Inventory of Foreclosed Homes Will Take Almost Three Years to Clear

GSIG LLC

According to a report from the credit rating agency Standard & Poor’s, distressed mortgages facing foreclosure as well as the “shadow inventory” of bank-repossessed properties, will take nearly three years to clear at the current sales rate. The analysts conclude that during this period, many servicers will likely alter their emphasis from mortgage modification to loan liquidation.

The “shadow inventory” of homes consists of delinquent loans and real-estate owned (REO) properties that have not made it on the market. Amherst Securities estimates the total number of homes in this “shadow inventory” at 7 million, while The Royal Bank of Scotland estimates it at 2.7 million, and First American CoreLogic estimates it at 1.7 million.

Standard & Poor estimates the inventory to equal a 33-month supply of homes. However, analysts insist the estimate is actually conservative, as they did not assume homes not showing signs of distress would default and push the overhang of supply even further.

Furthermore, due to political pressure, court delays and servicing backlogs, the flow of foreclosures hitting the market has slowed to a trickle. The delinquent borrowers who have not received a foreclosure, increase the “rapidly” growing shadow inventory of properties.

The report states: “Overall, it is our opinion that recent positive housing reports should not be construed as a sign that the distress in the residential housing market is abating, but rather should be attributed to the temporarily limited supply of homes on the market.”

Moody’s, another credit rating agency, showed that the underwhelming performance of the Home Affordable Modification Program (HAMP), which the US Treasury Department launched in March 2009, will drive down housing prices another 8% from Q409 to the end of 2010.

According to the report, it will take 29 months to clear this supply of homes. Homes are falling into serious delinquency faster than REO transactions are closing. The total balance of seriously delinquent loans reached well over 400 billion dollars through November 2009, while the balance of REO properties reached its peak in September 2008 and declined to 50 billion dollars. On average, 14.5 billion dollars of seriously delinquent loans or REO property liquidates each month.

The other four months worth of supply comes from re-defaults on delinquent loans currently cured – or brought back to current status through a loan modification. Following current trends, S&P analysts predict that 70% of the cured loans will re-default. The total balance of these re-defaulting loans and the current amount of serious distressed loans will reach 473.4 billion dollars, nearly 30% of the total outstanding balance on all privately securitized loans.

“We believe that the recent constriction in the supply of foreclosed homes on the market is a temporary one,” claim the analysts.

With the launch of HAMP, servicers shifted strategy from modification to liquidation. The amount of loans that progressed from seriously delinquent to REO fell to 28% in Spring 2009 from 58% in June 2008. In that time, seriously delinquent loans that cured went from 32% to 58%, according to the report. But analysts found that this shift was only temporary.

“Loan modifications and the observed extension of time distressed loans remained as such may simply have delayed the inevitable, creating the demonstrated shadow inventory of troubled loans,” they wrote. “Ultimately, the majority of the properties these distressed loans represent will likely have to be liquidated.”