Shadow Inventory to Linger Due to Longer Liquidation Timelines
Shadow inventory volume has been decreasing progressively in the last several months, but it does not appear this portfolio of loans will fully clear for at least another couple of years.
The volume of distressed nonagency mortgages dropped in 2013 to less than half of what it was at its peak in February 2010. As of November 2013, $232 billion of nonagency mortgages remain in the shadow inventory, down from $495 billion in the beginning of 2010.
However, since many of the nonperforming loans in the shadow inventory have remained there for several years, their liquidation timelines—the pace at which servicers are able to close nonperforming loans—have lengthened, according to a Standard & Poor’s Ratings Services report.
In order to clear the current shadow inventory, S&P estimates that it will take around 51 months, which is 14 months longer than a year ago. This also represents the biggest estimate to remove the shadow inventory volume since early 2011.
The New York-based rating’s agency computes this measure by dividing the total shadow inventory volume by the average monthly liquidation volume over the past six months.
“The overall volume of the shadow inventory has been steadily falling since 2010 because, since then, loans have liquidated or cured at a higher rate than new loans have defaulted,” S&P says in its report. “On the other hand, over the past year, the monthly volume of loans liquidated has fallen significantly, which is why we increased our estimate of how long it will take to clear the shadow inventory at current liquidation rates.”
The shadow inventory is composed of distressed nonagency loans, including seriously delinquent loans as well as those in foreclosure or held as REO by mortgage servicers.
A November CoreLogic shadow inventory analysis also determined that the national residential shadow inventory reached its lowest level since August 2008 with 1.7 million properties, in which almost half are delinquent but not yet foreclosed housing units. This figure is down 24% on a yearly basis and represents a supply of 3.5 months compared to the previous year’s supply of 5.8 months.
“The shadow inventory continues to decline, decreasing at an average monthly rate of 46,000 units over the last year,” says Mark Fleming, chief economist for CoreLogic. “Healthy market levels of shadow inventory are around 650,000 homes, so there is more to be done, but the trend is in the right direction.”
While fewer loans entered the shadow inventory through the first 11 months of 2013 than the same period of any year since 2005, some loans in this inventory continue to age, therefore causing longer liquidation timelines. However, the significantly lower total volume suggests the shadow inventory obstacle is not as big as it once was, S&P stated.
Since so many mortgages defaulted between 2007 and 2009, where total loan balances steadily increased from approximately $10 trillion to $30 trillion before beginning to fall again, the loans that account for the shadow inventory have been nonperforming for several years. Consequently, if you compare whether these loans were liquidated and measure the amount of time since they defaulted, it will constantly be on the rise.
A useful tool, S&P says, for assessing the shadow inventory would be to calculate the percentage of loans that are liquidated within six months of defaulting. For example, about 20% of the loans that defaulted in December 2012 were liquidated by the following June.
“The results of our analysis showed that there was indeed a steep drop in the speed of liquidations beginning in 2007, as a loan that defaulted in 2005 had approximately a one-in-three chance to be liquidated within six months, while a loan that defaulted in 2008 had about a one-in-six chance to liquidate within six months,” the rating agency’s report said.
“Although this suggests a significant decline in the swiftness with which servicers were able to liquidate nonperforming loans, the analysis also indicates that, since 2007, conditions have been relatively stable and even began to improve in 2011,” S&P added.
Rick Sharga, executive vice president at Auction.com, foresees the shadow inventory overhang being resolved by 2016 causing a more normal servicing atmosphere to also return.
Besides shadow inventory figures returning to normalcy in two years, Sharga forecasts that the “clock is ticking” on foreclosures too, which he believes will also be back to regular numbers come 2016.
“The overall shadow inventory will have no impact on home prices or sales until 2016 at the latest,” Sharga told this publication in an interview. “The market will absorb what’s in the shadow inventory over the normal course of time.”