I attended a foreclosure auction in Bellevue, WA last week to discover if the rumor was true that banks are opening their bids below the amount owed. I received confirmation from three professional investors that yes, the banks have been doing that, it’s no secret, and there seems to be no discernable pattern. It’s not one particular bank or lender, it’s not particular types of property or in any specific area. It appears to be random.
In addition to the 92 active trustee sales scheduled for that day in Bellevue (auctions were also going on in other King County locations,) there were 81 postponements. Only a few of the trustee sales attracted bidders, and the rest were deeded back to the bank. Out of the 92 active sales, 25 had opening bids below the amount owed to the bank.
Why would a bank or lender set their opening bid below the amount owed?
Banks and lenders have duties to their shareholders and investors to maximize profits and miminize losses (well, at least they use to.) If opening bids are set LOWER than what’s owed, perhaps the banks have already tallied their losses, realized that if they had to take back the house, get it cleaned out and cleaned up for resale, pay a real estate agent their commission to sell it, pay for title, escrow, excise tax, utilities, and any other carrying costs, they might as well sell it at a discount at auction. But maybe there are other reasons. I wondered if the banks were trying to keep more REO inventory off the market in an attempt to prop up home values for their existing REO inventory. Maybe appraisers can ignore trustee sale prices in their reports. Not knowing the answer, I emailed three appraisers for help and here’s what I learned: Appraisers need to mention trustee sales in the neighborhood if these trustee sales make up a significant percentage of available comps because they are legitimate sales even though title is transferred using a trustee deed instead of a warranty deed. If an appraiser choses to ignore these, he/she will run the risk of having the appraisal run through an “enhanced review” process in order to catch trustee sale market activity. If a trustee sale is a significant comparable sale, it can be used. The requirement to use closely comparable trustee sales as comps can also vary based on the requirement of the lender and investor. It may not be absolutely required but it may be in the appraisers best interest to mention trustee sales. Thanks to Jonathan Miller, Shane Leady and Richard Hagar for teaching me something new today.
That still doesn’t explain the phenomenon of banks undercutting their own principal balances at the auction. My theory is that banks are relying on third party information such as a mini appraisal or Broker Price Opinion (BPO) prior to auction. If the BPO suggests that the outstanding principal balance is so high and out of range as to likely attract no bidders at auction, then the banks have nothing to lose by setting the opening bid closer to or significantly lower than the principal balance owed. If no one bids at auction, they’re still only out the money they would have been out anyways and on the upside, if the low opening bid attracts investors, then perhaps the bidding will rise closer to the payoff. If not, they have an immediate loss that could be significantly LESS than losses that would add up over time, having to carry the REO on its books for months of marketing time in addition to the other costs mentioned above.
If banks are undercutting their own payoffs, then why isn’t this phenomenon more widely publicized? Okay, so we know that bidding on a home at a trustee sale is too frightening for most first time homebuyers but still, if more people know about this, then maybe there would be more folks showing up at the trustee sales and bidding those homes UP, thereby reducing the banks losses. There certainly is NO shortage of tall, well-groomed, good looking, muscular investor gurus in shorts showing off tanned legs, even though it was only 63 degrees outside hanging out at foreclosure auctions with all kinds of downpayment solutions to offer newby real estate investors: “We have zero down financing available for the right investor!” and “We have private hard money financing available for your purchase and you can refinance out of that loan in 30 days….My mortgage broker is right here, let me introduce you to her.”
Maybe the banks aren’t publicizing their low bids because they don’t want to bring buyer attention away from purchasing their REOs or short sales, knowing that investors are the ones who typically show up at the auction anyways. The banks also have a vested interest in keeping traditional buyers focused on MLS listings.
If I owned stock in a bank or lender that was undercutting their own payoff at auction, I’d want to be darn sure that this practice was saving the bank money and not hiding something else such as higher losses to be pushed on into the next earnings report…or the next stress test.