By: Carrie Bay

It’s no secret that the volume of distressed residential properties is weighing heavy on U.S. housing markets and is prolonging any meaningful recovery. Of even greater concern is the industry’s growing backlog of homes thatneed to be liquidated and resold but have yet to make their way to the market – that menacing shadow inventory that threatens to asphyxiate appreciation of home values and drive the industry to a new low in this down cycle.

Standard & Poor’s (S&P) defines this shadow inventory as outstanding properties whose borrowers are, or recently were 90 days or more delinquent on their mortgage payments; properties currently or recently in foreclosure; or properties that are real estate owned (REO).

The credit ratings agency has just released a new report in which it estimates that the principal balance of these distressed homes now stands at about $460 billion. S&P says this hidden supply represents nearly one-third of the non-agency residential mortgage-backed securities (RMBS) market currently outstanding.

“Given the pace of residential defaults during the housing downturn, the market’s inability to quickly absorb the excess volume has created a large ‘shadow inventory’ of distressed properties,” explained Diane Westerback, S&P managing director.

Westerback says her company’s estimates for the time it will take to clear this supply of distressed homes declined after reaching a peak in mid-2008, but unfortunately the number has been on the rise again since fall of 2009.

Now, S&P’s assessment of the stretch it will take the industry to clear the current volume of distressed properties in the shadows is about 41 months. That’s up from the 33-month timeline projected by the agency’s analysts earlier this year.

According to Nancy Reeis, credit analyst for S&P, the company’s estimate for the months to clean up the shadow inventory as a whole increased about 18 percent between the end of fourth-quarter 2009 and the end of second-quarter 2010.

For the same six-month period, she says, estimated months to clear were also up in each of the 20 metropolitan areas included in S&P’s ongoing analysis.

According to the agency’s report, the growth in the shadow inventory is having three primary effects in the housing market: low liquidation rates artificially skew the visible supply of distressed homes available for sale; the growing inventory negatively pressures existing home prices; and only when the backlog clears, will market home prices fully correct.

http://www.dsnews.com/articles/sp-460b-shadow-inventory-will-take-41-months-to-clear-2010-09-29