by Luke Mullins

Banks repossessed a record number of homes last month, an ominous sign for a real estate market that has seen demand slide substantially in recent weeks.

Nearly 94,000 properties were repossessed by lenders in May, an increase of 1 percent from April and 44 percent from a year earlier, according to RealtyTrac's most recent U.S. Foreclosure Market Report. "We are going through the eye of the storm," says Patrick Newport, an economist at IHS Global Insight. "Banks are taking over properties at a record rate right now."

The rise in home repossessions is linked to developments in the Obama administration's housing rescue initiative, says Celia Chen, a senior director at Moody's Analytics. The administration reported that 278,000 trial mortgage modifications have been canceled through April. As banks holding such loans learn they don't qualify for federal assistance, they can resume foreclosure proceedings.

"You can't save everybody," says Mike Larson of Weiss Research. "It's been a year and change since [the Obama administration's housing rescue] was rolled out and it's at a point now where some of these borrowers are going to be lost no matter what you do for them."

The increase in repossessions comes even as notices of default -- the first step in the foreclosure process -- fell 22 percent from a year earlier to their lowest level since November 2008. Although this trend may appear encouraging, Rick Sharga of RealtyTrac argues that in this case, the data belies the reality of the market.

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With their books already cluttered with distressed properties, many banks have delayed sending out default notices -- which initiate the foreclosure process -- until they have completed other transactions, he says. "Typically, you don't get a foreclosure notice until you are 90 days past due," Sharga says. "Everybody I've talked to knows somebody who has been in their house for over a year and hasn't made a payment and still hasn't received a notice."

These repossessed properties will eventually find their way onto the market, adding to a still-elevated inventory and working to drag home prices lower. The inventory of unsold homes rose nearly 12 percent in April, to just over 4 million homes. Demand for mortgage loans, meanwhile, has sputtered following the expiration of the federal home buyer tax credit. This increase in bank repossessions "will have a depressing effect on home prices," Chen says.

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But the housing outlook is not without hope. Sharga points to recent surveys from the Mortgage Bankers Association, which show that 30-day delinquency rates have improved. "That's the first glimmer of hope we have seen in over two years," Sharga says. (This improvement is tied to stabilization in the labor market.)

Still, the market will remain saturated with distressed properties for some time. "Those early-stage delinquencies that are starting to go down are on loans that were issued in the last couple of years -- and that's good. It means these loans are actually performing the way they are supposed to," he says. "But it won't really have a material impact on foreclosure numbers for another 12 to 18 months."

"There is definitely hope down the line, it is just that we have this big bulge of loans that are troubled and we have to work through them," Chen says. "With the large supply [and] weak demand, I think it will be probably 2012 before a lot of these homes are worked through."

Home Repossessions Hit New Record High