Guest Commentary: Ramsey on San Diego REO Auctions

Submitted by Rich Toscano on February 11, 2008 - 7:18pm

My old pal Ramsey Su is back with an analysis of the recent REO auctions held here in San Diego by REDC. He's drawn some very interesting conclusions based on the info he's been able to piece together from the auctions. If you'd like to read more after you're done with this one, the search function will meet all your Ramsey-related needs.


REDC AUCTIONS
by Ramsey Su

REDC has conducted four REO auctions in San Diego during the last 8 months, the most recent being January 26 of this year.

I have extensive data on 3 of the 4 auctions. Here are some of the findings:

Peak/Trough Analysiscurrently down 37%

Properties that went to auction likely represented the group that was purchased or refinanced at the peak and sold at the low of what the current market offers. The peak is at a fixed point in the past, the trough is dynamic and continues to change with market conditions.

73% - average auction/PVA* for the May 2007 auction
67% - average auction/PVA for the August 2007 auction
63% - average auction/PVA for the Jan 2008 auction

* PVA (previously valued at) is the number that the auctioneer publishes. Comparing that to the last sales price if a sale was involved or the total encumbrance if a refinance was more recent than the last sale, I only found fractional difference. It is consistent enough to use as a peak price.

Time Line Analysis – Current foreclosures have little to do with reset. BORROWERS SIMPLY WALKED.

These REOs are foreclosures of loans from 2004, 2005 and early 2006 vintages. Loans or purchases made in 2003 or earlier appear to be home free, unless they refinanced in 2004 or later. Using the January auction:

23% were 2004 loans
51% were 2005 loans
26% were 2006 loans

The average elapsed time between auction date and trustee’s sales date (the day the loans officially become an REO) is 8 months.

If we do a calculation in reverse chronological order:

Jan 08 auction = May 07 trustee’s sales
May 07 trustee’s sales = borrowers stopped paying May 06.

If borrowers stopped paying May 06 due to a reset, the fastest being the 2-28s, then it implies the loans should be of May 04 vintage. Since the majority of these loans were originated during 2005, or later, it suggested that borrowers are walking long before any reset.

In other words, for a loan originated during 2006 to be foreclosed in 2007, it would have to be an early payment default, defined here as defaulting less than 6 months from origination. These borrowers did not default due to reset--THEY JUST WALKED.

Loss Severity – Currently Estimated at Over 60% in the Aggregate

Loss severity is different for the senior and junior lien holder. Using the January auction:

76% had junior liens
100% of foreclosures were by senior lien holders

Not only are the junior lien holders wiped out in its entirety, they may have to charge-off interest payments that were accrued but never received.

As for the senior lien holder, in addition to the depreciation of the asset, there is a hard cost related to holding and liquidating this non-performing asset. I am estimating that to be between 20%-25% of the loan amount.

In dollar terms, the average PVA was $425,000 for the properties auctioned in January. Using the 60% loss severity estimate, this is $255,000 loss per property. Granted that San Diego is not only the high end but also one of the most volatile MSAs, this is still quite a shocking number.

Estimating REO Prevalence Including REDC Auctions – over 60%?

San Diego MLS data showed that 44% of January pending sales were REOs. REOs sold at auction are not reported in the MLS. At the current pace of one auction every two months, there should be 6 of these REDC auctions in 2008. Say 100 REOs are sold at each auction, 600 REOs need to be added to the REOs sold via the MLS.

Financing – Agency and FHA Loan Limits Are Non-Issues

In spite of SD being one of the highest priced MSA in the nation, problem properties are clearly well below agency limits of $417k. Using the January auction:

$425,308 – average PVA using auctioneer’s number
$438,285 – average PVA using last sale
$421,982 – average PVA using last refinance
$282,980 – average auction price (including 5% buyers premium)

While raising agency and FHA loan limits may address liquidity problems for the higher end properties, it has no effect whatsoever on the current pool of REOs. The financing problem is finding qualified borrowers, not availability.

Credit Bubble REOs – Already Setting Records

It is without a doubt that REOs in San Diego to date are credit bubble REOs. I define credit bubble REOs as properties with loans where the borrowers have no ability or no intention of repaying, unless the underlying property value appreciates. The household financial condition has not changed. Defaults are triggered by depreciation in value/equity.

Normal Downcycle REOs – Coming Around the Corner

Normal REOs are results of changes in household financial condition, most common of which are lost of employment or unexpected increases in expenses such as medical bills. Reset is a new factor unique to this cycle.

Auction Properties Quality – JUNK

Eye balling the properties, there are a lot of junk. 44% of the January auction consisted of condos versus 34% of sales during the last 6 months as reported by the MLS. Only 6 properties out of 118 sold for over $500,000 at auction with the highest sale at $761,250. This is confirming that REOs have not spread into mainstream properties, yet.

Conclusion

Looking ahead, the REO pipeline is going to swell as new REOs are added to the unsold inventory. This is a fact, not a guess. In order for the volume of REOs to decline, defaults have to be stabilizing and declining NOW, if not earlier.

Having been in real estate business for over 30 years, I have never seen market conditions like we have today. What is most puzzling is the level of complacency. While market consensus seems to recognize that there is a problem, fear of lost opportunities still appears to be much higher than fear of real loss.

If you think January was volatile, you are not going to like the rest of 2008.

(category: )

Submitted by barnaby33 on February 11, 2008 - 7:52pm.

What is most puzzling is the level of complacency. While market consensus seems to recognize that there is a problem, fear of lost opportunities still appears to be much higher than fear of real loss.

This quote really got me. I would suppose (though I do not know) that it is because you don't sweat it, if its not your money. Most of the "junk" was sold to Wall St. The local banks may hold some of the toxic crap, but the majority seems to be held in CDOs, many of which are owned by foreigners.

My second supposition is that these foreigners are shitting the bed, a large part of why our credit market is locked up. Once you take a bite of a shit sandwich, you don't want a second bite.
Josh

Submitted by SD Realtor on February 11, 2008 - 11:53pm.

Rich I really enjoy reading Ramsey's stuff... Not sure I agree about the 25% holding cost by the lender but he is much more adept at I in that analysis so who am I to argue...

One thing that is really irking me...

Why does everyone presuppose that foreigners are the majority holders of the cdos and such?

Can you please comment on other domestic entities who have made investments in these vehicles. People don't seem to acknowledge how much investment there is right here in the good old USA. You probably don't have to go much further then your own county or state government.

SD Realtor

Submitted by tickets on February 12, 2008 - 5:32am.

Ramsey has phrased it right, but it's worth making this point explicit. The fact that these REOs are EPDs, and not because of resets, does not mean that resets won't be an issue. For a 2005 vintage loan to be REO because of a reset, it would have to stop paying in 2007, a trustee sale in 2008, and couldn't be an auction until late in 2008 at the earliest. We just aren't far enough in to know if resets on the 05, 06, and 07 vintages will be a problem or not. The 2004 and earlier vintages got the benefit of the huge price run up in 04 and 05, so the reset issue would never surface with those.

These stats are sufficient to prove that there is a big problem with or without resets, but they aren't proof that resets won't be an issue.

Submitted by 4plexowner on February 12, 2008 - 6:44am.

"Why does everyone presuppose that foreigners are the majority holders of the cdos and such?"

making this assumption helps people sleep at night

the toxic trash has actually been sold to pension funds, state and industry retirement funds (think CALPERS), money market funds and college endowment funds here in the US

these entities don't have the same reporting requirements as publicly held corporations so they have either not realized the worthlessness of their 'investments' or they are keeping their losses under their hats for now

unless these investment entities are forced to sell or mark their toxic trash to market, it is better for them (and for your ability to sleep at night) if they don't publicly acknowledge that their 'investments' might not be worth what they are saying they are worth

remember, we are still very early in the great unwinding - at this point Wall Street and our government are still trying to pretend that over $500 trillion dollars worth of derivative paper (MBS, CDO, CDS, SIV, etc) actually has tangible value - they are correct in that paper always has value whether it is for starting fires or wiping your posterior

Submitted by Bugs on February 12, 2008 - 9:20am.

I just cruised through the pending sales in Oceanside to get a look at all the REOs. Ramsey didn't mention it, but there are also a number of short sales, too.

I also went through the YTD closed sales in 92056. Of the 21 homes that have closed escrow so far this year, 12 were REOs. By my count, that's over 50%. Remember when we were talking about REOs driving the market? We're already there in Oceanside.

A few of these pending and closed sales are indicating to 40% losses relative to their prior sales, not counting the holding costs and costs of sale.

Putting this in perspective, I remember last year when we were debating the merits of trying to get an 1,800 SqFt tract home in Temecula down to $350k. Well, we're now approaching having that same conversation for equivalent homes in the Rancho Del Oro area of O'side. When considering typical buyers in Temecula, this is a reasonable comparison that is sweetened by the much closer proximity to quality employment and the cooler weather.

Temeculaguy's pain train is marching south, and we've already booked some 40% losses here in SD County. As I see it, there's no way we're going to avoid booking some 60+% losses by the time this is over.

Submitted by Liz357 on February 12, 2008 - 9:36am.

second bite

This whole thing is a shit sandwich and everyone one of us will be taking a bite.

Submitted by SD Realtor on February 12, 2008 - 12:16pm.

4plex -

Exactly... Thank you for stating something that I have been trying to put across... The very idea that people think that all of these derivatives are owned by wealthy old men or foreigners is almost as comical as the people at NAR saying buy a home now.

When one looks into it, these entities are really the ones that are holding a sack of sawdust right now. The amount of domestic investment by entities that really provide sound infrastructure to our society is something that has not been discussed or barely touched on. It is THESE entities that the I believe are FEDs are really trying to protect. There is no easy solution because the problem is so widespread. It is my opinion that because of the widespread investment, there is NOT any possibility of a rip the bandaid off now solution. To many entities will flop and to much of the basic infrastructure will indeed be broke. Thus there HAS to be a way to throttle it back and let it bleed out slower.

Submitted by nostradamus on February 12, 2008 - 12:19pm.

Great article. Thanks Ramsey!

Submitted by stx_jay on February 12, 2008 - 6:36pm.

Mr. Su,

Thank you so much for these insights. It's valuable to see this kind of information at the atomic level. The days of the 800 sq foot, 2/1 shack going for > 5X area median household income are hopefully at an end. It sounds like we're getting there.

As you say, the junk is tanking. These shacks aren't anyone's idea of a dream house, so why burn a huge percentage of take-home income just to maintain these P.O.S.? Just walk away.

Submitted by barnaby33 on February 13, 2008 - 10:12am.

"Why does everyone presuppose that foreigners are the majority holders of the cdos and such?"

making this assumption helps people sleep at night

Actually no, I am heavily short XLF through puts. My use of the word foreigners was a potential mis-use of a moniker for the last people to the party, the bagholders. In point of fact foreigners are often the last ones left holding the bag on made-in-amerika scams, but nobody really knows who is holding the crap.

As to cal-pers, either they are lying or they only hold a very small percentage of assets in MBS, something like 3/10ths of a percent. Thats what they've stated in the past 12 months.

I'll sleep better at night once this really starts to unravel. Once the public starts seeing the banks come clean about their losses and exposures. Until then its not really relevant who the bag holders are (foreign or domestic).

On another note I would also like to thank Mr Su for his analysis of the recent REDC auctions.

Josh

Submitted by 4plexowner on February 13, 2008 - 6:14pm.

well, it took me less than 10 minutes to research CALPERS investment portfolio enough to have questions

"CalPERS began investing in hedge funds in April 2002 with the goal of diversifying its investment portfolio, managing risk, and adding value to the fund."

http://www.calpers.ca.gov/index.jsp?bc=/...

looks like CALPERS has about $10 billion in 25 different hedge funds - without researching what each of the hedge funds is invested in, it is impossible to say that CALPERS does or does not have exposure to derivative paper

~

the financial information I found at CALPERS site reminds me of the laws that govern food content labelling - for example, the law allows a manufacturer to state "yellow dye #3" as an ingredient without clarifying what yellow dye #3 is made of - CALPERS is letting us know that they have $10B invested in hedge funds but they don't tell us what each of the hedge funds is invested in - as always, caveat emptor or, in this case, "Do you know how your retirement money is invested?"

Submitted by SD Realtor on February 14, 2008 - 1:01am.

4plex I also think there is another 2nd order effect that is not discussed as well. That is, even without direct exposure to the hedge funds, collateral damage will happen. So Calpers has 10b in hedge funds. However what about investments in other financials or other entities that will go down because of their own investments. You see what I am saying? Implosions are less destructive then explosions and while we have been discussing a potential implosion, I think the effects will be more of an explosion. Again, to me, this is why the govie is going to pull out all the stops to delay or smooth this sucker out. Maybe they can delay it maybe not. Thanks for doing some legwork on the Calpers investment... I would maintain that in the worst case, they would be damaged much more by the hedge fund investment going south.

SD Realtor

Submitted by barnaby33 on February 14, 2008 - 5:14pm.

Here I was all prepared to say several European banks were the largest losers so far, but I decided to check with google first. Lo and behold I found this.
Back of the envelope calculation on losses. Seems like domestic banks are in the lead, when it comes to recognizing losses. I say recognizing because I have a feeling that when all is said and done, foreign banks and foreigners will still be the largest bag holders.

Josh

Submitted by sdrealtor on February 15, 2008 - 1:00am.

Just another piece of evidence confirming what I pointed out several weeks ago. The market shifted to a distress driven market a few months back and the rapid price declines followed accordingly. I've seen properties in certain categories that have dropped 30% in 5 months because there was absolutely no support for the prices in those areas. For some of these properties I find myself wondering how much lower they can fall.

How much lower can a 1BR condo in Fire Mountain (Oceanside) fall from the $137K asking price that currently sits on a probate sale there? The monthly carrying costs with 20% down are under $900 at this price. At $100K they would be down to about $700. At $80K they would down under $600.

I see 3000 sq ft highly upgraded nearly new homes selling in SE Hills for just over $500,000. Will they hit $400,000, $350,000, $300,000? I really have no idea how far they could fall.

To the contrary, the stronger markets have not seen these dramatic drops and the declines should continue to be slower and more orderly.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.