Industry’s Shadow Inventory of Distressed Homes Shrinks

Housing has become an industry afraid of its shadows. That shadow inventory of repossessed and soon-to-be repossessed homes has professionals from every side of the business worried about the impact such a sizeable volume of distress will have on property values and overall market fundamentals. But according to ""Standard & Poor's"":http://www.standardandpoors.com (S&P), the obscurity hiding in the corner is getting smaller.

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The analysts at S&P have issued a new report putting the shadow inventory into perspective. In the second quarter of 2011, the agency's assessment of how long it will take to clear the supply of distressed homes in the U.S. fell for the first time since mid-2009, and it has S&P analysts asking, ""Is it a sign of good things to come?""

The agency's current estimate of time-to-clear the market's distress is 47 months. That number represents a five-month decline from S&P's first-quarter estimate and the largest quarter-to-quarter drop since mid-2008.

S&P estimates shadow inventory as all outstanding properties whose borrowers are 90 days or more delinquent on the mortgage; properties in foreclosure; and REO properties that are owned by the lender but have not yet been resold.

The agency also factors in 70 percent of properties on which the mortgage delinquency has been cured within the last 12 months on the basis that historical trends show “cured loans are more likely to re-default,” S&P says.

To calculate the months-to-clear the shadow inventory of distressed properties, the agency’s analysts look at the six-month moving averages of default, liquidation, and loan-cure rates across the United States.

S&P’s analysis uses loan-level data provided by ""CoreLogic"":http://www.corelogic on non-GSE residential mortgage-backed securities (RMBS). The agency says while its assessment of the shadow inventory “uses only non-agency data, we believe that the months-to-clear is similarly high for the market as a whole.”

While the volume of these distressed U.S. non-agency residential mortgages remains “extremely high” S&P says, the total volume of distressed loans has been falling since the beginning of 2010.

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As of June 2011, this amount stood at $405 billion, the lowest level since December 2008. The agency’s latest assessment represents just under one-third of the outstanding non-agency RMBS market. At the end of March 2011, S&P put the distressed volume at $433 billion.

In tandem with S&P’s declining estimates of distress volume and months-to-clear the overall inventory, each of the individual top-20 metropolitan statistical areas (MSAs) the agency tracks reported lower months-to-clear estimates in the second quarter.

S&P says in its view, “this is a yet another sign that the months-to-clear has leveled off.”

At 144 months, the New York MSA still tops the list at the highest months-to-clear. However, S&P says even New York's estimate improved slightly by two months.

The improving shadow inventory trends reflect default rates that have been falling since the first quarter of 2009 and liquidation rates that appear to be stabilizing, S&P explained.

“Provided liquidation and default rates continue their flat trends, we believe our estimate of the months-to-clear should continue to decline at a steady pace of approximately three months each quarter,” the agency said.

S&P stresses that despite the recent stability of its months-to-clear estimates, these distressed loans continue to loom over the housing market and threaten to further depress home prices.

“Low liquidation rates over the past two years allowed the shadow inventory to grow as distressed homes have remained tied up in foreclosure proceedings,” S&P said in its report. “The shadow inventory will continue to jeopardize the housing market's recovery until servicers are able to improve liquidation times.”

However, the agency notes, if and when that happens, an influx of homes will likely enter the market, increasing supply and driving down home prices.

S&P says 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 both agency and non-agency loans.

“As long as these delays continue to affect the housing market, the shadow inventory remains a market-wide threat,” S&P said.

The agency’s analysis also provided a snapshot of the credit profile of shadow inventory loans. Their average FICO score is 645 while the average FICO score for current loans is 685. The average shadow inventory loan is significantly ""underwater,"" and loans that are currently 90-plus days delinquent, in foreclosure, or REO have missed an average of more than 19 payments.