In the residential whole loan market, many non-performing loan (NPL) buyers see an opportunity to rehabilitate borrowers, turn the assets into re-performing loans (RPLs) and eventually sell the assets to an investor that specializes in owning RPLs. The strongest buyers of RPLs are generally institutional buyers that oftentimes securitize the assets.
With this sale opportunity in mind, NPL buyers – when they’re purchasing the assets – are finding they need to be more aware of potential flaws that could impact the sale price later, according to Mike Kelleher, a vice president on the Transaction Advisory team at MountainView Financial Solutions, a Situs company.
“One of the biggest impacts on sale price we see is noncompliance with state and federal high-cost regulations,” said Kelleher. “In such instances of material noncompliance, we’ve seen very significant pricing decreases between initial bid and final price.”
High-cost regulations limit the points and fees that are charged at loan origination. If the charge to a borrower exceeds the maximum legal thresholds from the state or federal government, the loan is called a high-cost fail and is not compliant. In addition to taking on that potential legal liability, RPL buyers who want to securitize their assets generally cannot put leverage on loans that are state or federal high-cost fails.
Even though this error occurred at origination, the assignee can be liable. As with certain disclosure and underwriting issues that many loans have, the liability for certain origination issues is assigned to whomever currently owns the loan. Regardless of which company originated the loan, even loans with issues of noncompliance, it’s the current owner’s responsibility to understand and know the issues, because the liability follows the loan.
As you evaluate the opportunity to acquire NPLs with the intent of later selling the assets as RPLs, you may think different loan flaws or issues aren’t necessarily your problem, but they certainly will be if that liability is assigned forward to another investor, explained Kelleher.
“Most investors think about getting their house in order when it comes time to sell, but a lot of that work needs to be done at the time of acquisition,” according to Kelleher. “From a compliance standpoint, if you don’t run your own compliance review at acquisition, because you don’t plan to securitize the loans, you may not appropriately price for that risk.
“It’s important to understand how the institutions that you may sell to are going to account for those risks,” Kelleher added. “With that understanding, you’re making sure you buy those loans at the right price, so that when it comes time to sell, you’re not absorbing the discount in pricing attributed to outstanding issues of noncompliance. You want to account for the potential pricing discount upfront with whomever is initially selling to you – you don’t want to overpay for something that’s going to have these eventual haircuts to pricing when it comes time to sell to a larger institution.”
Another consideration when you’re actually selling a portfolio of RPLs is that you need to know which buyers have pricing reflecting these issues, which ones don’t, and which buyers absolutely can’t buy loans with these issues. You need an understanding of who is going to re-price and by how much.
“In our early discussions with sell-side clients, we ask what the known issues are for the RPL portfolio, and we specifically ask if a compliance review has been run,” said Kelleher. “We try to expose our buyers to as little risk as possible, and that in turn results in minimal re-pricing or ‘fades’ after the initial bid and after the buyer’s due diligence.”
An additional piece of RPL sales advice from Kelleher is to make sure that your collateral is perfected – review the assets and make sure that you have the full chain of title, and make sure your assignments and allonges are properly recorded and in order. While this may not have been critical to you as a NPL buyer, it will be a material issue to the RPL buyer. It’s another example of doing more upfront work when you buy to make sure that you’re better prepared for an eventual sale.
“With collateral defects, there’s a lot more variation in the impact to pricing at re-sale, and it depends on the individual loan’s defect,” said Kelleher. “If you’re missing a note and you don’t even have an imaged copy of the original note, that’s something that can make the loan entirely unsaleable. If the defect is a missing assignment or allonge, there generally are cures, but those cures take time and can therefore impact pricing and ultimately delay the sale.”
The bottom-line recommendation from Kelleher: Make sure you have more scrutiny in your diligence as a NPL buyer if you plan to eventually be a RPL seller.