidance Regarding Foreclosure Management Practices, dated July 7, 2011). As with the prior OCC release, we believe that the principles set forth in OCC Bulletin will shape the evolving industry standards governing the entire residential mortgage loan foreclosure and property disposition process. Consequently, the guidance is relevant for institutions other than national banks and federal savings associations, including non-bank mortgage servicers. Indeed, the standards set forth in the guidance may foreshadow future actions by the Consumer Financial Protection Bureau. Although OCC Bulletin by its terms applies to residential properties, the OCC noted that many of the principles also apply to commercial properties. 2. Obligations and Risks Related to Foreclosed Properties OCC Bulletin addresses an institution s obligations and expanded risks associated with foreclosed residential properties arising in three contexts: (i) as an owner of a foreclosed property, (ii) as 1 OCC Bulletin , Foreclosed Properties: Guidance on Potential Issues With Foreclosed Residential Properties (December 14, 2011), available at 2 OCC Bulletin , Foreclosure Management: Supervisory Guidance (June 30, 2011), available at

2 Page 2 a servicer or (iii) as a securitization trustee. The institution should identify these risks and ensure that its policies and procedures monitor and control such risks. A. Institution as Owner of Foreclosed Property When an institution becomes the owner of a foreclosed property (e.g., upon foreclosure of a mortgage loan held in the institution s own loan portfolio), OCC Bulletin highlights the institution s primary obligations for maintenance and security expenses, tax and insurance payments and landlord responsibilities with respect to rental properties. The OCC further emphasized the institution s duty to follow all legal and regulatory mandates (e.g., recordation of title in local land records, compliance with other real estate owned ( OREO ) appraisal and accounting requirements). This also includes adherence to restrictions on eviction under the Protecting Tenants at Foreclosure Act of 2009 (or any additional state law requirements that are not preempted by the Act), which imposes certain obligations upon taking title after foreclosure (e.g., honoring any existing rental agreement with a bona fide tenant and providing 90 days notice to the tenant prior to eviction whether or not the tenant has a rental agreement) and which may impose additional requirements with respect to rental properties (e.g., reviewing the lease to determine if the property can be shown to prospective purchasers and returning any security deposit upon termination of the rental agreement). Reflecting the importance that the OCC attaches to the community impact of residential foreclosures, the guidance also directs institutions to observe any requirements imposed by localities, a topical issue that we have recently described in various memoranda to clients for cities such as Cleveland, Ohio, Springfield, Massachusetts, Chicago, Illinois and, most recently, Las Vegas, Nevada. These requirements may range from the upkeep of residences to the registration of vacant properties. Additionally, an institution may incur important contractual obligations with financial implications, such as compliance with HUD property and preservation requirements to preserve the insurance claim and to obtain reimbursement for allowable expenses with respect to FHAinsured mortgages. With a direct financial interest in the property, the institution should maintain appropriate insurance on the property. OCC Bulletin also outlines various risks associated with the ownership of foreclosed property, which the institution should address in its policies and procedures. First and foremost, the institution must ensure adequate staffing to manage the portfolio of foreclosed properties. The OCC implicitly acknowledged that third-party vendors may supplement the institution s internal resources, but the institution s board of directors and management retain the responsibility to ensure that foreclosed properties are administered in a safe and sound manner and in compliance with applicable law. In short, the institution must apply the same risk management policies as if it were conducting the activities directly. The OCC has well-defined, longstanding guidelines for regulated institutions regarding the risk management principles governing vendor management and third-party relationships. 3 The guidance also emphasizes various financial-related exposures for an institution that are associated with foreclosed property. Such risks may arise in connection with the rehabilitation or improvement of foreclosed properties, where such expenditures for OREO are permissible if reasonably calculated to reduce any shortfall between the parcel s market value and the institution s recorded 3 See OCC Bulletin , Third-Party Relationships: Risk Management Principles (November 1, 2001), available at

3 Page 3 investment amount. 4 In this regard, institutions must adhere to applicable HUD requirements as well as local building codes and licensing requirements. When disposing of foreclosed residential properties, an institution should consider disposition costs and delays (e.g., advertising, broker or maintenance fees and repair costs) and financing for OREO properties that may result in unsafe or unsound concentrations (e.g., the sale of multiple properties to one borrower). The OCC also noted potential reputational risks if an institution favors cash investors over owner-occupants that require financing. In the sale or conveyance to HUD of foreclosed properties from FHA-insured mortgages, the institution must comply with HUD requirements to ensure receipt of insurance payments and other allowable reimbursements. The OCC also urged institutions to consider opportunities to participate in community initiatives, such as state and local land bank programs, neighborhood stabilization programs, redevelopment programs and other anti-blight programs, and opportunities to enhance owner occupancy. Finally, the OCC reminded institutions that they must dispose of properties within the established holding period. 5 B. Institution as Servicer of Foreclosed Property When an institution initiates a foreclosure in its capacity as a servicer of a defaulted mortgage loan, OCC Bulletin states that the institution will incur many of the same responsibilities described above for an owner. These obligations may arise under the Fannie Mae or Freddie Mac servicing guides or under contracts governing the servicing of the mortgage loan (e.g., a Pooling and Servicing Agreement in a private securitization). As a servicer, the institution may be required to advance funds (some or all of which may be reimbursable) for expenditures such as taxes, insurance and homeowners association dues, in addition to maintenance and security expenses. These obligations may extend to the rehabilitation, maintenance and marketing of foreclosed properties, even if performed on a limited basis (e.g., routine upkeep, such as winterization) for Fannie Mae or Freddie Mac for an interim period of time. The servicer may also be responsible for maintaining appropriate insurance on the property and filing claims with mortgage insurers. In all cases, the institution should adhere to the requirements of the applicable servicing guide or contract. These servicer responsibilities may include the registration of foreclosed properties, properties in foreclosure or vacant properties in accordance with local ordinances as well as compliance with the Protecting Tenants at Foreclosure Act of 2009 or other applicable state laws that safeguard tenants from eviction from rental properties upon a foreclosure. Similarly with respect to risks, an institution acting as a servicer should possess sufficient staffing and appropriate third-party vendor oversight to manage the portfolio of foreclosed properties. Although, the rehabilitation of foreclosed properties should comply with local building codes, licensing requirements and any contractual obligations, OCC Bulletin states that the disposition of foreclosed properties may nonetheless entail reputational and litigation risks for the institution. From a financial perspective, the institution may be required to advance funds for valuing and marketing the properties and addressing defects found at inspection, although such advances should ultimately be recoverable. As in the ownership context, the OCC urged institutions acting as servicers to consider opportunities to participate in community initiatives, such as state and local land bank programs, neighborhood stabilization programs, redevelopment programs and other anti-blight programs, consistent with the applicable servicing agreements. 4 See 12 C.F.R See 12 C.F.R

4 Page 4 C. Institution as Trustee of Securitization Trust Holding Title to Foreclosed Property When an institution acts as the trustee of a securitization trust, OCC Bulletin notes that the institution incurs contractual obligations that include ensuring the timely receipt of payments from the servicer, calculating payments, remitting payments to investors, circulating information to investors, monitoring compliance and determining if an event of default has been triggered. Although the OCC acknowledged that the contractual agreements generally do not grant the trustee any powers or duties with respect to the foreclosure or the maintenance, sale or disposition of foreclosed properties, OCC Bulletin nevertheless instructs the institution, as trustee, to work with the servicer to ensure the performance of its responsibilities, to the extent permitted by the applicable contract. The OCC observed that an institution, acting as a trustee, may be subject to reputational and litigation risks from a servicer s foreclosure actions taken in the name of the trustee. In the case of a servicer termination, the institution, as trustee, may also be subject to credit risk if it must act as a replacement servicer on an interim basis until a successor servicer is appointed. 3. Releasing a Lien Rather Than Foreclosing In a separate section of OCC Bulletin , the OCC addressed the discrete issue of a lender s decision to release a lien securing a defaulted loan instead of foreclosing on the residential property. The OCC noted that this is typically a financial decision when the institution determines that the costs to foreclose, rehabilitate and sell a property exceed its current fair market value. Moreover, the OCC observed that, when this decision occurs after the initiation of a foreclosure proceeding, the borrower may have abandoned the property or discontinued care and maintenance, increasing the likelihood of a blighted property in the community. In turn, this may expose the institution, either in its capacity as a prior mortgagee or as a servicer, to reputational and litigation risks related to the abandoned property. Consequently, OCC Bulletin directs institutions to ensure that their valuation of the property provides the best information practicable, while complying with investor requirements, before initiating foreclosure and subsequently deciding to release the lien and includes new notice requirements: If the decision is made to forego foreclosure and release the lien, the bank or servicer should notify, or attempt to notify, the borrower of the decision. Borrowers should be notified that (1) the mortgage holder is not pursuing foreclosure and has released the mortgage lien, (2) the borrower may continue to occupy the property, and (3) the borrower is obligated to maintain the property consistent with all local codes and ordinances and to pay property taxes and the debt owed. The bank or servicer should also make appropriate notifications to the local jurisdiction when it makes the decision to release a lien in lieu of foreclosure. These additional requirements would apply to an institution acting with respect to a loan held in its own portfolio as well as with respect to a loan that it services for a third-party investor. *******

5 Page 5 Please be advised that we are not members of the Bar in any jurisdiction other than New York, New Jersey, Pennsylvania and the District of Columbia, and we are not licensed to opine on matters in jurisdictions other than New York, New Jersey, Pennsylvania and the District of Columbia. Please call Stephen F.J. Ornstein at (202) , Scott D. Samlin at (212) , or William W. Carpenter at (202) if you have any questions regarding this information.