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Gunning for nonperformers

When is the right time to buy nonperforming whole loans?

In a transient market where investors want to stay ahead of the curve, nonperforming loans remain a considerable point of intrigue for investment firms that want to latch onto troubled assets and mentor them back to profitability.

In fact, the value of acquiring a nonperforming loan is not lost on real estate investors in today’s environment. And the atmosphere surrounding it all is unique, with rising mortgage rates and competition for REOs and foreclosures making the process of finding a good deal on the courthouse steps or after foreclosure more burdensome in certain jurisdictions.

John Vella, chief operations officer at real estate tech provider Equator, says it’s not surprising more investors are turning to nonperforming loans.

This is particularly true in nonjudicial foreclosure states, where faster foreclosure timelines and more competition for good deals at the courthouse force those looking for distressed assets to buy loans before the properties even end up at auction.

“We are seeing investors buying nonperforming loans to get ahead,” Vella told HousingWire in recent months. “The days of going to the trustee sales, and seeing if you are going to get a great deal, are gone.”

He notes that now “everyone wants to jump in,” so competition is higher and the margins and prices are not as enticing as they once were when betting on traditional foreclosures in nonjudicial foreclosure states.

Buying nonperforming loans gets investors ahead of the competition; it also fits in with today’s focus on special servicing.

As Vella points out, “nonperforming loans are going to buy at discount.”

The value of snatching up these loans at discount before a finalized foreclosure comes down to market dynamics and investor choice. An investor who has the money and servicing support to carry a troubled loan either through a full foreclosure or through some type of home retention plan is going to see nonperforming loans as diamonds in the rough.

But firms that lack a strong servicing partner, or who fear carrying these assets through a period of transition, are not going to experience the same levels of enthusiasm when nonperforming whole loans become available.

In the search for yield, expectations of rising rates can be a benefit for the investor who believes a loan can be saved and benefit from a borrower’s future performance.

But this asset class is an acquired taste and for a certain type of investor: namely, one with the platform to bring a full acquisition and asset turnaround plan to fruition.

The idea is to have a plan for the loans and quickly move them in that direction. If an investor buys on the cheap and connects with a quality servicer, they can work the loan out or eventually turn a profit on the rental or sale of the property after it goes through a foreclosure, Vella explained.

Companies seeing value in a nonperforming home loan are not new to the market. Last year, PennyMac Mortgage Investment Trust acquired a nonperforming whole loan pool valued at $452 million in unpaid principal balance. About 53% of the UPB was tied to loans backed by homes in foreclosure, while the rest were 90 days delinquent.

PennyMac Mortgage Investment Trust continued its buying spree in 2013. HousingWire reported in July that the firm decided to buy $140 million in unpaid principal balance nonperforming home loans from Citigroup Global Markets Realty Corp.

And Carrington Mortgage Holdings pointed out in 2012 that by the end of the year, the firm would have bought $800 million in nonperforming loans.

"It's a different investment strategy and there is a lot of opportunity in nonperforming loans,” said Rick Sharga, executive vice president of

“There are two different business models for this: One is investors who are looking to take over those loans, foreclose on the property and then resell them. The other really is a model where you buy the loans with the intention of rehabilitating them — and that is where the big players wind up participating,” Sharga says.

He estimates investors are buying loans for 40 cents on the dollar of the unpaid principal balance.

If these investors have a servicing facility to help them reform the loans, it’s an even better strategy due to the fact the facility allows them to transform the loans into profitable assets again, Sharga notes.

There definitely is a sea change, with nonperforming loans gaining more traction in the past year or so, market observers say.

“There have always been nonperforming loan sales, but we went through a period where there were very few being made available in the marketplace,” Sharga remembers.

But, he notes, in the last 18 months the market noticed more loans of this type up for sale at prices investors were willing to pay.

Sharga notes that investors grabbing the loans pay cash in many cases, shielding them from the effects of shifting interest rates. However, he says, if they are buying them to turn them into refinancings, rising rates could impact the affordability and the benefit of this type of transaction. For now, though, that is not a major concern.

So what strategy works best for investors who venture into this space? It might not be the clearest answer, but it all depends.

“So the general business model is typically: modify as many loans as possible; execute short sales or deeds-in-lieu if the loans can’t be modified; foreclose as a last resort; and then determine which REO assets make sense to rent or sell,” Sharga said.

Yet some of the advantages around the buying of the whole loan rather than a foreclosure or REO are offset by distinct risks stemming from the regulatory landscape.

“Government pools come with restrictions on foreclosure activity as well. As you can see, this isn’t exactly a plug-and-play replacement for buying an REO or a home at a foreclosure sale,” Sharga said.

The deals in the past year became a who’s who of financial companies, with some major firms looking to nonperforming loans as investments.

Back in March, mega insurer AIG announced plans to buy residential whole loan mortgages as investments and even created a new business unit for the endeavor called the Connective Mortgage Advisory Co.

The unit essentially combined AIG’s investment expertise with United Guaranty’s mortgage insurance subsidiary, allowing the new company to use both firms’ tools to find and invest in whole loans.

In late spring, analysts with Bank of America Merrill Lynch put out a report highlighting the fact that investors may lean toward nonperforming and reperforming loan securitizations as an investment alternative to privatelabel RMBS.

The idea behind the report is that investors would ultimately benefit as home values recover, increasing their returns.

At the time, the BofA Merril Lynch report accurately predicted that “NPL and RPL securitization volumes will continue to accelerate throughout the year as the investor base broadens with increased comfort and understanding of the assets.”

Nonperforming loans remain solid investments, but are not for everyone, analysts note.

“Most investors buying large numbers of properties either at or post-foreclosure auctions don’t have the infrastructure in place to successfully manage a pool of NPLs,” Sharga said. “Doing that typically requires having a special servicer to manage the loans (either to modify them or process them through a foreclosure), a loan originator to successfully refinance the loans that can be rehabilitated, and an asset manager to handle the properties that are foreclosed on,” Sharga added.

And even though rising real estate prices make the foreclosure auction and REO approach look more expensive, that doesn’t necessarily mean investors  will automatically run to nonperforming loans. “It’s more likely that they’ll enter different geographies or buy different property types,” Sharga said. “Not change their investment strategy this drastically. For the right investors, though, NPLs are a great investment.”

The takeaway from those who have been there is to ensure you’re the right kind of investor before nabbing nonperforming loans. An investor who pulls in these assets without a strong servicing partner or platform is simply taking on too much risk before having the appropriate recovery mechanisms in place.

With profitability often contingent on getting the loan performing again, those that lack the appropriate servicing functions or partnerships could easily lose the value in the proposition. Others may be snatching up the loans with the express purpose of taking them through the foreclosure process to eventually sell the homes off or rent out the assets.

Either way, the investor must decide where the value lies and whether or not they have the tools in place to bet on nonperforming whole loans when the price is right.

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