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Bad Values Lead to Big Discounts on 2005-2007 Vintages

S&P report warns that discounts on REO sales worsening

May 26, 2011

By staff

Discounts on real-estate-owned sales are rising, and a new report has identified three vintages that are responsible for most of the decline. Much of the problem lies with properties that were overvalued at origination.

Using the Federal Housing Finance Agency's House Price Index as a comparison tool, Standard & Poor's Ratings Services analyzed more than $505 billion of distressed sales out of the $4 trillion in non-agency loans originated between 2000 and 2007.

S&P found that while only 1 to 2 percent of loans originated between 2000 and 2004 were discounted by more than 25 percent, the share jumped to 4 to 5 percent for loans originated between 2005 and 2007.

The New York-based firm speculates that total losses on all of the vintages it studied with discounts of at least 25 percent amounted to $113 billion.

Losses are expected to rise by at least 75 percent if the loans that are currently delinquent follow a similar pattern.

"If we use the FHFA House Price Index as a base guide, we have learned that many properties are actually liquidating at discounts that significantly outpace the volatility that the HPI would consider," S&P Managing Director Diane Westerback said in the report. "What these large variances between loan origination and sale amounts generally suggest is that original home values were overstated on mortgage applications and not corrected during the originators' review of the property value."

The biggest problems with unexplained value discrepancy are with subprime mortgages.

The ratings agency noted that, contrary to popular opinion, there was no concentration of valuation issues with refinances, low-doc loans or low-balance loans.

Westerback acknowledged the imprecise nature of the HPI but warned that discounts of at least 25 percent warrant attention.

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