REQUIRED READING: The old saying ‘What goes around, comes around’ is certainly true within the default servicing industry. Just as the housing market, in general, has traditionally moved in cycles, so too do the residential real estate owned (REO) asset management disposition strategies of lenders and servicers.
Today, there is a noticeable trend for lenders and servicers to reduce their dependence on third-party asset management outsourcing companies and increase ‘insourcing.’ But with foreclosures on the rise once again and with a growing shadow inventory, outsourcing will not disappear anytime soon.
According to RealtyTrac, the backlog of foreclosures caused by the robo-signing debacle is just the tip of the iceberg. There remain millions of mortgages either in foreclosure or in other stages of default. RealtyTrac expects a 25% increase in foreclosures alone over 2011 numbers, rising to over 1 million this year.
Furthermore, Barclay's Capital has indicated that there could be as many as 12 million homes in the shadow inventory. Morgan Stanley goes further, projecting as many as 2 million foreclosures in 2012.
Over the past three years, there has been a very clear slowing of the default process, from notices of default filings to attempted workouts, to foreclosures, evictions and the release of REOs into the marketplace. This is, in part, because of mostly unsuccessful attempts by the Obama administration to help more Americans try to avoid foreclosure through foreclosure moratoria and loan modification and foreclosure alternative programs; however, the only real result has been a protracted housing slump, an ever-sluggish economy and the expansion of the shadow inventory.Â
Far too many loan modifications – approximately 70% – have failed, with many of these loans returning to default before the first payments were made. This has also impacted the flow of REO properties by delaying inevitable foreclosures and reducing inventories across the nation, thus diminishing the need for outsourced asset management assistance.
Many experienced REO and default servicing professionals believe there is often an added value in going direct to REO brokers rather than through third-party asset management companies, despite inventory levels. But these professionals also acknowledge that there are valuable benefits to outsourcing.
Since the very beginning of the debate over whether to go with outsourcing or keep the management processes in-house, control has been a touchy subject. Traditionalists who supported insourcing versus outsourcing felt strongly that control is enhanced through an insourced team in a broker-direct environment because there is no middleman.
But others believe there are trade-offs offered by outsourcing – such as reduced internal operating expenses, insulation from certain liabilities and process efficiencies, especially related to accounts payable – that trump control alone. And it is still possible to stay in the loop with the listing brokers to improve the level of control even when outsourcing.
Benton Neese, president of the trade association REOMAC, recently said, ‘Various lenders and servicers over the past few years had staffed up in preparation for the tsunami of REO properties promised by the experts. When the tsunami never materialized, many had to find other work for the staffs they had built or lay people off. A combination of the two happened, and the staffs were managed down. They decided to keep inventories in house because they had the staff to manage the properties and the systems in place were more sophisticated/cutting edge, thus allowing fewer people to handle more inventory.’
Keeping it short
Another factor impacting the availability of REOs is short sales. Known as ‘short payoffs’ prior to the latest housing bubble explosion, short sales offer a disposition strategy that was largely frowned upon by lenders in the past, despite reducing the loss on individual nonperforming loans in most cases. Short payoffs were generally only approved by lenders in severe situations that involved serious hardship on the part of the borrower. After all, the borrower had signed a binding contract – it was a matter of principle with the lenders, and it was taken quite seriously.
Today, however, things are very different. With a newfound tolerance for short sales – because losses are typically less on individual short sales than on an REO sale – available REOs released for sale were further decreased in the market. The downside to this, of course, has been the spread of strategic defaults. This can actually create higher aggregate losses for institutions because so many more loans have gone into default than otherwise would have.
It is quite possible that short sales will decrease this year as a percentage of real estate transactions for many lenders/servicers, just as loan modifications have, when they realize this. If true, this would potentially increase REOs on the market to some extent.
The increase in investor activity of purchasing foreclosed properties on the courthouse steps and in bulk sales to hedge funds and other investors has also impacted available REO inventories. That is not really a bad thing from the lenders' perspective, but it is another reason why outsource companies find themselves nervously seeking new business.
Accurately predicting whether REO inventories will rise or fall in the near future is difficult, at best. The bottom line is that the advents of improved technologies for inventory tracking, offer management portals, and streamlined processes have, in many ways leveled the playing field between REO asset management insourcing and outsourcing by lenders/servicers.
Highly effective internal asset management functions can often outperform the outsource vendors. That is why institutions – large and small, and somewhere in between – benefit from the inherent ‘champion challenger’ environment that comes from a blended or balanced disposition strategy.
While it appears that the current trend is to increase insourcing, there is no single ‘right’ strategy to manage, market and ultimately dispose of REO properties. Uncertainty remains about the direction the housing market will go in the months ahead, and the decision to increase insourcing activities appears to be largely based on rising or falling inventory levels.
Lynn Effinger is director of new business development for Transaction Dynamics LLC, a financial services consulting firm based in Roseville, Calif. He can be reached at email@example.com.