As the country continues to relax restrictions that were put in place to mitigate the spread and impact of COVID-19, many mortgage lenders are wary of a potential flood of bankruptcy filings that are looming on the horizon.
The actual extent of the filings to come, as well as which sector will experience the greatest impact, is difficult to project as the current situation lacks any counterparts with which it can compare.
Here are some things that we do know:
Increased Bankruptcy Filings Are Likely
Increases in unemployment and mortgage delinquencies are typically good indicators of increased bankruptcy filings. Our nation is currently faced with unemployment levels that we have not seen since the Great Depression. Furthermore, delinquency rates have spiked in recent months for both residential and commercial loans. However, the number of bankruptcy filings is substantially lower now than they were in 2019, with individual filings down 34% and 28% for business filings.
Rent Payment Defaults Did Not Drastically Increase
The infusion of trillions of dollars into the economy in the form of federal stimulus payments, expanded unemployment, and other government aid programs has helped to keep consumers and businesses afloat, despite a shutdown of a significant part of our economy, including devastating hits to the retail and restaurant industries. A key sign that the stimulus is helping can be found in the nominal year over year change in the number of payment defaults by renters (over the first two weeks of May 2020, there was only a 2.1% decrease in the percentage of tenants who paid rent over the same period in 2019). The performance is despite near record unemployment and suffering experienced by the retail and hospitality industries. It seems likely that unless there is an additional infusion of funds and/or the expanded unemployment benefits, which lapse at the end of July, are continued, rent defaults will spike. The spike in rent payment defaults will further spur mortgage payment defaults by private investors who own rental properties.
Evictions and Foreclosures Are Likely Once Moratoriums Are Lifted
The moratoriums placed on evictions and foreclosures by various levels of government have eliminated the urgency felt by many to file bankruptcy. An imminent eviction or foreclosure is a strong incentive to file bankruptcy. Once the moratoriums are lifted, it is not much of a stretch to anticipate that evictions and foreclosures will be commenced at a never seen before rate, which will in turn drive the number of bankruptcy filings through the roof. Adding to the problem is that many of the eviction moratoriums include rent deferrals, with all accumulated rent being due upon the lifting of the moratorium or within a specified number of months.
The Current Economic Conditions Were Created by Stay-at-Home Orders
Unlike many other economic downturns, the current economic conditions have been artificially created by stay-at-home orders. The hope is that as states continue to open, businesses will reopen, unemployed individuals will go back to work, and consumers will begin spending money. The speed and extent of economic recovery is unknown, but many feel that unemployment will remain elevated for some time.
Resiliency Is Key
The only thing we know for sure is that we are resilient, and we will get through this.
There are many things that we are facing that are out of control. Therefore, rather than dwell on the unknown, it is time to focus on what can be done to prepare for the potential flood of bankruptcy filings, including filings by borrowers.
An ounce of prevention is worth a pound of cure. The best way to avoid being a secured creditor in a bankruptcy is to work with a defaulting borrower to rehabilitate the borrower’s performance so the loan can reperform.
If you are interested in strategies on how to deal with the defaulting borrower see our previous articles on Forbearance Agreements 101, Modification vs. Forbearance in the Age of COVID-19, and How Commercial Lenders Should Navigate this Mortgage Crisis.
Sometimes a loan workout is not a possibility, so it is important to ensure that all of the ducks are in a row. Here are some steps that a mortgage lender can take to mitigate the impact of bankruptcy filings (many of these hold true regardless of the condition of the economy and our nation as a whole):
- Review loan terms and make sure that you have all relevant loan documents to support your claim.
- Ensure that you have a clear chain of assignments to support your ownership of the loan.
- Compile and review payment history to ensure compliance with the loan terms, including application of payments and assessment of fees and costs, conditions to charging default interest, and notice requirements.
- Compile and review servicing history, including any correspondence with borrower and borrower’s representatives, and internal notes concerning conversations with the borrower.
- Determine whether the borrower has previously filed for bankruptcy relief, and if so, when and where.
- Obtain a valuation of the property (ideally an appraisal should be obtained).
Consult with an attorney with substantial bankruptcy expertise. Experienced counsel will be able to guide you through the unsure waters of bankruptcy and ensure that you will be able to recover all amounts owing to you to the fullest extent available.
While nobody knows for sure what the future will hold, it is more likely than not that there will be an increase in rent and mortgage payment delinquencies, evictions, foreclosures, and bankruptcies. In these uncertain times it is critical for every business, especially lenders, to protect its investments to the greatest extent possible, and to maximize collection of outstanding balances owing. The best way to do the foregoing it to partner with an expert that understands your business, your industry, and the laws impacting them.
by DENNIS R. BARANOWSKI, ESQ. GERACI Law