The Landmines Within

Conventional wisdom says that once a home has gone through foreclosure, the sooner it is listed and sold the quicker the lender will recover losses.  This logic follows that expediency of the process maximizes a lender's recovery rate in areas where prices are rapidly falling, avoiding greater losses later. 

Well, we'll soon find that what is in a lender's best interest often defies our most basic conventions. 

More than a year ago I began pairing Realtytrac's foreclosure database against MLS inventory stats for every neighborhood I would appraise.  Almost immediately I noticed something rather peculiar: both datasets never reconciled.  In fact, in most cases, the number of bonafide foreclosures far exceeded the sum of listings and pendings combined. 

Perplexed, I subscribed to Foreclosure Radar, their California competitor, and ran into the same issue. Both resources confirmed data quality, update cycles, etc., yet no one could explain the obvious disconnect.  Consultation with some of our most beloved Las Vegas-based Rainers with plenty of foreclosure experience also confirmed widespread discrepancies. 

Naturally, nefarious assumptions festered.  Were banks looking to prop-up prices?  Probably.  Were they trying to stall losses?  Maybe.  Why else would banks keep from marketing vacant properties? 

As it turns out, it could be all of the above, and then some. 

Rick Sharga of Realtytrac recently spoke with CNBC's Diana Olick and had a rather interesting factoid to share. He said that roughly 70% of foreclosures in their database ARE NOT listed in the MLS. 

Again: 70 PERCENT of foreclosures in their database are not listed in the MLS... 

According to Sharga, no one is able (or willing) to confirm or deny the possibility that, "... lenders are simply trying to defer the losses to a later date, because having to recognize the losses short term might pose severe risks to the banks in question."

From the story:

"... when the properties are taken back by the bank at auction, they are often taken back for the value of the mortgage on the property. The bank puts in the bid for the value of the current mortgage and essentially pays itself back what it lost on the loan, and of course gets the house for all its trouble. In good times, the bank could profit by selling that house for more than the value of the loan, but not these days. The trouble now is just the opposite. On so many of these foreclosed homes, the property is actually worth far less than the mortgage on it. So the bank is taking it back at the mortgage value and not writing it down."

‘Untold numbers of these properties sitting on banks accounting ledgers where the imputed value is considerably higher than the market value,' says Sharga. And unfortunately nobody knows what that market number is."

emphasis added

Here are some examples.

The following zip codes were chosen at random and reflect typical neighborhoods in both Ventura and Los Angeles Counties.  We're looking at condos and detached single-family residences that are active, pending sale, or contingent with bank-ups.  The number of foreclosures below MLS totals include "pre-foreclosures" and "auction properties."

:: Zip Code: 93033 :: South Oxnard, CA
# Active Listings = 213
# Pending/Cont. = 135
# Foreclosures = 910

:: Zip Code: 93035 :: Oxnard, CA
# Active Listings = 217
# Pending/Cont. = 53
# Foreclosures = 330

:: Zip Code: 91320 :: Thousand Oaks/Newbury Park, CA
# Active Listings = 149 
# Pending/Cont. = 26
# Foreclosures = 250

:: Zip Codes:  91367, 91307, 91304 :: West Hills, CA
# Active Listings = 399
# Pending/Cont. = 170
# Foreclosures = 1,099

:: Zip Code: 91331 :: Pacoima/Arleta Area, CA
# Active Listings = 376
# Pending/Cont. = 206
# Foreclosures = 1,315

:: Zip Code: 91381, 91355 :: Valencia/Stevenson Ranch, CA
# Active Listings = 256
# Pending/Cont. = 116
# Foreclosures = 497

* data a/o 02/06/2009.

Sharga's view that lenders are purposely avoiding write-downs is probably corrrect.  It mirrors perfectly what's happening with mortgage-related securities.  Many so-called "toxic assets" aren't so toxic at all.  In fact, most are performing quite nicely.  What's happening here is that investors holding these assets are choosing not to sell at current "fire sale" prices.  If they did, true values would override their fluffy 'imputed' values as Sharga mentioned. 

Widespread devaluation of mortgage assets in related portfolios would almost universally solidify insolvencies at weaker banks since 'new' asset values couldn't support their liabilities.  Hence these assets are toxic, but not so much because they are "Alt-A" or "Subprime" related; but because no one wants to pay full asking price to the sellers.  Sound familiar? 

But there is more to this story. 

The Wall Street Journal reported yesterday of a suit involving American Home Mortgage Servicing Inc. - a Wilbur Ross owned subsidiary that last week went headlong into Citigroup's servicing portfolio for $1.5 Big Ones - and Carrington Capital Management LLC., a Connecticut-based hedge fund. 

Carrington claims Ross's American Home improperly conducted "rapid-fire sales" of homes within mortgage pools at "unduly low amounts" to cover debts elsewhere. Ross's attorney claims that properties were sold at "market value."

Who's right?  Most here understand that "fire sale" (or "liquidation value") and "market value" can quickly converge when foreclosures take over a market.  All of which points to Carrington's uphill battle in proving their case. (expert witness opportunity?) 

Nevertheless, the AHM scenario illustrates yet another reason that servicers and banks alike keep from offing properties -- lawsuits.  But this practice of backlogging REOs simply isn't sustainable.  Sooner or later balance sheets will reach critical mass, and when they do, these landmines will go BOOM!, potentially erasing trillions more in home equity from the fallout. 

So here's the $64,000 Q.: How do we reinstate confidence in the banking system when "legacy" landmines (mortgage securities and related real estate assets) threaten the value of future investments? 

PIMCO's Bill Gross jokingly suggested once that we could simply "blow-up a million vacant properties" and reduce supply that way; but somehow I don't think we're going to do that.  Thoughts?

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To find out more about the "landmines within" in your area, go to Realtytrac.com, input a zip code, then run a basic search in your MLS in the same zip.  You may be surprised at what you find.  Feel free to post your results here...I'm really curious.

*UPDATE: Clarification that "foreclosures" are inclusive of NOD and NOS filings.