Tuesday, May 20, 2008

More Servicers Turning to REO Auctions: Fitch

(Housing Wire) As REO inventory piles up nationwide, more and more servicers are turning to auctions as a disposition method despite the higher loss severity usually associated with the process, Fitch Ratings said in a report released late Monday. By the end of 2007, 60 percent of the nation’s servicers had used auctions to liquidate REO holdings, underscoring the widespread acceptance the model has gained among the servicing and default industry.

Despite widespread usage, usage ranged from as little as 1 percent of inventory to 44 percent of REO inventory, based on Fitch’s survey of servicing operations, and often varied based on geographic location.

Fitch noted that servicers tended to utilize auctions in areas where loss severities are highest, which in part explains why properties sold via traditional means averaged loss severity of 40 percent relative to unpaid principal balance, while auctioned properties registered 56 percent in loss severity.

From the report:

For certain properties such as those located in distressed geographical areas, that are vacant and exposed to higher instances of vandalism, in poor condition and/ or facing huge repair expenses, or are located in areas already saturated with REO properties, traditional REO liquidation methods may significantly increase holding times and repairs, as well as require multiple price reductions. Therefore, taking an up-front loss through an auction, although appearing larger, may indeed be better than incurring an ultimately greater loss through a prolonged REO liquidation effort.

As widespread as auctions now are in the REO marketplace, servicers suggested to Fitch that the use of auctions is likely to increase even further in the months ahead as inventories continue to swell. Of the 40 percent of services not using auctions, nearly all indicated that they would be exploring the option in the near future.

The REO auction marketplace is a hotly-contested and, ostensibly, relatively profitable business. Heavyweights including Williams and Williams and Hudson & Marshall have been aggressively pushing the auction model as an alternative disposition strategy for servicers and investors.


auction severity by servicer
click for larger view

The rating agency said in its report that it expects “servicers to establish a process to identify properties for auction, thereby using auctions as a specific and controlled exit strategy and not simply as a means to lower REO inventories, manage staffing levels, or reduce servicing costs.”

The remarks represent the first best practices guidance from a rating agency on the use of auctions in REO management; servicer ratings provided by agencies such as Fitch are a critical part of the secondary market, because higher-rated servicers can effectively reduce the overcollaterization requirements needed to structure a specific deal.

Sources told Housing Wire Tuesday that Fitch’s recommendations could possibly put some servicers into a tougher position than others, given that some servicers have moved towards a strong reliance on auction-based disposition. Fitch’s apparent view that auctions need to remain one of — but not the only — disposition strategy put into place would seem to contradict such as approach, a servicing manager that spoke with HW suggested.

“It really depends on how their view of best practices in REO auctions flows into rating methods,” said the source.

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