The folk/urban legend may have some validity. In my opinion, there are two primary events that have slowed the release of REO properties: 1) The Presidential Election, and 2) the Troubled Asset Relief Program (TARP). Iâ€™m just not sure which one should get the most blame.
1) The Presidential Election
Lenders/Banks put the brakes on foreclosures during the later part of 2008 due to Federal, State and self-established moratoriums. They also did this due to the polls that showed an upstart Presidential candidate making serious headway â€“ and he had been talking about a housing recovery plan. As soon as banks/loan servicers heard a plan was in the works they had additional reason to throttle back on the foreclosure process. The waiting ended in March after the plan(s) were announced in late February 09 - there wasn't much for the Banks/servicers to be excited about, and the current success of the loan modification program is a case in point: As of the end of June 09, HUD states that â€œSince the administration announced Making Home Affordable Feb. 18, more than 200,000 borrowers have received offers for trial loan modifications, tens of thousands of refinances and trial modifications have gotten under way and more than one million potentially eligible borrowers have been sent informational mailings.â€ Considering the depth of the problem, this does not give one a â€œwarm and fuzzyâ€ feeling does it?
In any case, since Banks/servicers didnâ€™t see greener pastures being delivered by the housing recovery plan they shifted their Notice-of-Default and Notice-of-Trustee Sale machines into overdrive. The non-judicial (i.e. trustee) foreclosure process takes about 3 months, 3 weeks and 3 days (starting with the NOD). So a healthy spike in supply around the end of this summer should materialize. This is the so called "REO Shadow Inventory" you may have heard of. http://docs.Steven-Anthony.com/REO-ShadowInventory.pdf (Article on backlog)
2) TARP and "loss share"
What the article from the link above does not touch on are the "loss-share" agreements tied to TARP money that banks accepted, which are being reached (once a certain level of loss is realized by the bank the government starts taking losses). I know for a fact that some lenders are laying off their REO employees to cut cost and are shifting straight to Realtors to sell properties soon (i.e. Downey Savings). I had heard rumors that the banks were "overloaded", but now that I understand the profit motive, or shall I say "capped liability" aspect, it's easy to understand why they might want to "shadow the inventory."
I do believe we will see a set of â€œsupply wavesâ€ tied to banks reaching their loss-share ceilings rather than a huge single deluge. However, you can bet the waves are on their way to shore right now.
One might also place blame on the new 90-day foreclosure moratorium in California for holding back REOs. I see this moratorium more as a political posturing than effectual in stopping the foreclosure process. Lenders and loan servicers that already have a comprehensive and systematic loan modification program in place are EXEMPT FROM THE LAW. Now, take a look at who is exempt: (some of the largest Loan Servicers in the Nation): http://docs.Steven-Anthony.com/90DayExemptLenders.pdf
In addition to all the great information posted here, I'd like to add another not so urban legend to the list. I work in the commercial sector, both finance and real estate and we see many lenders trying to sell both performing and non-performing paper as well as REO portfolios.
These portfolios (we generally see commercial but are asked about residential) tend to be offered at either bargain basement pricing to create a greater amount of single source capital, or at a relatively reasonable discount of what the debt was. This does create a delay in lenders holding REOs for what seems to be longer than one would expect, just like a single home sale there is a negotiation process, draft contracts, due diligence and other legal fair, and then of course the time is wasted when an investor decides they are no longer interested in the portfolio.
In addition to this fact, some lenders are holding more REOs, we've seen Private Equity firms foreclosing on commercial property and sitting on it to use as leverage and balance sheet enhancement to drive their company value up. This puts them in a better position to continue or acquire new LOCs.
What we've noticed with a lender like BofA is that they are releasing property portfolios in a more logistic manner...at least that is what we've noticed in NJ. Northern NJ has more BofA REOs on the market than they do in central and southern, but will be releasing more properties in those areas shortly. I believe it is a logistics issue to some degree with banks, they do not have the manpower to oversee a large number of properties spread over a large region.
I would advise clients to the two fold truth, ...and this comes from the lending side as well...yes prices may fall due to more foreclosures hitting the markets, which will probably continue for the next couple of years, however the trade is really "do you sit on the fence and hope that a home will come along at a bargain price and risk that while you wait for a better deal, your credit will remain healthy, rates will remain low, lenders will not change loan programs and the President is wrong that unemployment is going to rise?"
If we're talking about saving $20,000 ...then sitting on the fence risks far to much, they may not have a job in 3 months, their credit may decline (may improve too), rates may go up (can go down, but the fed is not ready to tank rates and kill the banking industry) and lenders have been consistently changing loan programs since 2007 (what was there today may be gone tomorrow).
CIT is about to collapse, this is going to stir the pot in the commercial and business sectors, but considering CIT also lends to small banks - warehouse lines of credit, I have to imagine that there is going to be some underwriting changes, lost loans and a few more smaller lenders taking a nose dive.
This really had me thinking about the mechanics of how this could be beneficial to the Banks. Here's my theory:
The Banks may be taking a page out of the De Beers playbook. There is an interesting similarity when you contrast what De Beers has accomplished and the distressed home â€œinventory controlâ€ suggested by Allysonâ€™s contact. Diamonds are plentiful and probably would be much less expensive were it not for the global cartel run since 1934 by De Beers, which controls 70 percent of the rough diamond market. The demand for diamonds depends on consumers' expectations about future prices. De Beers has successfully convinced many consumers that diamond prices will never fall and has often stockpiled diamonds, rather than sell them, in order to prevent prices from falling. You get the picture.
However, how does this benefit the banks? We have all heard thanks Banks are not in the business of being property owners with all the costs and liability that go with this. Sure, a better sale price for the home helps the bottom line; however, do they plan on just holding these homes and trickling them out to the market over the next 10 years or so before they reach their Promissory Note values? Did the Banks and the Nationâ€™s home builders sit down for tea and agree to a stop of all new home construction until the Bankâ€™s supply of homes are exhausted? Not likely (cue the Balance Sheet Accounting Gurus)
A few definitions are needed at this point:
â€œMark-to-Marketâ€ accounting requires firms to value securities they hold at the current market price, rather than the price at which they were purchased. Regulators put the rules in place to keep companies from hiding losses, but perhaps the Banks see some benefit when the downward trend in value reverses. â€œMark-to-Modelâ€ refers to the practice of pricing a position or portfolio at prices determined by financial models, in contrast to allowing the market to determine the price. Hmmm, you mean I can create my own model of future value? Interestingâ€¦.. (this is what caused the Enron collapse by the way).
So, lets tie this theory together.
As Bill commented, once the Bankâ€™s Trustee files a Notice of Default to start the non-judicial foreclosure process a non-performing asset is created on my balance sheet. The resulting reduction in portfolio value affects the reserve withholdings I need to have as determined by the Federal Deposit Insurance Corporation (FDIC).
For example, let say I (the bank) had a single $300K mortgage on a home, and the home is now only worth $200K. Using Mark-to-Market I would need to reduce the value of my held assets by $100K, thereby increasing the amount of liquid cash I must retain in reserve, which is then not available for lending (this is not a dollar-for-dollar adjustment, it based on a percentage determined by the FDIC). I move forward with the foreclosure and secure control of the property as collateral for the loan. I have a good idea of how many of these are coming (since my loan servicing department peppers me with status reports each week), and based on that knowledge and simple dynamics of supply and demand I know the more supply I throw out onto the market, the lower the prices will go, and the more in FDIC reserves I will have to hold. With the FED concentrating on 4.0-4.5% Mortgage Backed Security Coupon purchases, I also know rate escalation risk will be held at bay until the FED reaches its 1.25 trillion commitment mark.
Hmm, so, maybe I decide to play a little Poker and hold my cards close to the chest by controlling supply in hopes of stabilizing prices on the "hard assets" I now own by default. Using current comparable sales info I can now combine "Mark-to-Market" with "Mark-to-Model" accounting methods, thereby reversing the amount of reserve holdings I need due to the new-found stabilization of my collateral portfolio that has now increases in value every time a comparable property is sold. This allows me to lend more money that increases cash flow, mitigating the loss in cash-flow of the default. While this can only be defined as temporary financial triage, this is much better than the devastating affect to cashflow of releasing all the REO supply at one time due to the resulting increased reserve requirements of an ever-reducing â€œhard assetâ€ portfolio of homes.
I posed this theory to a contact who is the Director of Capital Markets for a Mortgage Bank, who responded with this:
â€œThere is some validity here. I hear nothing but how, if one looks at a graph of NOD's versus actual foreclosures, the NOD line is going up but foreclosures are relatively steady. Everyone expects foreclosures to do nothing but increase at some point soon. Banks can blame what they want for holding off, but the bankers with whom I have spoken say that no one wants to push supply up, driving prices down, if they don't have to.â€
What I want to know is what happens when they â€œhave toâ€ (is that a roar of a wave I hear?). Does anyone see the banks being able to pull off such a widespread orchestrated effort for any extended duration of time?
With inflation lurking somewhere in a dark corner, 11.6% unemployment in the State as of June, and all but certain market-driven mortgage rate escalation once the FED stops buying Mortgage Backed Securities, I'm starting to believe it will be 2012 before any glimmer of sustainable market normalcy returns. Until then, I believe the only thing that will be fixed, is that everything will remain variable.
Today on CNBC there was a small report regarding banks holding out on releasing REOs. I looked for the video on their website but did not find it.
The interviewee could not speak on behalf of banks, but did note that Fannie and Freddie would release REOs in slow succession [paraphrased] because of the 6 month supply of conventionally priced housing on the market (20 month supply in Jumbo).
It did not seem that there was any concrete evidence or discussion as to the validity of concerns regarding a deluge of properties hitting the market and driving the pricing down, but it was alluded to that Fannie and Freddie were thinking that way.
One has to suspect that if this is the case, then the rumor of new homes flooding the market is not true, price points won't fall into the abyss and the buyer is hedging on minimal savings. If Fannie and Freddie are approaching the industry with this thought process, we can be sure that some larger institutions will follow suit.
Buyers who are going to misread the report will believe that they may have better bargains six months from now when the 6 month supply dries up...we know it doesn't work like that, but that's why we are in Real Estate and they aren't.
Maybe the video report or the story will be up on CNBC by tomorrow.
You make an excellent point on balance sheet mechanics, however it is a short term fix as other regulatory issues come into play.
The publicly traded banks need to answer to shareholders...at least on the surface. A great portfolio of paper value does not extend to the real value of the business, which is ultimately based on cash flow. The shareholders do not want a paper value on a company, they want increased revenue, cash and if traded banks are going to stuff the balance sheet with arbitrary value, based on certain accounting formula, at some point the value of the shares, the portfolio and the business will come into question and regulatory groups such as the SEC and Banking regulators will require forensic accounting be done.
This type of "within the guidelines" value assessments are part of what collapsed many banks during the eighties as part of the S&L scandals.
These banks then, could not agree on what their notes, assets or holdings were worth and therefore, among mortgage paper not being able to be sold, REOs remained stagnant.
I agree with your theory as a part of the overall mechanics of why banks may not release REOs to the market, however I believe it is the sum of a whole and one other factor invading bank ops is the regulatory committees and federal oversight. FDIC says, "shed and increase liquid capital", SEC says "Don't dump assets and drive share price up to collapse." Local banking commissions are investigating for predatory violations and holding files and assets for investigation, finally the internal engine of the company is unsure what the hell to do, add that to the various logistics of how to manage such a large influx of REOs (not seen since the 80s) and none of these groups has a real clue as to what to do.
We were on a conference call with a CEO of a large bank in Canada...he read a banking report (paraphrased) and the final summation of the report regarding BofA was "Three guys running around with screwdrivers not sure what or how to fix anything." This was only a couple of weeks before the BofA/Merrill inquiry, but is a key indicator of many banks current situation.
We're negotiating with a small 100Million local bank on a transaction, and as much as they want to make the deal with us, they can't breathe without FDIC on them...I think that it is less myth, less accounting and less logistical issues and tons of unnecessary regulators which are propagating the myth.
At the end of the day, as professionals we should be overcoming objections or finding opportunity, because the reality is that most of the clients we have will not be able to swallow all of the theory we are tossing around here...if they couldn't read the trades and do the research like we did, there is a good chance that they will not sit through our long winded explanations.
What you say makes sense and would be a logical way to run a business, but the major banks are now OWNED mainly by our government and they STILL HAVE NOT REVEALED THE EXTENT OF THEIR TOXIC ASSESTS and WE are the ones footing the bill. So with that said I think the government doesn't want home prices to keep falling and my guess is THEY might be behind all of this as a way of saying " see the economy is begining to recover". I believe that they now dictate to these B of A's and Citi banks and it doesn't always make sense but it fits the facts.
I feel your pain. We haven't seen a flood of REOs in Miami, because all the properties seem to be in limbo. I have customers (with no attorney assistance, without speaking with their lender) who have been sitting in their home w/out paying their mortgage for over a year (and know of cases where it's been non-payment for two years). The banks have not foreclosed. They haven't done anything but call and ask for a payment.
Then, when I bring offers for short sale, they reject them as 'TOO LOW' ?!?!?! WHAT???? In a depreciating market?? Without even ordering an actual appraisal? Depending on some crappy BPO which doesn't take into account the VIEW? This creates a difference in value of $50K-$100K in my market!!
So, no, we haven't seen a tone of REOs in Miami, but so far it seems that it's due to a LACK OF FORECLOSURE in the first place. If the bank hasn't foreclosed, they don't seem to have much of a problem. I wish they would start working with the property owners.
My question is 'what is happening with the MAKE HOMES AFFORDABLE government program?' They even had a segment on NPR the other day about how nobody can get anything done with this program. Where is the oversight and enforcement? HELLO? That's one way to stave off foreclosures and stabilize the market.
Here in Phoenix the Banks are holding back on REO`s( why?...It`s their market, Money & Job), After all, these Ivy League misfits have been playing Monopoly since they were five years old.
In my personal opinion, here in Phoenix they (the Banks) have been dumping the Dogs, (50 to 75K) to "Cash Investors" which do not require an appraisal. Now these flippers are turning around (making Money, for now) and selling the homes to FHA buyers, asking for closing cost.
I am beginning to see a little bit of an appraisal problem, which is sure to get bigger.
That`s just Phoenix in July, the Heat tends to warp your judgement.
Great question, better answers.
It is definitely causing a substantial number of Buyers to stay on the fence and that is certainly not to the benefit of a stable market which would be in everyones interest.
Thanks to you all for a good exchange of perspectives.
Does this really have to be anything other than an Urban Legend?
My understanding is that from the point where the NOD is filed till the eventual REO is sold and turned back into cash the Bank has a Non-performing Asset. The "value " of this can no longer be considered as liquid, and therefore not part of the Liquid Reserves required by the FDIC. Its book value must therefore be replaced by other assets which consequently are no longer available for lending.
Asuming a $300,000 loan this means the Bank now has $600,000 out of circulation and producing no profits.
Where then is the motivation for Banks to hold REO inventory? After all, their reason for existing is to make a profit.
Allyson has the better explanation. Repeat it as fact, it has as much verifiable validity as the the objection you are overcoming. Basically why would anyone who has control of inventory hurt themselves by floodinig the market.
Let's assume Countrywide has the majority of bad paper and now B of A has the largest shadow inventory. They can track absobtion rates as well as anybody. Does anyone really believe they will damage thier return by putting the buyers in the driving seat?
Lets say there are 50 banks with tens of thousands of units top be sold. Again it is not in thier interest to give up control of the market. Individually they will control the release by tracking the absobtion rate.
The only time we will see a flooding of the market is if the properties become part of government program to liquidate the assets like the Resolution Trust Corporation of the S&L crash in the late 1980s.