Part I: Impact on inventories lags foreclosures
By Matt Carter, Monday, January 26, 2009.
Inventories of unsold homes are likely to swell in coming months as lenders begin to push a growing backlog of repossessed homes up for sale -- often in communities already awash in distressed properties.
While builders have cut back drastically on the production of new homes, it's likely lenders will soon be putting pressure on inventories even if they succeed in efforts to keep more troubled borrowers in their homes rather than foreclosing on them.
Because it can take weeks or months for lenders to put repossessed homes on the market, the impact of real estate-owned (REO) properties on inventories lags behind foreclosures. Government efforts to recapitalize banks through the Troubled Asset Relief Program (TARP) and other bailout measures may also have taken some of the heat off of lenders to unload REO properties at fire-sale prices.
But with the emphasis of TARP and other government relief efforts now expected to shift to creating jobs, helping troubled borrowers avoid foreclosure and providing incentives for home buyers, lenders could soon unleash a torrent of real-estate owned, or "REO" properties -- even in markets already flooded with an oversupply of homes for sale.
"It's almost like a tsunami -- you can see it coming and you know it's going to hit but you can’t get out of the way," said Ann Stickel, vice president of affiliated services with Sarasota, Fla.-based brokerage Michael Saunders.
The value of REO property on the books of FDIC-insured banks at the end of the third quarter surged 21 percent from the previous quarter, to $23 billion. That total -- which includes single-family to four-family homes valued at $11.5 billion and another $1.5 billion in property purchased with FHA-backed loans securitized by Ginnie Mae -- represents a 134 percent increase from a year ago, according to the latest quarterly report from the Federal Deposit Insurance Corp.
Repossessions by Fannie Mae and Freddie Mac grew by nearly 25 percent from the second quarter to the third quarter of 2008, hitting 15,196 homes, according to a recent foreclosure prevention report by the Federal Housing Finance Agency (FHFA). With Fannie and Freddie repossessing homes faster than they could sell them, the companies were left with 95,553 REO properties to dispose of at the end of September -- a 25.5 percent increase in just three months.
Not all of those homes are in areas hard-hit by speculation and subprime lending, either. About six out of 10 homes in Fannie and Freddie's REO inventory were purchased with prime loans available only to borrowers with good credit.
Fannie and Freddie both stopped foreclosing on loans they own over the holidays (Fannie's moratorium is in effect throughout the end of January and several states have passed legislation that's intended to slow down the foreclosure process. Lenders are also stepping up their efforts to do workouts and loan modifications with troubled borrowers, rather than foreclosing on them.
But those measures may only be slowing down the foreclosure process for many borrower, and the downturn in the economy and rising job losses have many convinced that foreclosure filings will continue to rise.
President Obama is promising Congress that $50 billion to $100 billion of the next round of TARP money will be committed to foreclosure-relief programs aimed at reducing mortgage payments for troubled borrowers, and broadening the scope of FHA's little-used "Hope for Homeowners" refinance program.
With more than half of the loans modified by lenders in the first half of 2008 already in default again, it's clear that lenders will have to take the more drastic step of reducing the principal balance to make loan mods work, said Sean O'Toole, founder and CEO of ForeclosureRadar, a company that tracks California homes through the foreclosure process.
Forgiving loan principal is something lenders and loan servicers haven't been very willing to do so far, O'Toole said -- in part because of the potential for legal objections by investors who own the securities many mortgages were packaged into.
"We likely have $4 trillion in bad mortgage debt created created during a period of inflated home prices," O'Toole said. "Any program that doesn't directly deal with eliminating that debt only delays the inevitable and makes this problem worse. Foreclosure remains the only working mechanism for clearing this bad debt at the moment."
If lenders aren't willing to do more meaningful loan modifications, Congress could give bankruptcy judges the power to "cram down" loan principal -- a bad idea, lending industry critics say, because that's likely to raise the cost of borrowing for all home buyers. Another idea is for the government to provide incentives to servicers or guarantee a portion of lender's losses when they agree to do loan modifications that involve principal write downs.
Some states have also attempted to address foreclosures, with limited success. O'Toole has been monitoring the impact of a California law, SB 1137, like similar statutes in other states including North Carolina, Maryland and New Jersey, is intended to slow down the pace of foreclosures by creating new hoops for lenders to jump through.
California's law, which requires lenders to reach out to homeowners and extends the waiting period before initiating foreclosure proceedings, put a significant dent in notice of default filings.
In the process of acquiring troubled rivals, banks may write down the value of some of the bad loans on their books. Once the loans are written down -- often to as little as 20 cents on the dollar, Olshin said -- some of the pressure to foreclose on properties and sell them is gone.
"The loans are being carried for what they are worth, and they think there's upside potential" to hold onto properties and sell them when prices rebound, Olshin said. "We think there's not an upside potential -- that we're going to be in this problem for awhile."
Lenders are trying to stretch out some of their losses, and avoid the need for massive new reserve funding when possible, said Norm Miller, a professor at the Burnham-Moores Center for Real Estate at the University of San Diego. At the same time, Miller said lenders are "overwhelmed with the sheer volume of defaults which may turn into foreclosure."
Auction boom
Regardless of any pullbacks by lenders, Tranzon and other auctioneers had a banner year in 2008, and expect this year will be even better.
"I think we'll see a lot more properties moving to auction as banks realize they need to sell at the market price," Olshin said.
Real Estate Disposition LLC (REDC), which claims to be the nation's largest real estate auction company, held 300 ballroom auctions in 2008 and sold nearly 33,000 foreclosed homes for $3.4 billion -- a seven-fold increase in sales volume and nearly triple the proceeds the company generated in 2007.
Company CEO Jeffrey Frieden said he expects to "smash that record" this year as banks and lenders continue to amass a huge inventory of foreclosed homes and are more motivated than ever to sell their inventory.
"I'd say all of the top 10 loan servicers have an auction strategy in place, and that between 5 and 15 percent of the (REO) portfolio is sold through auction," said Michael Davin, president and co-founder of Hermosa Beach, Calif.-based discount brokerage CataList Homes Inc.
CataList, which provides marketing and transaction management expertise for sellers, is a partner with the Los Angeles Times Media Group and others in Zetabid, an online auction marketplace for bank- and builder-owned properties.
Industry groups like the National Association of Realtors, the Mortgage Bankers Association and the National Association of Home Builders have been pushing for more emphasis on incentives for buyers, such as tax credits, subsidized interest rates, and higher loan limits for Fannie, Freddie and FHA loan guarantee programs.
But O'Toole thinks such subsidies were what "got us into this trouble in the first place. Subsidies may increase demand, and in the case of subsidized interest rates might even increase prices, but for how long?"
Some observers fear that if the massive amount of debt the government is taking on to stimulate a recovery, inflation -- and higher interest rates -- are inevitable consequences. Inflation can spur home sales because households are looking for an inflation-proof place to park their assets.
But rising interest rates can also reduce consumer's home-buying power, undermining prices. If interest rates shoot up, buyers who close a deal on a home with a subsidized mortgage could see the value of their homes plummet when subsidies end and interest rates shoot up.
"Unless we want to continue the foreclosure cycle, we need to return to traditional home-buying practices -- with qualified buyers, in affordable homes, at market interest rates," O'Toole said.
Stickel said she is all for programs aimed at preventing foreclosures and keeping troubled borrowers in their homes, because that would help check falling home prices.
"I really think if we can just keep people in their homes, we're going to do wonders for stabilizing our market," Stickel said. "I don't know if that's what a real estate agent wants to hear -- that if I can keep someone in their home, then I can sell a home."
But Stickel thinks a strategy emphasizing foreclosure prevention would actually produce a healthier environment than a market glutted with REOs, because stemming foreclosures would limit the carnage among lenders and get buyers off the fence.
From his perspective in Oakland, Calif. broker-owner L.J. Jennings said the key to stabilizing neighborhoods hit hard by speculators and foreclosure is to get properties in the hands of homeowners, rather than investors. That means bringing homes up to livable condition, or providing loans that provide the funds for buyers to make repairs on their own.
Jennings, whose Pyramid Real Estate and Investments specializes in REO properties, also wants to see more TARP money channeled directly into foreclosure relief -- including government guarantees of loan modifications -- rather than used to prop up banks' bottom lines.
"Let's hope the next round of TARP reaches consumers," Jennings said.