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Banks Outbidding Private Equity Funds at Foreclosures, Believing They Can Beat Them at the Pump and Dump Game

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It’s conventional to deem local journalism to be dead, but Josh Salman at the Sarasota Herald-Tribune has written well-researched investigative story on bank bidding at foreclosures in his neck of the woods, Big lenders bidding to keep homes, that has national implications.

Here’s the overview:

Banking giants from Wells Fargo to Fannie Mae are routinely paying top dollar on the auction steps to hold onto their own distressed properties, outbidding cash offers and paying well above assessed value, according to a review of thousands of Southwest Florida auction purchases.

They are speculating that the properties will appreciate even more in the next couple of years.

The article does not indicate whether the “banking giants” like Wells Fargo are only bidding on properties where the bank owns the loan or serviced loans for private label (non-Fannie and Freddie investors).

The degree of outbidding is not modest, at least in Southwest Florida (emphasis ours):

In some cases, lenders this year have bid up to 600 percent more than a property’s worth to retain foreclosures — one of the primary reasons the acquisition costs for competing real estate investors also has spiked in recent months.

In the 12 months ending June 1, 4,865 foreclosures were auctioned in Sarasota and Manatee counties. Lenders outbid third-parties to keep 3,754, or 77 percent.

Banks paid $259.2 million for the properties, an increase of 34 percent from the amount they spent in the same 12-month period a year ago…

“The banks seem to be offering more than they usually would — going for market value and above,” said Shannon Moore, broker and owner of Green Lion Realty in North Port. “I don’t quite understand the logic. It’s a vast shift from the last few years when would take any reasonable amount just to get rid of them.”

Now it’s worth keeping in mind that in the good old fashioned days, when homeowners had equity in the home at the time of purchase and prevailing home prices went down only at most on a regional basis, and then usually not too much, the bank would put in a bid for the home at the courthouse for the value of the mortgage so it would take it into “real estate owned” inventory and dispose of it later if no one was willing to snap it up on the courthouse steps for a high enough price. But analysts would probe banks about their REO inventories, particularly in a weak economy.

But the “paid” is a misnomer unless the bank bid above the mortgage balance to win at the auction, which the article says doesn’t happen that often. So from an accounting standpoint if the mortgage was $160,000 and the highest third party bid was $90,000, the bank could take the offer at $90,000 and recognize a loss of $70,000 plus foreclosure costs. Or it can bid $110,000 and move the property into REO. If I read the OCC guidance correctly, the bank has to value the REO at the lower of the “recorded investment in the loan satisfied” which I assume is the mortgage balance PLUS the foreclosure costs OR fair market value as determined by an appraiser. Gee, we know how independent those appraisers are!

And with appraisers relying on recent sales for valuations….you can see the logic of the bank overbidding on such a grand scale. They can bid up to the mortgage balance and not increase their loss exposure. Overbidding systematically increases the comparable sale prices appraisers will look at to prepare their valuations. And with the banks accounting for 77% of purchases out of foreclosure sales (and foreclosure sales representing 20% to 30% of all sales in these counties), the bank activity can influence appraisals, particularly since one might expect foreclosure sales to be concentrated in certain neighborhoods. And it’s even great enough at 15% to 23% of all sales to move overall price averages and trends.

It’s also important to not to dismiss this as “oh, this is just two counties in Florida.” Large banks are not set up to have local offices operate with discretion and go load up on real estate because the manager thinks it is a hot time to buy. This is clearly a policy decision at work, and the policy decision appears to be to “outbid” the private equity giant Blackstone:

Most industry analysts attribute the change in direction to the so-called “Blackstone effect.”

The infusion of capital from the giant New York-based hedge fund and several others like it has boosted home values and tightened supply since Blackstone began buying single-family investment homes in Southwest Florida last fall.

Coupled with pent-up demand from baby boomers, and conditions that make it difficult for many boom-time purchasers to list a home for sale, banks can hold onto distressed houses with less long-term risk.

“Why sell for pennies on the dollar to Blackstone, when they can do it themselves now,” Adamaitis said. “Blackstone set the market, and now banks are taking advantage of the opportunity. They now have all of the top variables to control the market.”

The idea is that the banks would turn down bids at auction — presumably from a local flipper or investor — to instead list the property on public Realtor databases, where it can draw higher offers from owner-occupiers.

The lenders hope to mitigate their losses on their bad loan by cutting out the middleman and waiting for prices to increase.

So we can expect to see similar behavior (which amounts to holding inventory off the market through bidding it back in at the courthouse) in markets with high PE fund activity. Readers can hopefully add to this list, but aside from big chunks of Florida, it includes Las Vegas, Phoenix, and Atlanta.

Needless to say, there are a lot of risks to this strategy. The first is that even in the Sarasota-Manatee market, with supposedly tight inventories, banks are only getting hit and miss results with this “let’s beat the speculators at their game” idea. Trying to best PE funds (whose exit is not typically a sale to an end user, but a rental income stream and an IPO of the rental company) isn’t necessarily smart, particularly if you are using Blackstone as your benchmark. That fund is the “buy Microsoft” of the private equity world. They can get away with mediocre investment performance due to the strength of their brand name. In the last real estate cycle, they famously bid for Sam Zell’s Equity Office Trust in February 2007, which was seen at the time and proved to be a peak of market buy.

By contrast, savvy real estate operator and early rental market entrant Carrington said more than a month ago that they had stopped buying homes altogether because dumb money was ruining the market, as in overbidding. From Bloomberg:

“We just don’t see the returns there that are adequate to incentivize us to continue to invest,” Rose, 55, chief executive officer of Carrington Holding Co. LLC, said in an interview at his Aliso Viejo, California office. “There’s a lot of — bluntly — stupid money that jumped into the trade without any infrastructure, without any real capabilities and a kind of build-it-as-you-go mentality that we think is somewhat irresponsible.”

The second issue that is if the banks don’t find buyers for these speculative purchases fairly quickly, the homes often deteriorate. Even though the strategy (in many cases) is premised on holding the property for a year or two to catch a rising market, that assumes the banks do a decent job of securing and maintaining the properties. Their track record is that they often don’t. Conversely, unlike the banks, the PE funds don’t lease out the properties as is. They all expect to at least spruce them up a bit; some even hunt for ones that need particularly types of upgrades that they’ve set out to do in a standardized way (same toilets, vanities, etc; they’ll bid with their upgrade in mind, meaning if their typical bathroom rehab won’t work, they won’t make the offer).

Third is the look like the banks are about to have the Fed wreck their clever plan of unloading homes later to real economy buyers at a better price. Thanks to the not-so-bad job numbers last Friday leading Mr. Market to up his odds of the Fed tapering QE sooner rather than later, 30 year mortgage rates are now 4.64% for a 30 year fixed rate mortgage, up from 3.25-3.30% in early May. And realtors say the decrease in buying power is even greater, since the FHA was giving a two point lender credit to help pay for closing costs. One mortgage broker pegged the apples-to-apples rate rise at 1.75% before the additional ratchet up at the end of last week, which Mortgage News called Among The Worst Days in Mortgage Rate History. And even though rates are low by historical standards, don’t kid yourself as to what this rate rise will do to the nascent recovery. From Housing Wire last month:

Fannie Mae Chief Economist Doug Duncan said the concern should be less about what the rates have risen to and more about the speed at which they are rising.

Duncan noted that in 1994, for instance, rates rose 2% over a 12-month period, resulting in a huge impact on home prices, which fell significantly.

“If the rise happens rapidly, it tends to have an impact,” said Duncan, who added that once rates rise 100 basis points, home sales may begin to slow.

Oh, but not only are banks likely to find themselves to have been too clever by half, but as usual, their cute fixation on their own accounting and profit fantasies is yet again hurting borrowers and leading them to skirt commitments made during those “get out of liability almost free” exercises otherwise known as mortgage settlements. Again from Salman:

The national mortgage settlement also was aimed at encouraging more short sales, loan modifications or deeds-in-lieu of foreclosure — all less bruising methods of disposing of distressed properties. Those processes have a smaller impact on a borrower’s credit and are generally thought to be less hazardous for the overall economy….

With banks now aggressively pursuing home seizures on auction again, some worry it will ultimately limit the envisioned impact of the mortgage settlement, especially if lenders believe they can command more for a bank-owned listing in six months than they can for a short sale today.

This approach might not seem as wishful as it is if the banks didn’t have even more foreclosures in the pipeline, a total of 15,000 in Sarasota, Manatee, plus DeSoto counties. Contrast that with the 1,300 houses sold to third parties in Sarasota and Manatee counties in the past 12 months. And remember, on top of that, many of those third parties were flippers or rental investors, not traditional home-buyers.

But aside from the banks’ questionable motivation, we also have Fannie’s and Freddie’s pursuit of the same strategy. Perhaps they are taking (bad) guidance from their servicers. But this may also be a way to max out GSE assets within the conservatorship guidelines. Remember, the GSEs are required to shrink their balance sheets over time. But the flip side is executive pay is based on the size and complexity of the organization plus apparent performance and the GSEs continue to peg their compensation at private sector levels. So keeping Fannie and Freddie as big as allowable and where possible, dressing up its accounts is also the path of increasing the pay of its top brass.

The most disconcerting aspect of the article was the confidence of some observers in the banks’ ability to manipulate prices. Or maybe not. As Abigail Field said via e-mail, “There’s so much bid rigging among bankers that it would be weird if there wasn’t bid rigging.”

But how successful are you, really, if you have more than an order of magnitude more product in the pipeline than you unloaded to third parties last year, and many of those are speculators who are already starting to withdraw from the game? The last time banks were all over virtually all sides of the market was in CDOs, where they had less than third-party relationships with collateral managers who were major buyers (they funded them!) and wound up with tons of inventory, either because they had badly clogged distribution pipelines or because they gamed their banks’s risk and bonus systems by hedge AAA tranches and generate what turned out to be almost entirely fictive profits. And we know how that move ended. In general, the history of market corners is not a pretty one, and the banks’ and the GSE’s behavior in hot investor markets, if Sarasota and Manatee counties are any guide, looks like a close cousin.

Banks appear not to have heard the old Wall Street saying, “A position is a trade that didn’t work out.” I suspect they are going to be long their REO for a more protracted period than they anticipate. Stay tuned.

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25 comments

  1. Aaron

    LOL! Just one more reason not to do a short sale. The banks were already dragging their feet, and now they think they’ll game the system even further for a little extra profit.

    I’m sure this will all end well.

  2. Estudiante

    Well, it’s not like banks have anything to lose; if something goes wrong, we’ll be glad to make it up to them, right?

  3. G Man

    Capitalism and Greedalism are also closely related. This should be the leading story on the morning news but nothing. As construction begins to recover, they are again poised to ruin thins for those that can’t compete. Let’s take the money away from them and pit it in banks that swear not to engage in anything other than lending. We also have an administration that has been paid to do nothing.

  4. clarence swinney

    SUCKERED INTO A LONG TERM NATIONAL PANIC
    9-11-01 was not a national act of terrorism.
    It was ONE MAN. Osama Bin Laden Act of Revenge.

    He had said earlier on videotape that he had no problem with America except for military bases in Holy Land.

    Then, a videotape had him saying: “I have had nightmares since watching Tall buildings fall from American shellings. I have since dreamed of watching Tall buildings fall in America.”

    He hired the 19 suiciders. We reacted as expected. In Horror.
    Then, we sent special force troops to locate and eliminate him.
    We gave up the chase and invaded a destitute, unarmed nation that had nothing to do with 9-11-01.

    Why? Cheney had been overheard telling Rumsfeld the day after inauguration “Prepare to invade Iraq? Cheney and Rumsfeld were surrounded by Imperialistic persons.

    The Imperialists created a sad future for us by alienating 1500 Million Muslims.
    We now spend more on killing machines than remainder (95%) of people on earth.

    Imagine our nation had we found/eliminated Osama Bin Laden shortly after 9-11.
    More Peace on Earth especially in America.

    1. steelhead23

      Good points all – but not germane to the subject. Please check before posting.

  5. TedWa

    You state : “And with appraisers relying on recent sales for valuations….you can see the logic of the bank overbidding on such a grand scale. They can bid up to the mortgage balance and not increase their loss exposure. Overbidding systematically increases the comparable sale prices appraisers will look at to prepare their valuations.”

    Actually appraisers do not use foreclosure auction sales – they only use market sales. Foreclosure sales do not influence the market. I state that as I am an appraiser with over 20 years experience.

    However, you are right about banks influencing appraisals as power was given them by then AG Cuomo and his HVCC in ’08 to take away appraiser independence. Banks now basically “own” most of the appraisers that work for their AMC’s (I don’t). And if the banks want values to go up, they employ the most vulnerable and least skilled appraisers and pressure them to increase values like they did in the run-up to the meltdown. See WAMU and Eappraiseit and the recent settlements/fines paid for influencing values by all the major banks. The B of A case might be the easiest to find.

    1. Yves Smith Post author

      There are lots of reports that say otherwise, that foreclosure sales DO affect appraisals:

      http://www.huffingtonpost.com/2010/01/04/foreclosures-hurting-home_n_410181.html

      This one indicates a reluctance to use FC sales but still concedes they are used in some cases:

      http://homebuying.about.com/od/4closureshortsales/qt/0507-4-closeval.htm

      This is from the appraisal institute. It says the appraiser must consider all comps and select the best comps and make adjustments:

      http://www.appraisalinstitute.org/about/downloads/Distressed_Sales.pdf

      If banks have a lot of FC inventory and are going to be dribbling it into the market for years, as is the case in FL and Las Vegas, how are FC sales NOT relevant????

  6. nohomehere

    stop listening, housing prices going up fast , hurry you might miss out if you dont buy now, hurry get in while you can afford too. interest payments wont stay low forever . your house price goes up cause the last one sold for x amount. next one will be more for sure….. meet the new boss same as the old boss , same same ! people will never learn to control greed and envy and self comparing . Look its a home to live in raise your kids and grow old in . dont let the greedy ones pray on our weaknesses , where is the gov . protection or oversite of these same problem makers as the last time have´nt we or the gov, learned anything yet. all these loan mods and gov help to get the people back on their fight and look what they do! its like the bailed out banks using the money to go to las vegas, that table has to pay some day right ! i liked that song saved by zero, maybe thats where we have to be to learn!

  7. Bud in PA

    If you take the nearly $260M the banks have paid out for the 3754 properties in this article, that’s about $70,000 per property on average. What does that tell you?

  8. down2long

    Thanks again Yves for staying on top of this. In my little world of bank hell I had Green Tree servicing suddenly spring up like the Alien after my 6 year old bankruptcy and the discharge of their second in 2009 with the confirmation of the reorg Plan. As a Chapter 11 filer I DID pay them deficiency payments as required by law. So Green Tree calls, somehow grabbing a friend’s number from my in-phone register as Caller ID, and the woman asked me “What do you plan to do to pay off this charged off balance/”

    I was incredulous. The question answers itself. “I plan to do nothing, since I already met the terms of the law, and you should not be calling me, and furthermore I feel sorry for you working for such a corrupt organization.”

    To which she replied, as have other servicer reps in the past “They pay me very well.” And I said, “As well they should since you are breaking the law and furthermore what you are doing is immoral as well as illegal, and they will dump you in a second, as they have dumped all the other servicer reps I have dealt with over the years.”

    This resulted in her shouting to not hear my other points, and finally yelling in a whining tone “Now I have to send this back to our bankruptcy department.” I told her that’s right you better or I’m getting a lawyer practiced in credit law and Greentree is paying me triple damages. Greentree also pulled my credit report, resulting in an inquiry ding on my score. Baaastids.

    Wells woke up from their slumber demanding payment on the property in which they’ve been sending back my payment checks for three years, including my deficiency payments. I reminded the guy (who was Minnesota nice and sympatico I might add) that this was a bankruptcy matter. He said the file did not have any reference to BK. He said it would refer it to the BK department, but I could write a letter to the “President’s Office of Special Cases” or some such. I will do, but I reminded the servicer that with three years worth of returned checks, the approved BK plan that clearly stated the approved valuation and payments, Etc., that I was in a very good position for a jury trial in Los Angeles, which given how folks hate banks, could result in a very interesting judgment indeed.

    And now the a**hole banks want credit unions to pay taxes “to level the playing field,” as reported in several news outlets, including the L.A. Times. My reaction is, OK. we abolish the Fed, close the discount window, under NO circumstances loan you money or bail you out, etc., THEN we will discuss taxing CU’s. Apparently the banks are VERY upset that millions of people are voting with their feet and moving their money to CU’s, resulting in the largest credit union, Navy, having more than a billion in deposits, and the biggest number of new CU customers in a long time. In one quarter in 2012 CU’s got more new customer than in the previous 11 quarters, or some such. Horrors!!!

  9. F. Beard

    With a 100% reserve requirement or least no government privileged credit creation just how much mischief could the banks do?

    Equity = Assets – Liabilities but government privilege ensures (insures?) that the Liabilities are mostly virtual for the banking system as a whole since there is no risk-free place outside the banking system (I include credit unions) for people to transfer their deposits to. So the banks need not fear excessive deposit creation.

    During the bust, the Assets become significantly virtual too but not to worry since government will suspend mark-to-market requirements.

    Question? What good is accounting if the banks are privileged by government? What good is keeping score if some are allowed to cheat? Will not Equity in such a system be instead a measure of inequity?

  10. Jason Boxman

    Indeed, my mother has been seeing this when looking for properties around Orlando, Florida for the past year or so. The bank always outbids and wins.

  11. steelhead23

    Could there be another reason for large banks to take such risks? I read somewhere recently that in adopting recent Basel reserve standards that the Fed had, in effect, placed a substantial margin call on the banks. Their assets were underscale. So, if a bank holds RE as an investment, does it have to hold reserves to cover the downside? I really have no idea, but since this is a recent phenomenon, it makes sense to see where things have changed for the banks. It is totally weird that the banks ARE the markets.

    1. R Foreman

      I think you’re just one step shy of the truth. The banks aren’t just the market.. the banks are the government. And it’s not multiple independent banks, but one single global banking entity (libor interest rate collusion, currency swap lines and unlimited global bank-bank lending by the Fed, and coordinated global action by the world’s central banks; we know that much of the Fed QE is ending up at foreign banks).

      It should be obvious by now the Fed is no longer the house, but has become the single largest market participant, the world’s largest hedge fund, and creates money at will with full backing of the US Government.

      One global banking entity acting with authority of all governments in coordinated action, and no central banks any longer. Your statement that the banks are the market is true. The banking entity has pricing power over all other market participants, and ‘allows’ other large institutions (PE firms, pension, hedge funds) to participate in the market if they agree to play ball.

      The few instances we’ve seen where firms self-destruct is when they either don’t play ball, or they try to play outside the confines of the established game (eg they use real accounting or mathematics with the press or investors). To survive this negative interest-rate, hyperspastic inflationary-deflationary environment, these firms must consult the banking entity when they get in trouble, and be given the nod in committing a legalized fraud.

      1. Carla

        “the banks are the government.” Thank you.

        and @steelhead 23 — banks don’t take risks. They fob off all the downsides on you and me. There are NO risks for the banks, nor for their top management who keep raking in bigger bonuses every single year that they rob the American people blind.

        Repeat after me: Banks live in a risk-free universe. Banks live in a risk-free universe. Banks live in a…

        Banks are not regulated by the governement because Banks ARE the government.

  12. Dino Reno

    The Fed plan to lend money at 0% to banks and hedge funds to buy housing in order to drive prices up is brilliant unless you’re a regular Joe looking for a place to live. They don’t care who sops the excess inventory as long as the prices are driven higher as a result. Stock and housing prices are the measure of wealth in this society. Jobs not so much. The Fed is already doing a happy dance in the end zone. Now all we need is Larry Summers to take the reins and drive this puppy home right into the lap of the Blackstones of the world. Gotta love it when a plan comes together.

  13. CD

    The foreclosures should have been sold at auction prices to returning soldiers of stupid wars, letting the pigmen play “let’s control the libor in the housing market” is just another tell tale sign of how the government has lost all resemblance to a govt.

  14. rc whalen

    Bad article, many misconceptions built in. Remember that most banks will “buy” at the foreclosure sale to protect their position in the property. Author sites a 34% YOY increase in bank purchases but doesn’t tie that to the right numbers on foreclosure sales overall.

    1. RC Maggot

      Still protecting the taxpayer? I guess DeMarco’s a real good guy. Protecting the taxpayer has been the propaganda victory for the Bankstas. You, your hedge friends, Santelli and Rossi for lack of any more immediate names, are careerist cancer.
      Rossi needs to leave Maryland (the school).

  15. Jim A.

    Didn’t this used to be the norm, in pre-bubble days? Since the bank is effectively the seller in these auctions, they’re bidding their sunk cost. When foreclosures and other distressed sales don’t dominate the market, it isn’t at all unreasonable to think that marketing and selling a house normally will net more (well lose the bank less) than a distressed cash sale at auction.

  16. mark

    The banks are being cutter by half. When they overbid a foreclosure, instead of suffering a loss on their balance sheet, they now show a profit. Instead of taking the distressed property off their books, they are putting it back at a higher value.

    Since their cost of money right is essentially zero, they can actually cook the books for free!

  17. goodrich4bk

    The reason for “overbidding” is to reduce the loss that would otherwise occur at the trustee’s sale. For example, if the property sells encumbered by a $150k loan is sold at the sale to a third party for $100k, the bank immediately recognizes a $50k loss. But if it “overpays” by credit bidding $110k of its $150k loan, it takes only a $40k loss and now has a REO inventory with a cost basis of $110k, so long as it can find an appraiser to say that is the property’s fair market value. As the author states, that is never difficult to do.

    If the bank believes prices are rising, it may even pay $120k or $130k for the property and reduce its realized loss even more. When the quarter ends, the bank suddenly has fewer loan losses than had been projected, so it can then reduce its allowance for loan losses; this reduction goes right to the bottom line as profit — to be expensed out as executive bonuses, of course.

    If the market turns down, or the bank actually overpaid in its bidding, that loss will not be realized until a much later quarter, in which case it might be somebody else’s problem. And by then the banker can blame “the market”, or the “Fed” or any number of things for the “unexpected” REO losses —- other than his conflicted decision to overbid for the bank’s REO inventory, of course.

    In short, the banks are behaving for the benefit of their executives. When has it ever been otherwise?

  18. Jason

    Excellent piece of info, it goes beyond this in the Tampa area. I attend the auction almost every day and have warned my private money to use caution as the banks are driving the market by purchasing hundreds of homes every month in this area. I have actually posted screenshots of the banks going above and beyond to retain the asset at foreclosure sale up to and including “preservation” companies stripping the home while in foreclosure or objecting to the sale to a 3rd party bidder because they felt they(the bank) stopped bidding to soon.

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