Slow Loan Resolutions Extend Shadow Inventory's Staying Power
Given the pace of defaults during the housing downturn, the market’s inability to quickly absorb the excess volume has created a large “shadow inventory” – which S&P defines as outstanding properties whose borrowers are 90 days or more delinquent; properties currently or recently in foreclosure; and properties that are owned by the lender but have not yet been resold, or REO.
S&P also factors in 70 percent of properties on which the mortgage delinquency has recently been cured through a modification. Diane Westerback, managing director at S&P, explained that these properties are included in the agency’s shadow inventory equation because based on historical performance trends, S&P expects 70 percent of modified loans to eventually re-default and again become part of the industry’s distressed property supply.
Because of the sheer magnitude of foreclosed homes either on the market or waiting to be remarketed for sale, the company’s analysts warn that their estimate for how long it will take to clear the backlog continues to grow.
Based on data through the end of the third quarter of 2010, S&P puts the principal balance of the nation’s shadow inventory of distressed homes at more than $450 billion – a log jam that will take 44 months, or more than three and a half years, to clear from the market.
Westerback says the historical average of shadow supply overhang is a little more than a year and a half, around 20 months. “Our estimate for the average time to clear these properties in the U.S. has increased by about 25 percent since the start of 2010 and increased 7 percent between the second and third quarters,” S&P says.
In its Q2 2010 report, S&P put the industry’s shadow inventory at $460 billion. The fact that the agency’s purge timeline keeps growing while the size of the shadow supply is decreasing suggests that a sluggish sales pace and diminished consumer demand are factoring strongly into the dynamics.
But Westerback says the drawn out clear-time is also because lenders are taking longer to foreclose on properties that have been languishing in the seriously delinquent bucket for months on end. She says there’s been a lot of pressure to “slow down the machine.”
“What really concerns me most about the servicers,” Westerback said, “is that the percentage of loans in the 90-plus day delinquency bucket but not yet in foreclosure is almost equal to the percentage of loans that are in the process of being foreclosed.”
“So my concern is, why aren’t servicers pushing those into the pipeline,” Westerback questioned, referring to the growing volume of loans that are already more than three months past due and in default.
“One would hope there’s some ray of hope on those loans, although we’re not really seeing that in terms of cure rates,” she continued. According to Westerback, it seems servicers are simply “delaying the inevitable and pushing the timelines out until there’s more stability in the market.”
Westerback notes that there is a “capacity problem in the industry,” but she says the capacity is not just with the servicers, but also with the courts.
Westerback also points out that S&P’s $450 billion, 44-month shadow inventory does not include agency, or Fannie Mae and Freddie Mac, mortgages. She says the order of magnitude is about the same in the agency space, which is about one-third of the market currently outstanding.
The government’s push to emphasize modifications means most servicers have backed up from foreclosing, Westerback says, which has had a net effect of slowing up the flow of loans to resolution.
But based on the number of delinquencies that are actually cured and their post-modification performance, she says mod penetration alone is not going to solve this overhang.
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