Distressed Mortgages for Sale

Foreclosed properties have been flooding the auction block following the housing crisis. Less visibly, pools of distressed loans are also being sold off—and it’s a market ripe for partnership with neighborhood stabilization actors.


As of late 2011, residential NPLs were trading in the range of 50 to 65 percent of the current market value of the underlying property. These prices are down 5 to 7 percent from their early 2011 highs.

NPLs in states with long judicial foreclosure processes (such as Florida, New Jersey, New York, Illinois), trade at the bottom of that range (or even lower, depending upon pool composition), because longer foreclosure times reduce the return on investment for certain investment strategies. States with non-judicial, and therefore relatively shorter, foreclosure processes (such as Texas and California), trade toward the top of that range (or even higher, depending upon pool composition).

Knowledgeable market participants believe that the attorneys general lawsuit against large national mortgage lenders and bank earnings that are not large enough to adequately offset losses on sales of loans explain the decrease in the volume of NPLs sold in 2011 versus 2010. Another major reason for reduced volumes of sales is that NPL prices have declined as underlying real estate prices have declined. As real estate prices stabilize, or eventually even begin rising slightly, prices of NPLs will rise and even more sellers will come into the marketplace.

Distressed Loan Investment Strategies

There are two general types of strategies used by NPL buyers. Short-dated strategies typically have a time frame of 18 to 30 months and proceed through the following steps: Modify loans if possible. Refinance loans if possible (acquired loan is paid in full). Complete a short sale or pay cash for keys if possible. Foreclose on the rest. Sell the foreclosed property. Sell the modified loans.

These strategies work best in nonjudicial states, and are being used by some hedge funds and private equity funds. Because of the short duration of the investment, there is often insufficient time to repair borrower credit or perform other financial counseling and supportive services that would allow more people to qualify for modifications.

Long-dated strategies have a typical time frame of 36 to 72 months. They usually look like this: Modify loans if possible, remodify if necessary. Provide counseling and credit repair to increase the percentage of loans that qualify for modification, and then modify those as well. Refinance loans if possible (acquired loan paid in full). Complete a short sale or pay cash for keys if possible. Foreclose on the rest. Sell or rent the foreclosed property. Season the modified loans, sell them as reperformers. Sell the rented properties.

Because these strategies operate over a longer time horizon, they can be used in both judicial and nonjudicial states. In a long-dated strategy, more options are open to the patient investor to maximize returns and more people are kept in their homes.

However, there are relatively few for-profit investors putting long-term, patient money in the NPL space because many investors are loath to tie up their funds for extended periods of time due to global economic uncertainties. Some nonprofit investors, due to their interest in keeping more families in their homes, are exploring long-dated strategies (see page 12).

Finding immediate take-out funding for reperforming modifications has been difficult. American Mortgage Capital Group has recently seen reperforming, modified mortgages sell at levels that would yield the buyer a high single-digit return if all the reperformers continued to reperform. The yield to the buyer would be a very low single-digit or possibly a slightly negative return if every loan in the pool defaulted. Realistically, therefore, returns to investors in reperforming mortgages are likely to be in the mid single digits. That return is insufficient to attract large volumes of for-profit capital.

However, if reperforming mortgages are “seasoned” (i.e., held for one or two years after they begin reperforming), their risk is considered to be much lower and they can be resold for a potential profit — another advantage of a long-dated strategy.


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