Why Servicers May Bite Bullet This Year

US Banker | January, 2010

With more than a million homes headed for foreclosure, and hundreds of thousands more in the process or repossessed, how long can lenders put off dumping these properties?

There are two main views on that question, and neither is particularly reassuring.

One group says a breaking point will come in the second or third quarter: The supply of these distressed homes will get so big that banks and mortgage servicers will have no choice but to begin moving more borrowers into foreclosure and working through their stockpiles of seized collateral.

Others say banks' reluctance to record losses, combined with the government's continued attempts to stem the foreclosure tide, could prolong the situation for years.

"When the shadow inventory will hit the market and what the impact will be are still the big unknowns," said Dan Reynolds, the director of business development at LAMCO, a Littleton, Colo., company that manages repossessed properties for banks. "The scary thing is that if they don't deal with it, the problem just gets larger and larger."

First American CoreLogic, an analytics unit of the Santa Ana, Calif., title insurer First American Corp., has estimated that 1.7 million homes make up the shadow inventory — properties that have been repossessed, are in foreclosure, or are seriously delinquent. This supply is not included in the official measure of inventory — amounting itself to 3.75 million homes — listed in Multiple Listing Services across the country.

Reynolds, a former vice president of mortgage lending at Merrill Lynch & Co., said banks are trying to figure out how to unload the shadow inventory without causing housing prices to plummet. "We're in a situation where no one has pointed out how to fix this problem, and the only strategy they have is to slow things down to get their arms around it," he said.

George Schwartz, an executive vice president at ServiceLink, a Pittsburgh firm that services defaulted mortgages, is one of those who say something must give, and soon.

"These loans just are not coming out of the foreclosure process, so the real estate-owned inventory is declining when we ought to see it increasing," Schwartz said. Meanwhile, "servicers are looking at their servicing costs going through the roof," he said.

"There is a view that the REO volume is going to spike, and the question really becomes, when do we think the tide will turn? I think it will come late in the second quarter, because servicers kept a lot of borrowers in limbo because no one wanted to throw people out of their homes at Christmastime," Schwartz said. (ServiceLink is a unit of Fidelity National Financial Inc., a Jacksonville, Fla., title insurer.)

Diane Pendley, a managing director at the rating agency Fitch Inc., agreed that the industry is likely to step up dispositions somewhat. "There's a huge inventory of 90-plus [-day] defaults, and the servicers will have to move more of these properties into liquidation and finally sell them this year," she said. "It also appears that the market is there to absorb these properties."

Even so, Pendley sees strong reasons for the situation to drag on, and one of them is the Obama administration's Home Affordable Modification Program.

"The time line for a recovery has been stretched out, because some of these government programs can't cleanly separate out the borrowers who can be saved from those who can't," she said. "Five years from now seems to be the time line for a lot of these servicers."