THE BASIS POINT

Shadow inventory, principal reductions, loan modifications

A constant concern is the “shadow inventory” and how this seemingly huge number of houses makes its way through the system. “Excess” supply appears to not be an issue in many areas – in fact in the West the supply of homes for sale is markedly down.

Wait, what happened to the title wave of supply that everyone was expecting? It appears to be being soaked up by demand, modifications, or other measures.

A while back American Banker’s Kate Berry reported that 6 out of 10 homeowners who received a loan modification stopped paying their mortgage again after 18 months, but there may be a modest silver lining buried in the high recidivism rates.

“A study by TransUnion has found that borrowers who received a mortgage modification performed materially better on new auto loans and credit cards than those who did not receive any help, an indication that some consumers who fall far behind on monthly bills are able to regain their financial footing. ‘Once consumers have gone through a serious delinquency, there is still an opportunity to lend to them down the road,’ says Charlie Wise, TransUnion’s director of research and consulting. ‘We’re going to see more and more consumers that had a loan modification and the mere presence of a modification, regardless of whether the borrower continues to pay, would indicate better performance’ in paying other debts. Researchers examined data on five million mortgages including 600,000 borrowers who received a modification between January 2008 and July 2011. The study found that borrowers who had previously gone delinquent only on their mortgages – but not other loans – were better credit risks than borrowers who went delinquent on other loans as well as their mortgages. Still, high recidivism rate are a concern since most of the borrowers will re-default within 18 months and are likely to end up in foreclosure. The study also found that nearly 42% of borrowers who received a loan modification stopped making payments within a year.”

Thank you Kate!

Kate also wrote a story a while back about Wells Fargo’s stab at a down-payment assistance program. In general, DAP’s give money to prospective borrowers who otherwise could not afford to buy homes. Wells’ NeighborhoodLift program requires that participants attend financial education classes before receiving grants. Jon R. Campbell, Wells Fargo’s director of social responsibility, said, “This is not a giveaway program. You have to qualify and prove you have the ability to repay – there’s nothing easy about that part.”

Many remember HUD banning certain seller-funded down-payment assistance programs after the FHA found widespread fraud. Loans from such programs went into foreclosure at three times the rate of loans made to borrowers who supply their own down payments. Kate’s article said,

“But Campbell says he is not worried about history repeating itself with Wells Fargo’s new program. ‘We believe these are sustainable homeowners. We’re really worried about the stabilization of neighborhoods, because a huge supply of REO [property] with nobody living in the homes causes extreme problems.’ Borrowers are required to attend eight hours of financial education classes through affiliates of the non-profit NeighborWorks America. Wells funds the grants to people whose incomes are 120% or less than the median income in their area, but the actual decisions of which borrowers qualify for the grants are made by NeighborWorks, not Wells.”

And then there is the subject of principal reductions. A while back I received this note:

“I left the mortgage industry about a year ago, and your commentary reinforces my decision on an almost daily basis. Instead, I have done some business consulting and have been trying to buy a home to update and flip. Obviously, my target market to purchase is foreclosed homes in decent neighborhoods that have good bones. Not to sound altruistic, but my hope is to help housing values increase by doing this. Of course I would like to make money at the same time, but I am having a helluva time trying to bid on anything.

The Agencies and HUD have a mandatory period in which ONLY owner-occupant buyers can bid on recently foreclosed properties. After that, investors can bid on the property. Most half way decent homes are snatched up prior to the waiting period being over. I’m not sure if this is a good thing (a true upswing in housing interest) or if investors are simply lying about their intent and purchasing these homes as “owner occupied” and they turn around and rent them or flip them. Contrary to what this sounds like, this is not sour grapes.

I think it is short sighted of the Agencies and HUD to give owner occupants first right of refusal. If investors had the same opportunity to purchase these homes, property values would increase on a greater scale … especially in the first time homebuyer market. Just because 100% financing has gone away doesn’t mean the first time homebuyer demographic is now flush with cash to make a down payment, pay closing costs and do property renovations. Yes, there is the FHA 203K, but there are very few people willing to live in a home while it is being renovated. Let the investors buy these neglected properties, update the kitchen, bath, flooring, appliances, etc. and resell them at a higher price point.

Before too long, those higher property values would become the norm, and not the exception. People would regain lost equity and short sales would drop….especially the “strategic defaults”. Everyone wants the HGTV ‘after’ house, not the ‘before’ shack that is stuck in a time warp. Give us ‘flippers’ an even playing field and we can help get the housing values on a steady upswing, create jobs and reduce neighborhood blight. Ironically, I am not a republican or democrat….just a guy who sees a way to make the housing market better without some sort of giant government bailout or ‘principal reduction’ plan that we would all end up paying for anyway.”

Of course, if you’re a bank, in order to minimize foreclosure-related losses you must find a way to move REO inventory more quickly at the highest possible price. Auctions seem to be the way to go (HUD having done a few, for example) since lenders and servicers can achieve both of these goals by creating demand with them. While the housing market may still be in a slump, there are interested buyers, including qualified owner-occupants and investors who want to purchase residential real estate at competitive prices. Attracting these buyers “en masse” enables institutional owners of REO to move inventory more quickly. And we’ve seen venture capital firms come in and buy thousands of houses in one swoop. Some folks complain about this, while others view it as a necessary evil in taking care of excess supply.

From an individual point of view, if you’re earning (basically) 0% on your savings, and don’t mind the management, and have enough cash, why not buy a non-owner in a depressed area? Cash-on-cash returns seem to be in the 5-10% range. One can, of course, do this on the proverbial courthouse steps, or one can keep their ears open for an auction.

To achieve the highest possible return rates, lenders and servicers must choose an auction company with an established track record and the ability to implement a full spectrum of auction formats. I am not going to present a complete list here, or any kind of list, of auction firms. But from a seller’s perspective, the right auction firm can maximize returns by selectively deploying the most appropriate auction format for a lender’s particular asset mix. For example, where there is a high geographical concentration of REO properties, a ballroom auction with an online component is an effective auction method. Alternatively, when REO properties are geographically dispersed, online auctions should include a real-time “Bid Now” option to encourage bidders to submit bids for acceptance prior to the actual auction sale.

Or course, no one knows how to market properties better than a local real estate professional. Love ’em or hate ’em, they bring added visibility to your property listing and assist with open house events for prospective buyers, and auction houses often engage local experts in the sales process.