The Nasty Secret Behind Banks and Their Repossessed Homes

Westcoe Realtors, Riverside California…The great unanswered question that has vexed the real estate community for the past 6 months or so has been this:  “Where are all the repos?”  We’ve known for months that there are literally tens of thousands of unaccounted repos in the Riverside area that have not been placed on the market for sale. So where are they?

Well, we think we finally have an answer for that question.  Granted, what will follow is merely our opinion, but it is based on 30 years in the real estate business and the reading of just a few financial tea leaves.

First, in a simple explanation, understand that the rules for banks used to be that once a property was identified as a “non-paying” asset (like when the foreclosure process was initiated), the bank had to reassess the asset’s value at that time.  As an example, if the bank held a note for $400,000 on a home, and then they had to repossess that home for non-payment, then the bank would have to reassess the home’s value at that time.  In this market, it would not be unusual for the $400,000 note to really be worth approximately $250,000.  So…the bank would have to show a loss of $150,000 on it’s books, which would certainly affect both their profits for that particular month/quarter, as well as increase the cash reserves the bank would be required to carry…because the more losses a bank has, the more cash it is required to have on hand.

However, note in the explanation above we used the phrase “used to.”  Approximately 6 months ago (if you are really anal, you can look up the exact date, but 6 months works for us at this point), there was a change in how banks had to evaluate their “non-performing assets”.  In the old way, as above, they had to “mark-to-market” (mark-to-market means that you had to establish the new value based on the current market for that asset, not the original market) the asset when they realized it was no longer worth it’s $400,000 value…and certainly the foreclosure process would be a good indicator that something was wrong with the value!  NOW…the bank does not have to “mark-to-market” the non-performing asset until they finally acquire the home through the foreclosure process or are ready to sell it.  A HUGE difference.  This means that a bank can throw as many non-performing assets as they want into the closet, and only pull them out when they are ready to declare the loss.

Why would a bank want to sit on these properties instead of selling them right away?  Because a bank would rather dole out their losses a little at a time instead of all at once so that their monthly/quarterly profits look better for Wall Street investors…and that is the ugly little secret massive financial institutions don’t want us to know.  Their closets are full of repos, or potential repos, that they are sitting on so they do not have to declare their losses now…they want to control the date when these losses are admitted on their books.

Remember when, during the heat of the financial crisis, major banks (almost all of them) were announcing “write downs” in the billions of dollars?  This was because at that time, they were required to perform their “mark-to-market” reassessments at the time foreclosure was initiated.  It seemed like almost every day some major bank was announcing another billion dollar “set aside” to cover bad real estate loans.  They were all doing it because they all had bad real estate loans.

Now, fast forward to today.  Most of the remaining large banks still have as many, if not more, bad real estate loans (and huge amounts of foreclosed properties as well), but you are no longer hearing about massive “write-downs.”  Why?  Because they are no longer required to report these repos and bad loans until they finally acquire or sell them.  They are still there, but locked in the “repo” closet, only to be let out when the bank wants to acknowledge them.

Eventually, the banks will have to deal with all this closet mess…but they want to have the time to offset these obvious losses with some future gains.  In theory, it’s just like your own house payment.  You could pay it all off today, or make monthly payments over the life of the loan…which is easier?  However, in reality, this delay is, in our opinion, only going to cause more problems for the real estate market.

First, the above scenario explains why banks are still very reluctant to use their own money to make real estate loans unless they can sell the loan to FNMA, Freddie Mac etc.  If they sell the loan, they get their money back from Fannie or Freddie…if they use their own money, then they will not have that cash on hand to cover any future real estate loan losses they currently have in their “closet.”  This explains why any type of lending (business, credit lines, personal loans, etc) that requires the banks to use their own funds is very difficult to obtain at the moment.

Secondly, this approach will significantly prolong our current real estate market…making it much longer for “regular” home owners to see a rise in their equity.  As we have said many times before in this blog, as long as banks remain in the home ownership business, this market cannot expand….and with thousands and thousands of repos sitting in the closet, who knows when this will all be over.

Thirdly, anyone else wondering about the true health of today’s banks and financial markets?  There was a big hoopla over the Dow hitting 10,000 this week, but does anyone else think this is all smoke and mirrors?  We are not “doom and gloomers” here by any stretch of the imagination, but with all these unaccounted for repos hanging around in a dark bank closet, what is the real picture out there?  Also, according to one source, there is  about 3.4 trillion dollars of commercial loans out in our system, with approximately 800 billion of that behind in payments.  So far, we have only been talking about single family housing here…but what about all the commercial loans as well?  Better get a bigger closet.

And finally, if all the above analysis is even remotely accurate, then all those buyers who have heard about the pending “tidal wave” of foreclosures that will be coming on the market soon…well, it could be a long wait.  If we are accurate here with our analysis, then there will be no tidal wave coming, but more of a steady flow…and right now, in our Riverside area, our housing demand is so strong that this steady flow does not cut it.

So…what to think?  Only time will tell..and in may ways, we sincerely hope we are wrong on some of the above conclusions.  However, there is no denying that there are thousands of unaccounted for repos in the Riverside area…and in many other cities as well. Anyone else  got a better idea where they are?