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Are Declining Foreclosures Good News for Housing?

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A healthy housing market is at the center of a robust economy, so the dribs and drabs of good news regarding the housing sector have been especially welcome. Last week, an especially tasty morsel was reported by real estate data company Realty Trac: Foreclosure filings for April represented the lowest since 2007, falling 14% from a year previous. In addition, the Mortgage Bankers Association noted that delinquencies decreased in the first quarter as well, hitting the lowest mark in more than three years.

This is good news, indeed. Looking a little deeper uncovers some of the reasons for these improved numbers -- one being that banks are disposing of troubled properties using an alternative to foreclosure called the short sale.

Banks discover the utility of short sales
Banks have stepped up the use of short sales over the past year, partly because of incentives from Freddie Mac, but mostly because of the increased efficiency and cost savings. Foreclosure proceedings are long and grueling and can cost banks upwards of $60,000 for each property it processes. Although short sales can complicate sales by requiring the bank, borrower, and buyer to come to an agreement on price, banks are finding that accepting less than the homeowner owes is preferable to foreclosure. They like the method so much, in fact, that some of the largest banks are offering incentives to troubled mortgage holders to enlist their participation.

Bank of America (NYSE: BAC  ) , whose exposure to bad loans intensified when it acquired Countrywide Financial in 2008, began offering incentives last year of up to $30,000 in relocation expenses to homeowners who qualified and signed on for the program. JPMorgan Chase (NYSE: JPM  ) also started offering borrowers amounts as high as $35,000 last year, acknowledging that short sales are a quicker solution than the foreclosure process. Wells Fargo (NYSE: WFC  ) jumped in last year as well, though its incentives are lower than what the other two banks offer -- between $3,000 and $20,000.

Banks that signed the $25 billion foreclosure settlement earlier this year will also be offering select customers principal reductions as part of the agreement. Bank of America recently sent its first batch of letters out to eligible borrowers, and fellow signatories JPMorgan Chase, Wells Fargo, Citigroup, and Ally Financial are expected to follow suit. This should help keep hundreds of thousands of underwater loans from entering the foreclosure pipeline as well.

Fool's take
Short sales and other programs are helping to lower foreclosure numbers, which can only help the housing recovery. They have the added benefit of being less destructive to the borrower's credit, which might help turn at least some of them into buyers of more affordable homes more quickly than if they had been foreclosed upon.

Short sales are also on track to become shorter. New regulations are coming soon from Fannie Mae and Freddie Mac, requiring banks to decide on terms within 30 days. Halting steps, perhaps, but forward motion, at a quickened pace, is just what the housing market needs right now.

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Fool contributor Amanda Alix owns no shares in the companies mentioned above. The Motley Fool owns shares of JPMorgan Chase, Wells Fargo, Citigroup, and Bank of America and has created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (2) | Recommend This Article (3)

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  • Report this Comment On May 31, 2012, at 6:05 PM, MHedgeFundTrader wrote:

    This is far and away the world’s premier banking institution. Estimates of the huge trading losses by the London “whale”, initially pegged at $2 billion, have since skyrocketed to $6 billion. I’ll ignore the Internet rumors that speculate about a $30 billion hickey. As you well know, almost everything on the net is not true, except what you read in my own newsletter.

    Back in the 1980’s when I was at Morgan Stanley, the inside joke was to look for nice office space for ourselves whenever we visited clients at (JPM). The expectation was that they would take us over when Glass-Steagle ended, as they were both the same institution before the Securities and Exchange Act broke them up in 933. When the separation of commercial and investment banking finally came in 1999, Morgan Stanley had grown far too big to swallow and the egos too big to manage.

    I’ll tell you another way to look at this trade. (JPM) lost 4.7% of its capital, so Mr. Market chewed 30% out of its capitalization. Sounds a bit overdone, no? The bad news is already in the price. A large part of the offending position has already been liquidated.

    I have analyzed the specific trade that got (JPM) into so much trouble, the now infamous “Investment Grade Series 9 Ten Year Index Credit Default Swap.” The chart of its recent performance and its hedge is posted below. It was in effect a $100 billion “RISK ON” trade that came to grief in early May.

    Few outside the industry are aware that this was a $6 billion gift to two dozen hedge funds who are now shouting about record performance. It is, after all, a zero sum game. Didn’t Bruno get the memo to “Sell in May and go away”? He obviously doesn’t read The Diary of a Mad Hedge Fund Trader either.

    Even if the worst case scenario is true and the $6 billion numbers proves good, that only takes a 4.7% bite out of the bank’s $127 billion in capital. It is in no way life threatening, nor requiring any bailouts. These shares at this price are showing an eye popping low multiple of 7X earnings, and have already been punished enough. Getting shares this cheap in this company is a once in a lifetime gift, and twice in a lifetime if you count the 2009 crash low.

    You don’t have to run out and bet the farm right here. Scale in instead, and if the market drops, you can always cost average down. If Greece forces us into major meltdown mode, we can also hedge this “RISK ON” trade through taking more aggressive “RISK OFF” positions, like selling short the (FXE), (SPX), (IWM), (GLD), or the (SLV) by buying puts.

    Mad Hedge Fund Trader

  • Report this Comment On June 01, 2012, at 10:06 PM, MHedgeFundTrader wrote:

    The March Case Shiller Home Price Index is out, showing that the fall in home prices continues unabated, paring -2.6% on a YOY basis. Detroit delivered the biggest drop, down a shocking -4.4%, followed by Chicago (-2.5%), and Atlanta (-0.9%). But 14 out of 20 markets managed increases in prices. The national index is still declining, but at a slower rate. Given that this indicator lags real time by about three months, is there something going on in housing that we should be anticipating?

    Don’t get your hopes up and rush out and place a deposit on a new home. I think that the strength that we are seeing may be only a short term anomaly of the marketplace. So much hedge fund and private equity money poured into the foreclosure market recently that we suddenly ran out of inventory. Up to 60% of recent home sales have been in the foreclosure area. This explains the sudden pop in the average cost of homes sold.

    These funds have set up local management companies to rent out properties and are soaking up 1,000 homes at a throw, looking to sit on them for a decade until the demographic headwind turns to a tailwind. They are encouraged by negative real interest rates, the 30 year mortgage now plumbing an unbelievable 60 year low of 3.75% that made this investment a no brainer for the patient and deep pocketed. The goal is to eventually securitize these holdings and sell them for a premium.

    We are not by any means out of the woods. Pending home sales plunged by 5.5% in April, and March was revised down sharply. The west showed the steepest decline, down 12%. The banks also have a seemingly limitless ability to produce new foreclose inventory.

    The demographic headwind is still at gale force strength, as 80 million baby boomers try to sell houses to 65 million Gen Xer’s who earn half as much money. Don’t plan on selling your home to your kids, especially if they are still living rent free in the basement. There are six million homes currently late on their payments, in default, or in foreclosure, and an additional shadow inventory of 15 million units. Access to credit is still severely impaired to everyone, except, you guessed it, the 1%. Many deals fall out of escrow at the last minute over appraisal issues which fail to meet the banks’ new, more demanding requirements.

    I think the best case that can be made for housing here is that we may finally be coming into an uneasy balance that sets up a bottom for prices which we will bounce along for five to ten more years. This has been made possible by the arrival of an entire new class of buyers, the opportunistic hedge funds.

    The Mad Hedge Fund Trader

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