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Moody's: Short Sales Help Lower Liquidation Losses

Only a few years ago most of the talk about short sales revolved about how to make the process more efficient—meaning shorter, since on average it lasted anywhere from 60 to 90 days. That worry is a thing of the past.

According to a Moody’s report compared to foreclosures now short sales are a “shorter wait” that helps servicers mitigate the high loss severity associated with liquidating delinquent loans.

Moody’s reports the incidence of liquidations through short sales “has increased dramatically” over the past two years from around 8% of all liquidations in August 2009 to 25% by midyear 2011.

The primary reason why lenders and servicers and borrowers prefer a short sale is loss mitigation. It results from the dual effect of technology and industry efforts that have helped reduce the short sale processing time and the foreclosure alternative.

The increasing foreclosure backlog, longer foreclosure processing timelines that may exceed months and even years while legal costs accrue are a strong driver. “Servicers are increasingly opting to bypass the foreclosure process,” Moody’s said because they can liquidate distressed properties faster and also reduce loss severities.

The report also shows the average loss severity on liquidated loans remained “fairly constant” over the past year at least in part due to “a rising number of short sales through liquidations” that help reduce default loan losses.

In the past year loss severitiy on liquidated loans averaged about 60% of the outstanding balance of the defaulted loan.

As a result currently loss severities are elevated but stable.

Moody’s finds that one of the factors that pushed the loss severity up was the longer timeline between when the borrower defaults or is 60 days or more past due on the mortgage and the time when the property is liquidated, which keeps increasing.

If in January 2009 the average liquidated timeline was at 15 months, by June of this year it increased to about 24 months. Data show the increase has been consistent throughout 2010 and into this year.

By January 2011 the average liquidation timeline reached about 22 months up from 17 months in January 2010. Similarly, by mid year 2010 the timeline extended to 19 months and further up to 22 months in June this year.

Another well-publicized reason is “the glut of foreclosed properties along with attorney general proceedings and litigation” that slowed down the foreclosure process in many states.

As a result residential mortgage-backed security trusts have faced higher expenses in advanced principal and interest payments on delinquent loans, tax obligations and property maintenance costs—which in turn increase losses when the loan is liquidated.