Foreclosing on 2010

Palm Coast, FL – April 11, 2011 – Last year was a rather volatile one for the economy. While the economy did improve, unemployment remained at elevated levels. Housing affordability was at record levels and mortgage rates extremely favorable for homebuying – but even some qualified borrowers had challenges in obtaining mortgages. Inflation remained tame, but consumer confidence still struggled to improve.

2010 was a volatile year for foreclosures as well. Last year around this time we examined the question of shadow inventory (see the March 2010 issue of Real Estate INSIGHTS). We noted then that shadow inventory could be defined in a number of ways. Some consider all loans with at least one missed payment as part of shadow inventory while others account for cures through modifications and short sales in determining shadow inventory. In terms of foreclosures, things appeared quite dismal last March. So, is the worst behind us?

It is still difficult to say. What is relatively safe to say about 2010 is that the bottleneck has shifted – from delinquencies to the foreclosure inventory. In other words, a significant portion of the delinquent inventory that built up since the beginning of the crises is now moving into the foreclosure inventory as modification efforts and cures are taking effect. The result is declining delinquent inventory and increasing foreclosure inventory. What is also relatively safe to say is that new problem loans continue to improve; all states are showing significant 12-month declines in new seriously delinquent loan inventory and a 38 percent annual decline nationally.

To put it into numbers, according to Lender Processing Services (LPS), there were 8.1 million total non-current loans (delinquent and in foreclosure inventory) in February of 2010 – the peak of the foreclosure crisis. Currently there are about 6.9 million non-current (i.e., at least 30-days delinquent) loans. This decline has contributed to a significant drop in delinquencies. Delinquencies fell by 18 percent over the course of 2010, while more serious delinquencies (90+ days late) fell by 12 percent. Since a share of these delinquencies that have not cured or been modified has ended up in the foreclosure inventory, the foreclosure inventory is up over 9 percent over the past year.

Similarly, foreclosure starts were up over 10 percent over 2010, though the evolving crisis in documentation and foreclosure processing might slow the rate at which delinquent loans move to foreclosure starts. Early 2011 numbers already suggest that trend. Nevertheless, out of 6.9 million first-lien, non-current loans, 2.2 million are in foreclosure inventory, 2.1 million are seriously delinquent, 1.8 million are new delinquencies and around 710,000 are 60 to 90 days late.

Again, early 2011 numbers are showing a greater impact from the foreclosure processing and documentation scrutiny banks are currently under. This will result in a longer “hanging” period of the foreclosure and REO inventory. For example, while foreclosure sales (moving of loans from the foreclosure inventory to REO status) topped out at over 120,000 a month before the documentation scrutiny began, they are currently down to about the 65,000-80,000 range.

Another interesting occurrence resulting from the foreclosure documentation and processing scrutiny is the recycling of loans previously in foreclosure inventory back into the seriously delinquent inventory. As LPS’ decomposition of seriously delinquent inventory shows, over one-third of that inventory are loans 12 or more months delinquent; a third of those are 24 months or more delinquent. The share of seriously delinquent loans grew by 172 percent over the last year. Another indication of the recycling of previous foreclosure inventory is that 35 percent of foreclosure starts are actually repeat foreclosures; this share has been consistently rising since the last summer.

What does this all mean for the shadow inventory? In short, there is still a lot of it out there. There are currently a little over 3 million loans in the shadow inventory. This number includes all loans in the foreclosure inventory and a share of delinquent loans. It also includes delinquent loans that are anticipated to enter foreclosure over the next year. These “new entrants” account for about one-third of the 3 million shadow inventory estimate. The loans excluded (i.e., subtracted) from the shadow inventory are those serious delinquencies already listed for sale and modifications. According to the Mortgage Metrics Report from the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) for the fourth quarter 2010, non-HAMP modification activity seriously ramped up in 2010. Two-thirds of the modifications in 2010 were non-HAMP and there was a total of 939,835 modifications in all of 2010. With trial modification, that adds up to over 2.1 million modifications for the whole of 2010. The Mortgage Metrics Report also shows that about 30 percent of those modifications will re-default 6 months after the modification. Lastly, REO inventory not yet on the market is added to the shadow inventory. This brings the final figure to about 2.36 million properties. All of that information allows us to estimate the number of months it would take to clear the current shadow inventory. Again, if we do not account for delinquencies anticipated to enter foreclosure over the next year, the final shadow inventory comes out to 1.5 million properties.

Over the past year, distressed sales have accounted on average for 34 percent of existing home sales. If this trend continues, current shadow inventory would take about 16 months to clear. This figure naturally varies significantly among the states. But also, the share of distressed sales has been growing in recent months. The NAR’s REALTOR® Confidence Index shows increases in distressed sales from 37 percent in January to 40 percent in March. At the March rate of 40 percent, shadow inventory would clear in 14 months.

When comes to shadow inventory, there continues to be many moving pieces which affect the way in which shadow inventory may clear. One issue that could have the most impact is banks’ handling of foreclosures and how that will play out. Another continuing issue is the number of homeowners who are “underwater” and the likelihood of whether or not they will walk away from their mortgages. And there are still a number of Option ARMs scheduled to reset in 2011 and 2012. With tightening of lending rules, these homeowners may have a more difficult time refinancing their loans into more favorable terms.

©National Association of Realtors® – reprinted w/permission