Six out of 10 loan servicers are resorting to auctioning off real-estate owned properties, despite evidence that they may see bigger losses than if foreclosed homes are marketed and sold in a more traditional fashion, according to a report by Fitch Ratings.
Inventories of real-estate owned (REO) properties more than quadrupled from the end of 2005 to the end of 2007, Fitch analysts said. To get properties off their books and reduce long-term carrying costs, more servicers are resorting to auctions, the report found.
"Fitch believes that the use of auctions will continue to increase as servicers are faced with growing REO inventories and increasing loss severities," the report said.
Although loss severities are typically higher when properties are auctioned off instead of listed and marketed to home buyers, there may be cases when taking an up-front loss at an auction is preferable to taking the time to market a property, the report concluded.
Auctions can be the best option for vacant properties in distressed geographical areas that are vulnerable to vandalism, and for homes in poor condition that require expensive repairs. Home in areas already saturated with REO properties may also be good candidates for auction, the report said.
Loan servicers surveyed by Fitch reported higher loss severities on properties sold at auction compared to those that were traditionally marketed.
But the cost of maintaining and managing swollen REO inventories for longer periods is decreasing recoveries and increasing loss severities when they are finally liquidated, Fitch analysts said.
Loss severities on subprime loans averaged 52 percent for the 12-month period ending in February 2008, the report said, up from 41 percent in 2005.
Loan servicers surveyed by Fitch said they believe home prices in declining markets will not begin to level off or reverse until the volume of REO properties available for sale in those areas returns to more historical levels.
Several of those surveyed "indicated that they believe the sooner servicers are able to work through the current and anticipated REO inventories, the more likely property values in these neighborhoods will start to rebound."
Many of the loan servicers that use auctions said they expect to use them more frequently in the future, and among the 40 percent who were not using auctions, several were exploring the possibility.
Fitch analysts said that while some servicers carefully select properties best suited for auction, others use more informal selection processes such as length of time in REO inventory, which may not produce the best return.
The report recommended that loan servicers perform property-by-property analyses to compare expected loss severities if a property is marketed through traditional means instead of auctioned off. Such evaluations should include property condition, property value, geographic concentrations, competing market values, and the history of auctions in the area, Fitch analysts said.
The report recommended that if loan servicers are resorting to auctions for the first time and don’t have information to compare projected loss severities, they should use traditional sales methods with a control group of properties to see how the results compare to auctions.
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