Bloomberg Discovers the REO Industry

By: PAUL JACKSON
July 23, 2008

A piece today at Bloomberg co-authored by Bob Ivry marks the financial news outlet’s “come to Jesus” moment with the REO industry, and reading it is certainly amusing for anyone that’s actually spent time working in the space. (BTW, Bob, if you’re ever doing another story on this, we’re here for you on background.)

The crux of the article, however, lies here:

Together, Fannie Mae and Freddie Mac, the two biggest U.S. mortgage finance companies, owned a record $6.9 billion of foreclosed homes on March 31, compared with $8.56 billion held by all 8,500 U.S. commercial banks and savings and loans.

Those outside the industry — and perhaps a good percentage of those inside the industry as well — might miss the real significance here. We know that Fannie and Freddie’s defaults are below those in the private party market, so you should be surprised to see such a large REO inventory on the books. At least until you realize just how large Fannie and Freddie really are relative to the rest of the market.

But the difference underscores one other aspect to the REO management ops at both GSEs, something the Bloomberg story scratches on:

Fannie Mae’s goal in selling its properties is to get the highest possible price, even if it means hanging on to them longer, said Gabrielle Harrison, the company’s vice president for REO sales. REO stands for “real estate-owned,” a designation for properties that have been repossessed by creditors. Getting the highest price helps preserve neighborhood property values, she said.

Besides the humor for me in seeing REO merit a formal definition, what Harrison is alluding to is both GSEs’ focus on neighborhood stability; both have long been famously adamant in their selling prices and hesitant to sell to investors in service of this goal, preferring owner-occupants buy the properties instead. (You see, when you’re Fannie or Freddie, timelines apply less so than in the time-is-money world of private-party investment interests).

Had Ivry and his intrepid co-author Sharon Lynch explored the topic further, they’d have found out that while both GSEs have an interest in maintaining stability in their neighborhoods, right now this policy will translate into loss severity that goes well beyond the standard 20 percent once these properties are finally sold. Dean Williams, the inimitable CEO of Willliams and Williams, gives us part of the answer why:

It costs creditors such as Fannie Mae 2 percent of the value of the property every month in taxes, insurance, utilities, lost revenue, maintenance, management and cleanup after vandalism, Williams estimates.

Williams is referring to what’s known in the trade as cost of carry, and I’ve seen estimates ranging from 2 to 2.5 percent of unpaid principal balance — not “the value of the property,” as Bloomberg suggests, which would suggest declining carry costs right now in many markets when the exact opposite is taking place. I’ve also started to see cost of carry estimates reach up to 3 percent in certain cases lately, depending on where a portfolio of loans is concentrated and the investor behind a deal. In Fannie and Freddie’s case, the cost of carry is probably on the higher end of the spectrum, since the GSE’s disposition operations like to actively repair and maintain properties (part of selling to owner/occupants, as opposed to investors).

But cost of carry isn’t the only reason that loss severity is likely increasing for the GSEs — home price declines are eating away at any recovery value tied to the property itself, as well, and it’s doubtful that either GSE will hold onto properties long enough to see property values recover.

While the GSEs don’t disclose loss severity — and that’s one change I’d love to see made, given that these are government-regulated entities, after all — the above should illustrate why loss severities have been rising in the private-party market. I’d doubt that Fannie and Freddie are immune from a similar jump.

Nor are they immune, apparently, from an influx of inexperienced agents that are easily able to get REO listings assigned simply because of the sheer volume or work to be had:

Part of the difficulty for all owners of foreclosed property, and not just Fannie Mae, is a shortage of qualified agents in the field who can sell the homes efficiently, said Jesse Ramirez, a broker associate at Re/Max Partners Real Estate in Corona, California.

“They are all recent college grads without experience,” Ramirez said. “They have 300 files each and they’re overwhelmed. They don’t understand how the typical transaction goes. These people didn’t have jobs two years ago, not doing this.”

You’ll have to excuse me for a minute. I have an REO brokerage to go form….