Feb 19 (IFR) - Delinquent and defaulting mortgage loans to
struggling US borrowers have become big business on Wall Street,
as investors scoop up bonds backed by non-performing loans
With millions of borrowers still under water or facing
foreclosure, real estate investment trusts (REITs) and others
are snapping up NPLs at a discount, hoping to earn returns from
their eventual resolution or liquidation.
And the more value that can be extracted from each loan, the
better the returns - which means it is in the interest of
investors to work with troubled borrowers to find solutions.
As the cost of funds comes down and yields tighten, loan
buyers are finding it more attractive to finance these purchases
through securitization, which can sometimes fund between 75% and
85% of the market value of the NPLs, according to structured
"Investors are interested in buying NPL securitizations
because the senior bond has tremendous credit enhancement and
it's a fairly short-term investment providing more yield," said
Eric Burner, a partner at law firm Hunton & Williams.
"In this interest rate environment, that's appealing."
Moreover, the deals delever quickly, and issuers can call
the deal after about a year, which is an attractive feature for
investors worried about so-called tail risk, or the possibility
that an external shock can suddenly cause losses in a portfolio.
From the issuer's point of view, "securitization is a good
way to lever up if you're a buyer of these assets", and is an
efficient exit strategy, said James Raezer, the head of RMBS at
Royal Bank of Scotland.
"There are potentially good returns and you can redeploy the
Last week, Wells Fargo led a US$260m residential mortgage
NPL bond with participation from California-based broker-dealer
Carrington Investment Services, which was also the servicer. The
distressed loans were bought from several different sellers,
including CitiMortgage, Bank of America, and BankUnited NA. The
aggregate unpaid balance of the pool was more than US$700m,
according to a term sheet.
The deal had a thick 63% layer of credit enhancement and a
short maturity of just 1.5 years. The unrated transaction,
Stanwich Mortgage Loan Company 2013-NPL1, was priced to yield 3%
and was oversubscribed.
SERVICING IS KEY
Most NPL securitizations include loans where foreclosure,
short-sale, or modification are offered as potential resolution
options for borrowers but increasingly deals, including the
Stanwich transaction, include an option to rent as well.
Some investors frown upon this because the more rentals of
REO properties, the less cash coming into the deal and the
longer it will take for the bonds to pay down. In other words,
the transaction will receive monthly rental payments rather than
the proceeds from the sale of the property.
Experts say that players getting into the business of buying
and servicing NPLs stand a better chance of maximizing returns
when they communicate closely with borrowers to find the best
"A big part of value creation is through the servicing
process," said Chris Whalen, executive vice-president and
managing director at Carrington.
"The key question to the borrower is, Do you have the
capacity to get back on track? Do you want to stay in the
Whalen called Carrington a "high-touch" servicer that talks
to borrowers in a very constructive way to find strategies to
either keep them in their house or talk about creative ways to
exit their distressed situation.
"The servicer must be hands-on, and experienced with NPL
loans," said Burner.
"To the extent that you can modify the loan, you want to
have a servicer that can work that out and not drag their feet."
In assessing each deal from a bond investor's perspective,
"so much depends on the expertise and cost of the servicer in
concert with the enhancement protections", said Chris Sullivan,
chief investment officer of the United Nations Federal Credit
"In this environment, the note buyers will be forced to
weigh these factors and others - including assessments about
future home price appreciation and recovery values - against the
prospect of receiving a 3% return attached to a presumably
relatively short-lived asset."
In addition to Carrington, firms such as Bayview Financial,
Arch Bay Capital, and Residential Mortgage Services Inc, and
alternative asset managers such as Oaktree Capital Management,
have also been heavily involved in the burgeoning NPL
MARKET HEATS UP
NPL assets typically trade as a percentage of their market
value, and for distressed loans this is approximately 50%-60% of
aggregate unpaid balances in the current environment, experts
Supply of these loans emanates from any financial entity
looking to offload NPLs from their books - banks,
government-sponsored enterprises, the Department of Housing and
Urban Development (HUD), the Federal Deposit Insurance
Corporation (FDIC) or the Federal Housing Administration (FHA).
But given the current uncertainty as to whether these
entities will continue providing a fresh supply of NPLs, as well
as the fact that the booming real estate owned (REO)-to-rental
market has attracted new players hungry to buy up distressed
loans, prices of NPLs are getting bid up higher than expected -
a concern for observers who worry that the market might get too
competitive and frothy.
"The REO-rental players have driven NPL prices up, because
they view it as a good way to source product," said RBS's
Raezer. "They are converting them to REOs."
And because of the high level of credit enhancement and
short duration, most issuers don't bother getting credit
Raezer said that rating agencies take such a long time to
get through the process, and the deals factor down so quickly,
that it's typically not worth it to get a rating.
So far, the transactions have performed well, with no
blow-ups. Mostly money managers, insurance companies, and REITs
buy NPL bonds, the securitization executive said, although the
chief investment office of a large global bank also invested in
several recent NPL deals, according to market sources.
However, some participants are worried that if the market
heats up too quickly, there could be risk to retail investors
who have recently been attracted to the yields that the product
"Historically, the NPL asset class has been an institutional
fund - or vulture fund - product," said a senior executive
involved in purchases of NPLs. "The notion that you can address
a retail audience is untested."
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