Preparing for the Housing Industry's Shadow Inventory
The nation's shadow inventory, or the growing backlog of pre-foreclosure homes, is looming as a major threat to the mortgage industry and nation. Much research has been conducted throughout 2009, and this data points to an estimated 7 million homes that are in some state of delinquency or have already been issued a foreclosure notice. The "cure rate" trend is worsening by the month, and if the trends of default from 2009 hold the course then the inevitable will occur with this inventory heading towards foreclosure. This astronomical volume of properties weighs heavily on the shoulders of an industry that is trying to get its legs under itself. However, the preamble to this looming crisis offers many opportunities for lending institutions that proactively take the necessary steps to prepare.
As we know, there are several key drivers generating these pending foreclosures. One of them is the issue of negative equity. Increasingly, homeowners who owe more than their property is worth, seemingly choose to walk away and rent instead, a much cheaper alternative than remaining "upside down" on their mortgage in a world when real property values are in a steep decline without a true barometer of when things will turn around. Good, bad or indifferent we are hearing more and more about this new industry term of "Strategic Default."
Another factor causing the shadow inventory is high unemployment. People without work are simply unable to pay their mortgages. Finally, federal and state regulations and government programs designed to help the housing crisis may be delaying inevitable foreclosures with good intentions, adding to this backlog of "shadow inventory" and REO that will ultimately burst. The sheer volume of homes headed towards foreclosure may seem daunting to the unprepared, but there are several steps lending institutions can take to navigate effectively and sell foreclosed properties quickly. The first decision a lending institution should consider is whether or not to outsource the influx of additional responsibilities that inherently come with undertaking such an unfamiliar situation and evaluate those costs and risks of building infrastructure to handle these tasks in-house. There are a number of benefits to outsourcing the responsibilities, which include lower capital costs, increased efficiency, reduced labor costs, reduced compliance risks and increased focus on the lending institution's core competencies.
If the lending institution decides to keep its services in-house, it will provide a higher sense of control of the entire process but must realize that it has to accomplish the very same level of roles, responsibility and results as that of the outsourcer and their expertise in the core competency of REO disposition. The shadow inventory's demanding breadth of responsibilities and size will be a challenge that the lending institution will need to consider when analyzing facts prior to decision.
Whether the final decision is to "in-source" or outsource, there are a number of steps that lending institutions must accomplish in order to survive the shadow inventory's immensity of expected foreclosures throughout 2010 and beyond. First, they must set up a multi-tiered program in preparation for the high volume of foreclosures. The program should include ongoing training to existing staff, hiring and training new personnel, establishing additional facilities to further accommodate the need for scaling operations and continuing to build a strong network of reliable vendors providing the many different components of the REO services spectrum.
Holders of REO must also implement a quality maturity system embodying oversight management for securing and reselling REO properties in full compliance with local and federal regulations. The lending institution should establish specialized teams of experts that handle very specific activities associated with the liquidation process, such as compliance-related issues. The idea is that the more conversant the specialized team is with its particular niche of the REO disposition process, the more successful the execution of disposition management will be in reducing costs and mitigating risk (no one wants to be in the limelight right now). And lastly, bolster the technology behind it all, so the many disparate systems across mortgage origination, loss mitigation, REO and its vendors can communicate.
It is important to understand that the shadow inventory is not a matter of "if," it is really only a matter of "when," and those lending institutions that decide not to swiftly start the preparation process now will struggle to cope with the changing responsibility, overwhelming volume of properties and legal risk associated. Those without a plan in place may risk the health of their entity and ability to maneuver towards future organizational stability.
A word to the wise: entrench yourself with all data points available, surround yourself with people and business partnerships that will elevate your performance, strategize, plan and execute as if your organization's survival depended on it. "Success by design" is warranted; random acts of execution will prove harmful.
If the "cure rate" trend continues, the current shadow inventory of 7 million properties and the estimated 250,000 inventory growth each month forward represents one of the largest and most challenging hurdles to the recovery of our nation's housing market. The industry must collectively unite to solve this issue. When times are tough this nation is known for pulling together to overcome what seems to be impossible!
Dan Reynolds is executive vice president at Lenders Asset Management Corporation (LAMCO), a full-service, nationwide REO management company that enables lending institutions, servicers, investment firms and insurance entities the ability to efficiently scale operations and liquidate REO assets with mitigated risk. For more information on the privately held company, visit www.lendersreo.com.