Not Necessarily Gold In Them Thar' Hills (Could Be Gold Dust)

Housing Wire reported last week that Silverleaf Financial issued a press release announcing it acquired a $28 million pool of mortgage notes for $4.9 million. National Mortgage News editor Paul Muolo reported earlier that Wells Fargo had sold a $600 million pool, naming the suspected buyer and offering the price the buyer "reportedly" paid.

Both of these pieces list prices paid by investors, inferring that investors are making out-sized profits on nonperforming loans and foreclosed properties-a veritable Gold Rush at the public's expense. Muolo suggests in his article that sellers of these assets don't want price disclosed, because it will be the equivalent of airing dirty laundry by showing the public how bad the assets held by sellers really are.

I'd like to dispel that myth.

Investors don't want price disclosed because they don't want to disclose their strategy, holdings and worth in a highly competitive environment. Maintaining confidentiality of private transactions is business basics and in no way underhanded. In fact, it would be imprudent to make such disclosures. I'm a firm believer that transparency is a key to how our industry will re-emerge and avoid mistakes of the past, but reporting buying prices isn't the right kind of transparency to demand.

The prices paid for these pools, if reported accurately, are low, but they reflect the risky nature of the pools.

Investors target nonperforming loans and REO for a net yield in the range of 12 to 15 percent, factoring in risks, resources and expenses to overcome in realizing these profits. That's not an astounding yield but rather typical for a risky investment. In order to obtain that yield, they use conservative assumptions. The true market discipline investors work within is to determine accurate assumptions and reasonable returns that will allow for a good opportunity to make a positive return and still beat competitors in the bid process.

There is fierce competition among investors in this space currently. Knowledgeable bidders spend tens of thousands of dollars to analyze assets in these pools before they submit or finalize a bid. They put a value on every asset in the pool. In some cases, the value they attribute is zero. A severely run-down house may cost more to scrape and reclaim than an investor will get back on the cleaned up lot, as an example.  Valuing assets and analyzing them takes infrastructure, talented people and financial resources.

Successful bidders still have a long road ahead of them, with considerable risk to their capital. Once they win a pool, they then have to execute an exit strategy for those assets, whether through loan restructuring or foreclosure and property sale. Silverleaf, in a subsequent announcement, reported it is selling many of the nonperforming loans it bought at steeply discounted prices because "it would be too time-intensive for us to do 321 separate workouts on all these notes."  As this buyer may have realized late in the game, the financial risk the investor takes is not inconsequential.

One risk of buying nonperforming mortgages and foreclosures is that moratoriums can be instituted, preventing the investor from taking action on what can be a hopeless loan situation. Investors clearly recognize loan modifications as a way to keep a loan alive and paying, but it is very costly to implement a modification program, whether for one loan or for loan pools. Also, when principal is written down in a modification, that money comes from the investor.  The financial risk the investor takes is tremendous.

When the dust settles, I hope we can say investors made some money on these loans. The prices sound cheap, but when you factor in what it costs to breathe life into a nearly dead loan, this might not be the Gold Rush that's been portrayed. Investors are taking risks and investing money in servicers who can do workouts that will keep people in their homes. By doing so, they are bringing the real estate and mortgage markets back to life. If they don't put the money into these assets, the consequence to the rest of us is that toxic loans will continue to gather dust, and the economy will remain at a standstill.