Patent Application
20140164216
This disclosure relates generally financial instruments for large assets, such as houses, which are typically arranged through mortgage financing.
Mortgages are typically used to arrange financing for both consumer housing and commercial real-estate. Typically the property purchaser will arrange financing through a bank to acquire the property in exchange for a loan instrument in which the borrower makes payments over a period of time (such as 30 years) to pay off the debt as per the loan agreement. Sometimes the borrower is unable to make the payments. In these cases the lender may force the sale of the home (asset) to recover the principal of the loan or the lender may repossess the home. However this can only work when the property is worth more than the amount borrowed if the property has devalued or the market for such assets has collapsed then the lender may be unable to sell the property without sustaining a large loss of principal. Such was the case of the 2008 financial crisis. In this scenario borrowers were often “underwater” meaning that the amount that they owed was substantially less than the amount the property would fetch if sold on the open market. While per se this would not affect the loan arrangement between a homeowner/borrower and the lender, if the borrower could not make payments the following conundrum would ensue. Since the lender has the right to claim the property (through the foreclosure or short-sale process) the lender could take the property back from the delinquent borrower and then sell the home for what the market would bear. However since the whole market had also collapsed this meant that the lender would not be able to make reclaim the principal amount borrowed. During a normal time the lender would make back their principal amount but here the lender would also be realizing a loss. A secondary effect also developed—since the market was depressed whole neighborhoods would find themselves with distressed houses which were abandoned moving the problem from being one of a few bad home-buying arrangements to a neighborhood wide blight.
It is in societal interest to have a financial system which is strong in that it allows proper home purchasing and also a social system which is strong which allows neighborhoods to remain intact regardless of the price of homes in general on the free market. Related to the 2008 crisis was improper home lending practices and a “bubble” of home valuation which exacerbated these problems for lenders, borrowers, and neighborhoods. Several solutions were proposed either from government agencies or societal pressure to either forgive loan principal amounts, reduce financing terms (e.g. lower existing loan interest rates), or short sale properties.
Any of the interventions would work if either the home was appreciating as in most normal market conditions or if the loan amount outstanding meant that the parties could be made whole by simply selling the property. At a societal level three broad hazards exist if too many distressed properties enter the market at the same time. The first hazard is the market for such assets will collapse causing a severe price downturn for such assets. This can be viewed as a simple market correction for the asset category, in this case the housing market. However the next two concerns are much broader and can literally destabilize an economy or even a neighborhood or society. The issue of moral hazard is that by forgiving distressed loan principal amounts or providing related outside assistance that distressed loan arrangements are rewarded while those making good on their payments are effectively penalized because they are not eligible for the assistance given to their distressed counterparts. This can encourage borrowers in good stead to demand a deal comparable to their distressed peers further collapsing the market and encouraging “bad” behavior from a socio-economic point of view. The issue of social hazard occurs when society does not find a way to deal with a market collapse gracefully essentially resulting in bankrupted neighborhoods with large tracts of abandoned or neglected houses—in other words simply doing nothing and waiting for a market to fix itself can cause severe lasting damage to areas.
The invention described herein provides a way for borrowers and lenders to work together, without outside financial assistance (such as government funds for principal forgiveness) to work out a payment mechanism which minimizes both the moral and social hazards as described.
a represents different scenarios under which a PABS can exit from holding a particular property in its pool. In box 410 which represents asset exit scenario 1, the borrower elects to buy the remaining portion of their property. This gives cash to the PABS while the borrower finances the asset (remaining portion of their home) using conventional financial instruments such as home loan. Box 420 represents a scenario where the entire property is sold on the open market and the proceeds of the partial asset from the sale are provided to the PABS holders. Box 430 represents a scenario where the Partial Asset is sold to other concerns, for example another PABS agency.
In
If the buyer is distressed for any reason and can't make the payments and also the amount the house will sell for is less than the outstanding loan balance then selling the house leave the buyer with a debt. As mentioned in the background section, this is where the present method can be used to help both the home buyer keep their home and also minimize losses for the lender. In
In the example described herein, we will consider a typical homebuyer called Joe and his Bank. This also describes the preferred embodiment of the invention.
Joe bought a house for $200K in spring 2007, with no money down and had an interest only loan at 4%. This resulted in payments of $667 per month. Now he is at the end of the interest only portion of his loan (and hasn't paid down any principle) and his interest rate has reset to 6%. Since he will start to pay principle his resulting payment is $1199 per month. He can't afford the new payments and to make matters worse the value of the house is now approximately $130K. Since he still owes $200K he is $70 k underwater which represents 35% of outstanding loan principal should he try to sell it on the open market. If he defaults, turning the property back to the bank, then the bank would be forced to sell the house at approximately $130K taking net loss on principle less payments paid to date.
Rather than having the bank rent the house back to Joe (a current Bank of America program) or forgiving principal, Joe and the Bank refinance his property using a Shared Risk Asset Financing (SRAF) arrangement.
The Bank and Joe agree to reset Joe's loan to $120K (this amount can be chosen by the Bank and Joe for optimality). This represents 60% of Joe's original loan and as we will discuss in a moment, allows for refinancing to a portion he can afford. The other $80K of Joe's original loan will now convert into a percentage ownership share of Joe's property which will be held by the bank. In this case, $80K represents 40% of the original loan and hence converts in to the 40% share of the property. This results in the following:
This allows Joe to make his payments while allowing time for the property to appreciate. Should the property be sold, Joe will receive 60% of the sale and the Bank will receive the other 40%. The longer Joe can stay in his house the more likelihood that the home will appreciate putting both Joe and the Bank ahead.
Ten years from now Joe decides to buy the remaining portion of his home. Using one of several appreciation schedules (more on this later) the Bank's portion has been allowed to grow at 5.3% (same rate as Joe's loan). This results in the bank's portion now being worth $134,083. Joe can finance to purchase the Bank's equity with a standard loan product at that time. We will also look at options for when the Bank does not want to hold the equity portion of Joe's home in more detail.
This also allows the following objects and advantages:
This solves the first portion of the problem—working out a payment system which Joe can afford without resorting to selling the property when the market for such properties is distressed. However the Bank is now holding a portion of Joe's house which is illiquid. A tenet of the bank loan process is that the banks try to minimize illiquid assets so that they can free their cash to sell other loan and financing instruments.
Joe's house is an asset and the bank owns a partial asset (since it only owns a portion of Joe's house). In a normal loan, once the payments are completed the bank has all its money back and hence can invest its capital in other ways. To allow the bank to exit this illiquid asset we must introduce a way for the bank to sell its ownership stake in Joe's house to an outside investor. We will call the bank's portion of Joe's house a Partial Asset as it represents a fractional ownership share of Joe's house. What is now introduced is a to sell this Partial Asset so that the lending institution can maintain liquidity. In box 500 we see this process take place. The lender can sell its Partial Asset to investors. The amount the lender will receive is solely dependent on the negotiation with investors who may demand a premium or pay below what the partial asset was originally valued at when the Joe originally bought the house and arranged financing. However for the lender, even if this sale is at discount valuation compared to what the Partial Asset was worth when the home was originally purchased it still represents substantially less loss than should the entire property have been short sold or foreclosed. For the investor it provides a secured asset which if left over a longer period of time should appreciate when market forces allow the property to be sold under non-stressed (normally functioning) conditions.
In fact many of these partial assets can be bundled in to a security which we will call a Partial Asset Backed Security (PABS). While conceptually similar to a Mortgage Backed Security (MBS), where bundles of loans/mortgages are sold as investments based on loan repayment, in a PABS is backed by the actual property ownership. However the as the name implies, the PABS is only a ownership portion in a part of Joe's house. When the bank sells this ownership stake as an investment (Partial Asset), it receives cash just as if Joe had paid off the partial parcel.
The PABS acts like any pooled investment vehicle however instead of a mutual fund which owns stocks, the instrument of trade is partial assets. When Joe sells his house on the open market then the PABS receives the proceeds based on Joe's SRAF arrangement. A PABS can even re-sell a given asset on the open market to another investor for whatever price they (the PABS and investor) agree on without affecting Joe's SRAF arrangement. At any time Joe can opt to buy the rest of his home from the then-current investor per his SRAF contract appreciation schedule.
Should Joe exit his SRAF agreement early (e.g. less then a year and the property is still in distress) the SRAF may have liquidation preferences written in for the partial asset holder whether this is the SRAF lender with whom Joe worked or whether it is an unrelated owner of the Partial Asset.
Lastly a large institution (e.g. Wells Fargo or Bank of America), may have both banking and investment arms. Here the banking arm can refinance the loan using the SRAF system and then sell (even at a loss) the partial asset to a PABS in the investment arm. The SEC requires banks to have minimum financial strength measures so by moving the Partial Assets from the banking arm to an investment arm it will be easier for the bank to document its liquid financial strength to regulators. The investment arm, which has different capital requirements, simply maintains ownership of the asset as it would any other commodity.
Although certain methods, apparatus, systems, and articles of manufacture have been described herein, the scope of coverage of this patent is not limited thereto. To the contrary, this patent covers all methods, apparatus, systems, and articles of manufacture fairly falling within the scope of the appended claims either literally or under the doctrine of equivalents.
This patent claims the benefit of U.S. provisional patent application No. 61/646,912, filed on May 15, 2012, which is hereby incorporated herein by reference in its entirety.
| Number | Date | Country | |
|---|---|---|---|
| 61646912 | May 2012 | US |
