Remember a few months ago a big secret in plain sight was that many banks were awfully slow about foreclosing on deadbeat homeowners. Some of this was arguably not due to gameplaying but a function of overloaded servicing departments that were understaffed and backed up. But in many cases, the belief was that the delays were by design. Banks didn’t want to report higher levels of real estate owned (REO) which is where the homes wind up if no one offers more than the mortgage balance at the foreclosure auction. Some banks also may have preferred to keep homeowners in place, since a vacant property deteriorates and depresses values in the ‘hood. And some chose to present their strategies to flatter their financials as a benefit to homeowners, as Wells Fargo did last quarter in changing its foreclosure policies (and related accounting) to extend the process.
But the day of reckoning nevertheless eventually arrives. In this case, it is taking the form of banks having to unload increasing amounts of real estate, most often in markets that are continuing to deteriorate.
One thing that has surprised me about this housing market is that while there is decent data (given that real estate is local) on house price trends, there has been surprisingly little discussion, at least in the MSM and major blogs, of loss severities on foreclosures. Admittedly, banks probably don’t want to ‘fess up to how bad things are, but this is such an important element of the equation that I am surprised that it gets far less attention than it deserves (hint: anyone with knowledge is encouraged to speak up).
Losses are a function of home price appreciation (click to enlarge):
Now look at how high the losses are with merely 3% annual home price appreciation. Imagine what the losses look like with falling home prices.
Yet even the grim numbers reported in today’s Wall Street Journal seem better than what is implied by the chart above. Why? Probably because the houses that are selling out of REO are the ones that can be sold. We’ve heard stories of subdivisions in Cleveland being plowed under for farmland. That’s extreme, of course, but it isn’t hard to imagine that in some areas, the houses that don’t sell readily will eventually go for very distressed prices, potentially for as little as the value of the improved land.
From the Wall Street Journal:
The steep losses on sales of foreclosed homes are painful for banks and investors in the short run but should help clear the backlog. That would allow for an eventual recovery of the housing market and clean up the banks’ balance sheets.
I can’t resist interjecting. That cheery statement is technically correct (it all hinges on what one means by “eventually”), but that assumes the bathtub is draining faster than new water is coming in. With Alt-A and Option ARM resets occurring at high levels in 2010 and 2011, this crisis is far from over. And Housing Wire points out that a far higher proportion of Alt-As were retained on bank balance sheets than subprime, so banks are unlikely to “clear the backlog” anytime soon.
Back to the Journal:
One example of the deep price cuts on foreclosures: A 1,230-square-foot home in Corona, Calif., was sold by a unit of investment bank Credit Suisse in June for $198,000, down from $450,000 when the property sold in a regular transaction in December 2006.
“I do not think this is the time to be holding onto [foreclosed homes] and hoping for a better day,” Daniel Mudd, chief executive of Fannie Mae, said during a conference call Friday.
Banks and investors have grown more leery of the rising costs of holding onto vacant homes. Along with such expenses as insurance, lawn care and maintenance, banks are being hit with higher costs for complying with local regulations applying to vacant homes.
The price cutting may mean even deeper losses for banks, but in some areas price tags have fallen enough to entice bargain hunters back into the market. According to the S&P/Case-Shiller indexes, prices in Las Vegas, Miami and Los Angeles are back to 2004 levels, while those in San Diego have retreated to 2003 levels….
For subprime loans, those to people with relatively poor credit records, loss severities averaged 41% of the loan balance in 2005 and 54% in the 12 months ended in May, according to Fitch Ratings. For loans made in 2006 and 2007 that end up being foreclosed, severities are likely to average more than 60%, Fitch says. Analysts at Credit Suisse see a range of 63% to 71% on foreclosed subprime loans by late next year, depending on how far home prices fall.
Comparable historical data are sparse…
Losses on prime loans also are growing, particularly on option adjustable-rate mortgages, or option ARMs….Wachovia disclosed last month that loss severities on option ARM foreclosures averaged 36% in the second quarter, up from 32% in the first quarter. Fannie Mae says severities on prime and Alt-A loans (a category between prime and subprime) recently have reached 40% in California….
Financial institutions are acquiring homes through foreclosure much faster than they can sell them…
Not all foreclosed homes go for a song — even though the loss to the bank can be stiff. In the Las Vegas neighborhood of Summerlin, a foreclosed three-bedroom home, built in 1999, sold in May for $259,900, the original listing price, after just three days on the market….
Local governments are adding to the pressure on banks to sell foreclosed homes faster. Providence, R.I., recently imposed a property-tax surcharge on vacant properties to discourage banks and others from leaving them empty for long periods. Many cities now require banks to register the vacant homes they own and pay registration fees ranging from about $50 to $1,000.
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Looks as if they’ve fitted an exponential curve to the data. If that’s an appropriate model that can be extrapolated (very important “if” – why is that curve exponential, exactly??), it implies that “on average” the foreclosure losses reach 100% *well before* the annualised HPA rate declines to zero. In fact around a 1.5% HPA is low enough to give a complete wipeout on foreclosure. If this very dodgy extrapolation is actually reasonable, it does look as if just not bothering to foreclose might be a perfectly rational choise for the banks, given what house prices have done over the last couple of years.
Re: “We’ve heard stories of subdivisions in Cleveland being plowed under for farmland. That’s extreme, of course, but it isn’t hard to imagine that in some areas, the houses that don’t sell readily will eventually go for very distressed prices, potentially for as little as the value of the improved land.” Actually, in the end large land areas, e.g the Michigan peninsula, Long Island, will be restored the wilderness. This is the next frontier of progressive environmentalism. Wolves on Long Island. Are you ready?
I live in a suburb of Cleveland and while I have not heard of subdivisions being plowed under I have been in the market to buy a new house and have looked at 3 REO homes. All three are in very very wealthy suburbs with excellence schools and services. All three houses were total disasters inside. 2 of the 3 were so bad fixing all the problems would negate the discounted price (they were about 100k below what other houses were selling for nearby) 1 of the 3 was so bad you could only tear it down. Based on my limited observation, I would guess in some cases the banks are actually holding property that is going to require them to completely write off the value and possibly be forced to pay for the demolition. I can’t stress enough the shocking conditions of the houses on the inside, they just look like someone willfully destroyed everything they could. The fact these houses are in such nice beautiful rich areas makes you scratch you head. I know in 1 of the cities they are just tearing down the houses and leaving vacant lots – allowing the next door neighbors to buy the lots or using them for ‘green space’ – but I think the city pays the bank $1 for the house. I can see this happening a lot. If these types of properties are on the books for even $50k then expect more write downs.
“Along with such expenses as insurance, lawn care and maintenance, banks are being hit with higher costs”
I might point out that many homeowners insurance policies have a condition whereby if the occupants/owners are away, traveling or otherwise not there, they must ensure that somebody visits the property (usually weekly). This condition is to protect the insurer and mitigate any losses if damages or accidents occur. Now, if a property is vacant, and there is a homeowner’s policy that is in force, and if the owner can’t prove the weekly visits, coverage can be denied should something happen.
I suspect there are a lot of insurance brokers out there that might now be cautious about selling a policy to anybody who is in or near default/foreclosure and a lot of insurers out there who are tightening their underwriting standards.
The upside is that we should see healthy profits for insurers who peddle homeowner’s policies (claim denied!) but softer sales as long as the housing market remains in this depressed state.
A f/u
If a person is sitting pretty in a REO and has maintained homeowner’s coverage by purchasing a homwowner’s policy, a flood policy, or an earthquake policy a claim may be denied because “they” were not or “are not” the homeowner at the time of the accident.
Get advice from a local professional insurance broker who might well advise a change towrds renter’s insurance (contents not house)…
I spoke to a builder friend of mine and he has five houses he cannot give back to the bank, they wont take them,,,,,,,he has ot made a interest payment in over 9 months,,,,,
Loss Mitigation has failed badly! I have friends that are trying to work with the banks to keep their homes but and it’s unfortunate they have to deal with the most incompetent and unprofessional of personnel, these are professional people CPA’s, Doctor’s and it’s embarrassing that they would hire such complete morons and idiots @ $10 an hour to save money, many so inexperienced and young, IQ less, talking to other people on the other who are professionals with families in such a demeaning way without a clue, it’s no wonder why most major banks will go insolvent at some point in time in 2009. How about a CEO take a million less in salary and hire some good people with good incomes that will make a difference, It might not mean an overnight success but a prolong opportunity to survive. It is worth it! I’m glad some institutions are being sued it’s about time.
You guys remember hearing reports that Fannie was offering unsecured installment loans to bring borrowers current on their mtgs. I always felt they were doing it to avoid reporting the loans as deliquent. Shameful IMO.
Data set appears to be highly heteroskedastic. Can you print the metrics on this? Probably valid from about 8 to 18%. The lower numbers look questionable though. As bad as things are, losses are not that high.