How will lenders liquidate their foreclosures?

This year lenders drastically reduced the number of REO they are getting at auction. The numbers are down 62% over this time last year. Further, they have reduced their MLS inventories by nearly 20% from last year’s levels. Apparently, lenders are going to continue to reduce MLS inventory until prices bottom to reverse the two-year slide.

This unexpected change is a desperate move to stop the market’s downward spiral. It means we will likely see depleted MLS inventories through the spring selling season and into the fall. At that point, the new crop of REOs from today’s default notices will enter the market. Lenders are hoping positive momentum from the spring rally will carrry them through the winter. I have my doubts.

Will this engineered bottom hold?

I don’t believe market interventions work. I kept writing throughout 2009 and 2010 that the bear rally was going to fizzle out because it was not stable. The bottom was based on tax credits, reduced supply, and artificially low interest rates. Many wrote me off as a perma-bear, but in reality, I saw the forces at work were much larger than the feeble efforts to move the market.

The tax credit props are gone, but the artificially low interest rates remain, and this time, lenders are even more aggressive about withholding inventory. Lenders probably can cause a short-term reversal in the price trend by withholding inventory, but they will never be able to sustain upward momentum given the huge supply of shadow inventory waiting to be liquidated — at least not if they want to sell their holdings in the next decade.

There are some markets where the false bottom may be durable. The most beaten down markets with the greatest affordability have the most chance of sustained appreciation. Markets like Phoenix and Las Vegas which are undervalued by 40% or more relative to historic norms have plenty of room for buyers to raise their bids. Unfortunately, these markets also have the largest reservoirs of shadow inventory due to strategic default from deeply underwater owners. Markets like Orange County which are only now reaching rental parity are less likely to bottom now because buyers have far less room to raise their bids, and much of the shadow inventory here is at the high end. The lowest rungs of the housing ladder may bottom, but the high end will continue to crumble no matter what lenders do.

Short Sale and REO workshop, Wednesday April 18, 2012, 6:30 PM

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Flood of foreclosures to hit the housing market

By Les Christie @CNNMoney April 13, 2012: 5:33 AM ET 

NEW YORK (CNNMoney) — The golden age for foreclosure squatters may soon be coming to an end now that the $26 billion mortgage settlement has been approved. …

Lenders hit the pause button on foreclosures because they “were afraid that anything they did would be under a microscope,” said Eric Higgins, a professor of business at Kansas State University.

As a result, borrowers who were seriously delinquent on their loans have been able to stay in their homes for months or even years without making a single payment. Nationwide, the average time it takes to foreclose on a home — from the first missed payment to the final bank repossession — stretched to 370 days during the first quarter,almost twice as long as it took five years ago, according to Daren Blomquist, the marketing director at RealtyTrac.

In some states, delinquent borrowers have been squatting in their homes much longer. In Florida, the average time was 861 days, and in New York it was 1,056 days — close to three years.

“Perhaps a million foreclosures could have been pursued last year but weren’t,” said Rick Sharga, executive vice president for real estate investment company, Carrington Holdings.

But that’s all about to change, he said. “We’re going to see an increase in the speed of foreclosures and a higher number of foreclosure starts.”

Notices of default have been rising all year, but notices of sale have been dropping, particularly since the start of 2012. Lenders are trying to reduce their inventory by not acquiring more right now.

In fact, there are indications that the pace of foreclosures are already starting to pick up.

While overall foreclosure activity was down during the first quarter, filings were up 10% in the 26 states where foreclosures must undergo court scrutiny, according to RealtyTrac.

You can see the false bottom being engineered in the two graphs above. Lenders consciously decided to stop taking back properties this spring to limit supply; however, they are also gearing up to take back more this summer by increasing their NODs.

The result of this precipitous decline in REO may be a false bottom this year — that remains to be seen — but it certainly means an increase in delinquent mortgage squatting. The decline in foreclosures is not because lenders have run out of delinquent borrowers to foreclose on. Lenders are simply allowing them to squat longer to manage their own inventories of REO.

It was in these judicial states that the processing of foreclosures slowed the most following news of the robo-signing scandal, said Blomquist.

Many banks in these states stopped filing foreclosures unless they were extremely confident it would pass muster in the court. (In non-judicial states, foreclosures are reviewed by a trustee, which is a third party such as a title company and less likely to parse every legal document).

But now lenders can move more confidently, said Brandon Moore, RealtyTrac’s CEO.

In the judicial state of Indiana, for example, foreclosure filings were up 45% year-over year. And in Florida, they were up by almost 26%, according to RealtyTrac.

The dam may not burst in the next 30 to 45 days, but it will eventually burst, and everyone downstream should be prepared for that to happen — both in terms of new foreclosure activity and new short sale activity,” Moore said in a statement.

The effect will be strongest in the judicial foreclosure states. So far in the non-judicial forclosure states of California, Arizona and Nevada, the numbers of REO are declining.

The resulting flood could bring home prices down even further — yet another impetus for the banks to clear out their foreclosure pipeline as quickly as possible, said Kansas State’s Higgins.

Then, industry thinking is, the housing market would be able to get back to normal and home prices could eventuallyfind their true value. Some industry analysts, such as the chief economist for listing site Zillow, Stan Humphries, are predicting that could happen as soon as the end of the year.

Zillow estimates that home values nationwide will fall another 3.7% by the end of 2012, and that price will likely bottom out by early 2013.

The way it looks now, we may get a false bottom in the non-judicial foreclosure states while prices plummet in the judicial foreclosure states like Florida and New York. We are still due for another period of declining prices here in the southwest as REO processing picks up again.

Should home prices hit a bottom then stabilize, it would push many potential buyers off the fence, according to Mike Fratantoni, a vice president at the Mortgage Bankers Association. House hunters would no longer be afraid of investing in assets that were losing money.

“The market is already on the verge of turning the corner on prices and this will help,” said Fratantoni.

Mr. Fratantoni echos the wishful thinking of all bankers he represents. Lenders honestly believe rising prices will be self fueling. Further, they must also believe legions of buyers are sitting on the sidelines waiting to get in once prices begin to rise. Lenders are due for a huge disappointment.

First, as soon as prices start rising, many cashflow investors will pull back from the market. The current group of investors buying for cashflow will not be as excited when prices move higher. Perhaps they will be replaced by momentum investors betting on continued appreciation, but I doubt it. Kool aid will not sustain a rally that doesn’t make sense on a basis of fundamentals. Ordinarily, value buyers are required to mop up the entire mess of distressed supply. Lenders are hoping to circumvent this market necessity, and they are likely to be disappointed.

Second, although many readers of this blog are sitting on the sidelines due to falling prices, very few other buyers are. People buy when they are ready to buy. There are simply not enough qualified buyers to absorb the plethora of inventory lenders have. Remember, each REO adds one to supply and eliminates one from demand as the former owner no longer has the credit capacity to get a loan. Lenders will need to wait years for those buyers to come back to the marketplace.

REO to rental programs

I think lenders will liquidate as much of their REO as they can through REO to rental programs. It has several advantages for lenders. First, it gives them immediate capital. They don’t have to wait as they slowly liquidate on the MLS. Opponents of these programs — mostly realtors who fear loss of commissions — postulate lenders will recover less when selling in bulk. Lenders will have to discount the properties more to liquidate in bulk, but they also eliminate a 6% commission to listing agents, so the net may be the same. And since lenders are recovering their capital more quickly, the benefits outweigh the discounts required.

Another advantage of the REO to rental program is that lenders don’t have to dispose of those properties on the MLS forcing prices to move even lower. When distressed sales dominate the market, prices move lower. If lenders can reduce the number of distressed sales, they can stop the decline in prices — which is why they are withholding inventory now. The REO to rental program takes sales off the MLS in 2012-2015 and moves them to 2016-2018 or later. This may stop the declines in the short term, but it will almost certainly inhibit appreciation in the long term as this overhead supply is metered out over time.

Since these two advantages to lenders are so beneficial, I suspect the REO to rental programs will see explosive growth over the next few years as investors gear up to buy billions of dollars worth of single-family homes. That’s how lenders will liquidate many of their upcoming foreclosures.