Fourth-Quarter 2011 Shadow Inventory Update: Overall Declines Mask Big Regional Differences

Over the past year, two divergent pictures have developed as foreclosure timelines continued to widen in some states, while other states have been able to steadily work on clearing the shadow inventory. The large difference in liquidation rates between states grew during the fourth quarter of 2011. The increasing timelines are primarily due to extreme foreclosure delays in states with judicial foreclosure procedures. And the number of months Standard & Poor’s Rating Services estimates it will take to clear the supply of distressed homes on the U.S. market rose two months to 47 months.

The volume of these distressed U.S. nonagency residential mortgages (which excludes loans from government sponsored entities, such as Fannie Mae and Freddie Mac) remained extremely high, at $371 billion in the fourth quarter, but has declined in each quarter since mid-2010. This latest number represents slightly less than one-third of the outstanding nonagency residential mortgage-backed securities (RMBS) market in the U.S.

Our fourth-quarter estimates of the months-to-clear were mixed: Four of the top 20 metropolitan statistical areas (MSAs) that we track reported lower months-to-clear estimates this quarter than the previous quarter. In the other 16 MSAs, however, our estimates rose.

These distressed loans continue to loom over the housing market and threaten to further depress home prices. Although fewer additional loans are currently defaulting, the overall volume of distressed loans remains huge. Low liquidation rates over the past two years have allowed the shadow inventory to grow because distressed homes have remained tied up in foreclosure proceedings. The shadow inventory will continue to jeopardize the housing market’s recovery until servicers are able to improve liquidation times. However, if and when that happens, an influx of homes will likely enter the market, increasing supply and driving prices down further.

We include in the shadow inventory all outstanding properties for which borrowers are 90 days or more delinquent on their mortgage payments, properties in foreclosure, and properties that are real estate owned (REO; meaning the lender has assumed ownership following foreclosure). We also include 70% of the loans that “cured” from being 90 days delinquent (loans that once again became current) within the past 12 months because cured loans are more likely to redefault. Our calculation of the months to clear the shadow inventory is the ratio of the total volume of distressed loans to the six-month moving average of liquidations (see the Appendix: Calculating The Months To Clear The Shadow Inventory).

In our analysis, we use LoanPerformance loan level nonagency RMBS securities data available through data-provider CoreLogic. Although our analysis of the shadow inventory uses only nonagency data, we believe that the months-to-clear is similarly high for the market as a whole. Long liquidation timelines and the accumulation of so many distressed loans are due in large part to rising court delays in foreclosure proceedings, a problem that plagues agency and nonagency loans indiscriminately. As long as these delays continue, the shadow inventory remains a market-wide threat. We will continue to monitor the impact that the large volume of distressed loans is having on the housing market.

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  1. By Tuesday Morning Links | Iacono Research on March 6, 2012 at 8:50 am

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