The Problem of Shadow Inventory

Recent indicators like rising unemployment, decreasing home sales, decreasing home prices, a rocky stock market, etc., have led more and more people to believe that a double dip may be coming. One additional factor to consider is the issue of shadow inventory. Shadow inventory is loans that are badly delinquent, but for one reason or another have not gone to foreclosure. Eventually those loans will go through the normal process and make their way on the market at a time when there are already a lot of homes on the market that just aren't selling.

Lee Howlett, president of ISGN's servicing practice, says the shadow inventory problem "is a moving number. Early this year the inventory of properties for sale was small. Inventory jumped in early spring through May. As I look in my local market it's dropping off again because it is taking so long for properties to sell. Properties are just sitting on the market with no buyers.

"The market is being squeezed. The government is doing everything to prevent foreclosures. The message to lenders is not to foreclose. On the other end, you have county judicial people that are increasing the requirements that a lender needs to satisfy before they can even foreclose if that's what the consumer wants. HAFA was introduced as another step to avoid foreclosure and it's been slow to implement.

"Consumers are struggling to understand what it means and Realtors are struggling to market those assets. Inventory has almost grinded to a halt and we'll see who blinks first. Without an avenue to get to a foreclosure or short sale, the only way to clear the inventory while avoiding foreclosure is principal reduction. Who's going to take that hit is the question. The government may do some kind of loss-sharing formula."

Going forward, Howlett thinks most in the mortgage industry are prepared this time around for more down times. "We're all prepared for more downside vs. upside. We can withstand this economically. For the past 25 years we as an industry focused on the origination process. Servicing systems are legacy systems that are 15 years old. Primarily they were accounting systems designed to receive funds and now they're being asked to do workouts. Retrofitting those platforms with rules around loan mods that are constantly changing isn't easy.

"There isn't a need to write a new servicing system though because that will take 12 months or more so we're surrounding existing systems with applications that can do loan mods the best way possible."

In addition, Joe Dombrowski, executive consultant at Fiserv, says that servicers will have to use technology to keep them more organized. "With shadow inventory you need to manage several timelines. You need to track properties in foreclosure moratoria, for example. You also need to do presale efforts before it goes to REO. We still support a servicer's right to look at property issues, title issues and borrower issues. You can't stop working the property even if it's sitting in a shadow inventory.

"You need to continually assess: Has this property been neglected? Maybe there is an appraisal ordered. All that is put in your cost analysis and how you want to treat the property. Second, we look at title. You can't do foreclosure until title is clear. We help servicers look at title issues and costs. We'll help the servicer put a dollar figure around that property so they know what their gain-loss proposition is.

"Lastly, we have people to deal with borrowers and renters. Also, if the property is evicted a lot of servicers look to rent that property out. We'll help the servicer become a landlord."