My last blog post Banks Sitting On An Inventory Time Bomb set off quite a stir among readers, and I think it bears more reporting.
Forgive the unusual length, but if you are interested in this stuff, as so many of you were yesterday, then you should read to the end.
One reader writes in:
"I work in a real estate special assets department at a bank in California and know a few things about how this process works. When a property goes into foreclosure we will order a current appraisal and then use the new appraised value less the cost of sales (somewhere between 6 and 10%) to determine the value we bid at the foreclosure sale. In the current environment it would not be difficult to assume the new appraised value would be less than the amount currently owed on the note. Given this assumption, banks would then be required to charge-off the difference between what that of the new appraised value less the cost of sales (bid price) and the current amount owed on the note prior to foreclosure. Therefore, the charge-off would hit the bank's balance sheet in the quarter in which the sale occurred."
This is absolutely correct, and banks are required to take the write-down when they take the property back as an REO. In fact, some say banks are actually taking the charge-off well before they get to the courthouse steps and are in some cases overcharging themselves on some assets that may not actually go bad. Another story for another time.
But it still begs the question: Why are the banks holding on to so much of this REO so-called “shadow” inventory? With home values decreasing at such a fast clip, the banks might have to take even more of a loss when they sell it at even less than they paid at auction.
Many, many of you wrote in to the blog with stories like from Kevin in Arizona:
There is a house on my street that fits your report to a tee. The family moved out 3 months a"go and the house has been sitting empty since with no for sale signs. I did some research and discovered the house was foreclosed on and the bank is not selling it?!? The banks are harming the housing market with these actions and delaying the bottom. I hope you can find out more about this in the future."
In digging a bit more, I spoke to Chris Whalen of Institutional Risk Analytics, who doesn’t believe for a second that banks are holding on to these properties on purpose. “That’s silly,” he says because of the overhead costs to the bank for carrying these properties.
- Freddie Mac to Offer Leases to Those Facing Foreclosure
But he also points out that banks don’t own the bulk of foreclosed properties, really only the ones they originally held on their own books. As we all know too well, most subprime loans, the ones that fill up the foreclosure rosters, were securitized and sold off to pools of investors. So “servicers” are the ones placing the bids at auction for the loans that are part of securities. Some servicers are independent and some are owned by banks.
Says Mark Hanson of the Field Check Group says, “Servicers who collect $60 a month to automatically collect payments are now dealing with thousands of defaults and REOs and laying out billions in payment advances to the bond holders each month while the borrower is in default. Then they have to be pricing experts and then real estate sales channels. They are not designed for this—they collect payments.”
One mortgage maven I talk to says, “Servicers are a disaster. They are the reason the Trustee Sale process is so jacked.”
I also got a look at the FDIC’s regulations for real estate transactions and appraisals (12 U.S.C. §323.3 Appraisal not required; transactions requiring a state certified or licensed appraiser) and in it there are exceptions, including loans that are part of a securitized pool and loans that are “eligible for sale to a government entity” like say FHA or Fannie and Freddie. So appraisals are not required in a huge number of instances, which begs the question, how are they setting the prices (and consequently the losses) at auction?
All I’m saying here is that the charge-off process and the home valuations that go along with it are muddled at best. There may not be any vast conspiracy by banks to hold onto these properties so as not to incur more losses; it may just be that they are so overwhelmed by the volume that they just can’t get them into the system or even find enough Realtors to sell them. Or it may be the servicers can’t handle the properties either.
Understanding this and making sense of it all is wildly challenging, which is why the blog, unlike traditional television or newspaper reporting, is such an important venue.
The blog allows for input, disagreement, expertise, advice and clarification. I appreciate all of it.
Questions? Comments? RealtyCheck@cnbc.com