American Banker | Tuesday, November 4, 2008
By Kate Berry

Despite a two-month surge in home sales in California, the state still has nearly a year's worth of bank-owned foreclosure properties to work through before home prices stabilize, analysts say.

Foreclosures in California could peak as early as next quarter, though prices are expected to fall 35% in the next year before the nation's largest housing market stabilizes in mid-2010.

Eager for any piece of good news, market participants seized on a report last month that California sales of existing homes rose 85% in August and 65% in September, after months of stagnant sales. But the statistics, from MDA DataQuick of San Diego, also showed that 51% of the September sales came from real estate owned by lenders, or foreclosed properties.

"There is an enormous overhang of distressed properties in California, and those REO sales are pushing down prices and driving the housing dynamics," Glenn Boyd, who heads mortgage strategy at Barclays Capital Inc., said in an interview Monday.

Foreclosures in California continue to rise even though default notices have slowed since September, said Fred Cannon, an associate director of research and the chief equity strategist at KBW Inc.'s Keefe, Bruyette & Woods Inc.

Mr. Cannon wrote in a report issued Monday that a new state law, which took effect in September, has caused some lenders and servicers to pull back from filing defaults by requiring lenders to contact a borrower 30 days before filing a notice of default.

The effect of the state law and an increase in loan modifications since the Federal Deposit Insurance Corp. seized IndyMac Bank in July have led to a drop in default notices but not a commensurate decline in foreclosures, Mr. Cannon said.

It typically takes four to five months for a bank to foreclose on a property after filing a notice of default. Mr. Cannon said he expects foreclosures to peak in the first quarter of 2009 with "a subsequent decline in REO inventory a few months after that" if REO sales remain at high levels.

Mr. Boyd said there may be a lag of as much as 12 to 18 months between a peak in foreclosures and a peak in REO inventories.

Mike Davin, the president of CataList Homes Inc. of Los Angeles, which auctions REO properties, called the drop in defaults "a temporary slowdown."

"The number of people missing their mortgage payments is not declining," Mr. Davin said.

Though a glut of REO properties has caused California home prices to fall as much as 60% in areas such as Stockton and Riverside, the prices have not fallen dramatically in more established high-end neighborhoods of San Francisco and Los Angeles.

The declines vary by neighborhood, but California home prices are likely to drop another 35% in the next year unless there is some form of large-scale government intervention, Mr. Boyd said.

"The REO market is going to suck demand out of the voluntary market," he said. "There's no fundamental reason to prevent borrowers from losing the same value of their home on the way down as they made on the way up."

Mr. Davin said there is a close correlation between bank-owned inventories and home price declines.

"We've seen banks in the last six months being very aggressive on pricing because the credit crisis has made it harder for borrowers to get financing," he said. "Increased supply with no purchasing power has led to rapid price declines in California."

Investors are finding that prices have dropped enough where they can produce "positive cash flow from market rents," so they are buying properties and renting them while waiting for the housing market to turn around before selling, he said.