Lenders are likely to add at least 1.75 million homes to their real estate owned (REO) property rolls that will take nearly three years to sell and put pressure on home prices, according to a new report from Standard & Poor’s Financial Services LLC.

Loan servicers appear to have "exhausted the supply of plausible candidates for loan modifications and switched their emphasis" back to foreclosure, the report said.

The high redefault rate on loan modifications will also add to the "shadow inventory" problem, analysts at Standard & Poor’s said.

To assess the potential magnitude of the shadow inventory problem — homes that are either owned by lenders or destined to end up in their hands but that have not yet been put up for sale — Standard & Poor’s looked at four categories of loans: performing; recently "cured"; seriously delinquent; and REO.

In early 2009, loan servicers had switched their strategy from rapid foreclosure to loan modifications, the report said. The percentage of loans moving from seriously delinquent to REO fell from 58 percent in June 2008 to 28 percent in the spring of 2009, the report said.

The trend has since reversed, with the balance of distressed loans directly paid off (as the result of a short sale, for example) or foreclosed on by lenders rising from 44 percent in April 2009 to 64 percent in October 2009, the report said.

The Obama administration last fall announced guidelines for a program that provides incentives for loan servicers and homeowners to engage in short sales when borrowers who are eligible for the Home Affordable Modification Program (HAMP) don’t qualify for a loan mod (see story).

"Servicers are requesting, and borrowers are accepting, short sales in increasing numbers," analysts at Standard & Poor’s said. …CONTINUED

On the other hand, the number of loans becoming seriously delinquent each month seems to have peaked and begun to decline, the report said, and the redefault rate on recently modified loans appears to be trending down — implying that modifications may be more successful in the future.

The Obama administration maintains that loan modifications made under the Home Affordable Modification Program (HAMP) will be more successful than those made before the program’s launch last May, because borrowers are receiving bigger concessions that significantly lower their monthly payments.

According to the latest HAMP report, released Wednesday, more than 940,000 homeowners have reduced their monthly mortgage payments under the program, with a median savings of more than $500.

With nearly 1.3 million trial modifications offered, the program is on pace to meet its overall goal of providing 3 million to 4 million homeowners with loan modifications, the administration said.

But Standard & Poor’s analysts say their report may also understate the problem, as it doesn’t assume any loans that have yet to show serious signs of distress will default and further increase the "shadow inventory." Even if no additional loans default and only the current inventory of nonperforming and REO loans eventually end up back on the market, it will take 29 months to sell them.

If 70 percent of recently modified loans redefault, that would bring an increase to the "shadow inventory" to 1.75 million properties — a number equal to nearly half the properties on the market in December — adding another four months to the inventory overhang, the report said.

That number accounts only for expected defaults for mortgages outstanding in the private securitization market, which makes up less than a third of the total securitization market, Standard & Poor’s analysts noted.


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