S&P: Shadow Housing Inventory to Clear in Four Years

It will take less time than previously expected for the housing market to clear the supply of distressed homes on the market, but that so-called shadow inventory will still be around for nearly four years, Standard & Poor’s Rating Services said last week.

It was the first time in two years that S&P had lowered its estimate for the life expectancy of the shadow inventory. The agency estimated last week that there was a 47-month supply of homes at the end of the second quarter, which was five months shorter than its estimate at the end of the first quarter.

But even over a slightly shorter period, the lingering glut of homes in foreclosure threatens to further depress home prices and postpone a recovery.

“Though fewer additional loans are currently defaulting, the overall volume of distressed loans remains huge,” Diane Westerback, S&P’s managing director of global surveillance analytics, wrote in an 11-page report released last week.

The total volume of distressed loans dropped 6% in the second quarter to $405 billion, the lowest level since December 2008, S&P said.

But the worst is not over.

“We believe prices are likely to fall further as servicers clear the shadow inventory backlog and the properties under the distressed loans crowd the already weak housing market,” Westerback wrote.The New York metropolitan area alone will need another 12 years for its entire inventory of distressed homes to be sold. S&P’s 144-month estimate reflects the fact that liquidation rates have ground to a halt in judicial states where foreclosures are processed through the courts. Finalizing foreclosures has become more difficult because servicers have been caught skirting legal rules and procedures.

Rick Sharga, a senior vice president at RealtyTrac Inc., said the housing market is close to hitting bottom. The Irvine, Calif., data firm estimates there is a three-year supply of distressed homes, which does not include delinquent loans.

“We are still not selling enough of this inventory to make a dent,” Sharga said.
Servicers essentially are stuck in a Catch-22, according to the S&P.

“Although liquidation rates seem to have leveled off, foreclosure timelines are still very long and do not yet show signs of improving,” Westerback wrote.

Sooner or later liquidation rates will have to rise, she said. But if servicers do speed up liquidations significantly, the housing market “may be inundated with properties, driving home prices still lower.”

It also comes as no surprise that distressed loans in the shadow inventory have weak credit characteristics. The average Fico score is 645 and borrowers typically are underwater, owing more on their mortgage than the home is worth. Borrowers that are 90 days delinquent or in foreclosure have missed an average of 19 mortgage payments.

Moratoriums on foreclosures have resulted in low liquidation rates over the past two years, allowing the shadow inventory of distressed homes to grow dramatically.

S&P defines the shadow inventory as properties in which borrowers are 90 days or more delinquent on their mortgage payments, properties in foreclosure, and properties that are real estate-owned. It also includes 70% of the loans that “cured” from being 90 days delinquent in the past year, because S&P believes such loans are likely to redefault.

The estimate of the length of time it will take to clear the inventory fell from a peak in March of 52 months and represents the largest quarterly decline since mid-2008. “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,” Westerback wrote.