Dear Readers,

This report was first published as part of the Mortgage Pages research series on 9/13/09. I have researched and written about the new-era housing market and its unprecedented dynamics since mid-2006. Many of you know, I have done extensive reports on shadow inventory the entire time because it is such a significant and disruptive factor for the market. However, this year shadow inventory evolved and its potential for destruction became much greater. This report highlights what shadow inventory is today and what that means for tomorrow. Mark Hanson

HAMP has Effectively Served as a Long-Term Foreclosure Moratorium Soon to End

A Second Stream of Foreclosures Will Emerge from Failed HAMP Trial Mods

Mods Made This – Shadow Inventory has a Whole New Meaning

CA Foreclosures and Shadow Inventory

The foreclosure wave is still out there…but it is more of a tsunami now. When tsunami’s build the tide (foreclosures) rolls out for a protracted period of time while the sea (foreclosures in process) swells. Due to foreclosure prevention efforts the sea of foreclosures in process has swollen larger than ever before. In the end these efforts will only serve to make the wave larger and the hit, longer in duration.

A wave actually began to come ashore in Spring. In CA in March foreclosures hit a low of around 9k. In the subsequent three months they jumped to 22.5k. On a national level, they went from 64k in April to 87k in July as shown in the images below. It is important to note how quickly this wave began to ramp.

But then the President rounded up all the servicers to DC for the July 28th come to God meeting and immediately foreclosures dropped again. About the same time FHA-HAMP, which went into effect mid-August, was detailed. FHA-HAMP clearly stated that ‘loans in the process of foreclosure must be considered for FHA-HAMP before a foreclosure sale can be made’. Back to sea they went.

But actual foreclosures are a byproduct of a loan defaults and lagging indicator of the wave. Loans in the delinquency and default pipeline are the leading indicator, which is why our default and foreclosure research has always centers around the Notice-of-Default stage as a leading indicator to everything foreclosure, housing and balance sheet related. Through all the national and statewide moratoriums except SB1137 in CA in Sept 2008, the servicers kept filing Notices of Default and Trustee Sale in order to get borrowers on legal record for action in the future.

The bottom line is that the number of loans in the foreclosure pipeline — post NOD and NTS (image 1 and 2) — have never been greater. This all is future housing market supply that must be considered.

Of the four charts below, image ‘2’ represents ready-to-go second stage foreclosures — this bucket is full like never before. This is the bucket that has been held back due to the HAMP’s that could spill foreclosures at any time.

After an NTS/NFS has been filed and a few months have passed the trustee can take the house to foreclosure immediately – even 6 months or a year down the road after a failed trial mod the house can go to sale immediately in most cases. All of the other charts of the various foreclosure stages show activity at or near peak levels, other than the actual foreclosures, which dropped slightly last month.

HAMP has Effectively Served as a Long-Term Foreclosure Moratorium Soon to End

HAMP has effectively served as a long-term foreclosure moratorium. The lack of foreclosures while servicers retool their systems for HAMP, which really didn’t get rolled out until April, has created quite a back-log as the charts above show. In fact, the President first announced his foreclosure ‘plan’ in February, which is really when HAMP began interfering with the numbers. Additionally, FHA-HAMP was made known in May and recently rolled out at the beginning of August. The past six months have been a big HAMP can kicking game.

When the HAMPs were finally rolled out servicers essentially had to put hundreds of thousands of foreclosures in process on hold while they went through the entire process of contacting borrowers, aggregating paperwork, re-qualifying the borrowers under HAMP’s incredibly detailed guidelines, making a new offers, getting borrowers acceptance, signing and moving paperwork etc. This can take months – HAMP has only been around about six months.

Many HAMP-eligible borrowers may have been mostly done with an old-vintage mod and were stopped in their tracks in April. When you factor in the servicer retooling time, the couple of months for mod processing, and the new 3-month trial period before a mod is made permanent, it is obvious why foreclosures have been lower that last years peak despite defaults averaging well above. But we have an end game that has not been present in the past — borrowers are ineligible for another HAMP mod if they fail their trial. The only place to go is directly to foreclosure.

A Second Stream of Foreclosures Will Emerge from Failed HAMP Trial Mods

At present there is only one stream of foreclosures, which is why they are so low. Most foreclosures coming through now are from a) borrowers who don’t qualify for a mod b) borrowers who know they are better off losing the house and renting c) vacant houses. Very few are coming from failed HAMP 3-month trial mods because of the time line.

But when borrowers begin to come off 3-month trial periods, a second stream of foreclosures will emerge from those who don’t make it. We know that re-default rates for borrowers in default prior to getting a mod is as high as 70%. Even if HAMP performs better than any other program ever has and only 40%-50% re-default, that will mean a quick surge in monthly foreclosures. Remember, after a failed trial the borrower is no longer eligible for a HAMP mod.

The chart below shows the national monthly Notice-of-Trustee Sales (late stage) vs Foreclosures (last stage) counts from March through August. In that short 6-month period, there have been 390k NTS’s that have not resulted in a foreclosure (circled in red). Many are on trial mods.

If we assume that 250k of the 390k are presently on a trial and 40% fail, then beginning shortly 100k new foreclosures will spit out over a short period of time that will be added to the foreclosures that will occur naturally for reasons mentioned previously. If 60% fail, then the number goes to 150k. With foreclosures only averaging 73k over the past six months, this new stream of foreclosures is significant — it has the potential to double foreclosures over a single month.

The bottom line is that there simply has not been enough time from April through August to incorporate HAMP and have failed trial mods spit out the other side. But this is exactly why the foreclosure wave will still happen. It is important to note, when I refer to a ‘wave’ I am simply talking getting back to levels at or above the peak and staying there for an extended period of time — exactly like we have seen with Notice-of-Defaults and Notice-of-Trustee Sales in the bubble states and nationally.

Mods Made This – Shadow Inventory has a Whole New Meeting

Shadow inventory is no longer just the foreclosures taken back by the servicer and sitting on the shelf unsold. This is because of the artificial decrease in monthly foreclosures and high demand for low end properties by first timers and investors this year. The pending foreclosures hung up due to HAMP and other initiatives are also a form of shadow inventory that must be added to the mix.

The chart below really highlights the growing spread between late stage foreclosures (blue) and actual foreclosures (red). Unless all those loans that make up the spread result in a successful mods, foreclosures will jump again in the near-term.

The gap between late stage (NTS) and actual foreclosures (highlighted in red circle) represents almost a half million foreclosures ready to go. This foreclosure-ready inventory, much of which is on HAMP trial, represents a clear and present danger to the housing market at any time. Obviously, loans at the Notice-of-Default stage that happens months before Notice-of-Trustee Sale can also be viewed as future supply, but for the purpose of this report, I chose the second stage because they are the here and now.

CA Foreclosures and Shadow Inventory

The chart below shows CA foreclosures vs. foreclosure resales for the past 20 months. There have been 364k foreclosures and 318k resales. The 46k difference is what shadow inventory used to be. Where are these houses? The shadow knows.

In the past year, approx 20k monthly foreclosure resales have occurred making for a little less than 2.5 months supply. The CA low-end housing market can handle this right now.

However, when add to the shadow inventory pool the jam-packed late-stage foreclosure pipeline things change considerably. The chart below shows that over the past 12-months, 458k NOD’s have turned into 356k NTS and only 238k foreclosures. The difference between the foreclosure-ready NTS stage and the foreclosure stage is huge at 118k.

If only 50% of those late stage foreclosures come through as foreclosures because of failed mods, then three additional months of supply appear from the shadows hanging over the market’s head at any given time. If these would have come out during the busy season with stimuli was on they may have sold but it would have made for a much sloppier market than what we saw during the season. Now we enter the slow season and an extra 60k foreclosures hitting over a short period of time on top of the average 17,500 foreclosures over the past year could seriously impact this housing market.

Because Notice-of-Defaults have not backed off from their peak levels this year, the foreclosure pipe line will remain full through early next year even if all NOD’s stopped today.

Best Regards,
Mark Hanson

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Filed on: September, 26 2009 by Mark

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