Distressed inventory is on the decline, but the number of months it will take to clear that distressed inventory from the market is on the rise, according to the latest reportfrom Morningstar Credit Ratings.

Distressed inventory among non-agency residential mortgage-backed securities (RMBS) dropped 20 percent year-over-year and 5 percent quarter-over-quarter in the third quarter of this year, according to Morningstar.

By the ratings agency’s calculation, total private-labelRMBS distressed inventory–-including properties in foreclosure, 90 or more days delinquent, REO, and half of all modified mortgages–-stood at about 891,000 properties as of the end of September.

Morningstar includes half of all modified first-lien mortgages in its distressed inventory count because these properties are more likely to default than those that have been performing steadily since origination, the agency explained.

Fifty-seven percent of this distressed inventory is located in judicial states, according to Morningstar. States with the highest levels of distress include New Jersey, Florida, New York, Maine, and Illinois.

Colorado, Arizona, and Wyoming hold the smallest distressed inventories.

While distressed inventory is declining, the time estimated to clear these distressed homes from the market is rising, up five months from the second quarter of this year and 11 months from September 2012, according to Morningstar’s analysis.

It will take 49 months to work through the private-labelRMBS sector’s distressed inventory “given current market dynamics,” Morningstar forecasts.

Here too, there is a clear distinction between judicial and non-judicial states. Judicial states hold about 61 months of distressed inventory, while non-judicial states hold about 32 months’ worth.

Morningstar also measured distressed inventory across the 20 largest metropolitan statistical areas (MSAs) in the nation, finding it will take an average of 55 months to clear these inventories.

By far, New York holds the longest distressed inventory timeline at an estimated 230 months. Boston ranked second with 120 months of distressed inventory as of the third quarter.

With an estimated 20 months of distressed inventory, Phoenix holds the shortest distressed inventory timeline.

Short sales made up 49 percent of distressed sales in the third quarter of this year, up from 45 percent a year ago, according to Morningstar.

The percentage of voluntary prepaid loans as opposed to liquidated loans is on the rise, Morningstar reports. Forty percent of all loans paid off in the third quarter were voluntary prepayments in judicial states, up from 25 percent in the previous quarter.

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Jerry Gusman

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