The use of short sales as a loss mitigation strategy is rising as short sales tend to cut loss severity by 13% more than real estate owned (REO) sales, according to market commentary by risk analysis provider Clayton Holdings. In states with extended foreclosure timelines, short sale loss severities came in 26% lower than REO loss severities in the six-month period from October 2009 to March 2010, when Clayton conducted its study: “Overall, data shows that short sales cost bondholders about half the amount in fees and advances as REO sales, saving roughly $16,000 per sale,” Clayton said in the latest InFront monthly report. “Given the reduced loss severities, it appears that short sale strategies currently used by servicers are producing favorable outcomes when compared to REO sales.” Servicers with the lowest loss severities for short sales tend to use outsourcing, dedicate whole teams to short sales, working directly with local broker networks and setting listing prices incorporating historical REO net proceeds. Clayton also found that servicers with delegated authority from the mortgage insurance companies to approve short sales tend to have lower loss severities. Although servicers may be seeing success within proprietary short sale programs, government-led short sale efforts still have several kinks to work through. For example, the federal Home Affordable Foreclosure Alternatives (HAFA) short sale program lacks specific instructions relating to short sale strategies tat servicing data show to be successful. And although servicers are able to place borrowers on a repayment plan during HAFA, it’s not a requirement, which may in turn affect cash flows to bondholders. Additionally, Clayton expects short sale timelines to increase initially as servicers stop short sales in progress to ensure borrowers are notified of HAFA eligibility. Once approved, properties are required to be listed a minimum of 120 days, which could increase loss severities when servicers have less negotiating room. Loss severity is not the only thing risked by increased liquidation timelines. Toronto-based credit rating agency DBRS recently linked delayed timelines with higher write-downs and expected losses to senior tranches of residential mortgage-backed securities (RMBS). Clayton noted it is unlikely short sale volume will increase significantly as a result of HAFA, as short sales are generally offered based on a borrower’s intent to remain in the home. “Overall, it appears that HAFA may not initially be as successful as servicer’s proprietary short sale programs due to extended timelines, negotiation limitations that may cause increased loss severities, and program restrictions that limit the pool of eligible borrowers.” Write to Diana Golobay.