With any black-swan event, lucrative opportunities present themselves. The Coronavirus Pandemic is no exception. This article explains the opportunity unfolding in the secondary mortgage market for distressed debt buyers. We’ll make this one short & sweet – you’ll quickly see the inevitability of a big year for note investors.
The story so far – Note Investing in 2021
December 2020 saw a near-record number of loans with seriously delinquencies but because of foreclosure/eviction moratoriums and a widespread forbearance enrollment campaign, foreclosure activity remained at a historically low level.
To make matters worse (and encourage “kicking the can”), two temporary financial reporting reliefs allowed big banks to suspend accounting for their bad debt through TDR & CECL relief. Instead of keeping their balance sheets relatively clean through the standard practice of charged-off loan sales, institutional lenders have been sitting on non-performing loans, causing a logjam at the highest levels of the real estate financing market.
As a consequence of the CARES act, business as usual in the secondary mortgage market almost came to a stand-still in 2021. Pricing for large portfolios of cash-flowing paper reached levels close to or even exceeding par value (as we heard from Jorge Newbery of AHP & PreREO). On the non-performing side, tight inventory took pricing on our client’s sales to 70-80%+ for NPL 2nd position liens with average pricing close to 50% of UPB.
The Top is in for Single-Family Residential Home Values
Although it is incredibly unlikely we will see anything like the housing crash of 2008, it does appear that pricing is cooling down and we have already seen the peak in the latest cycle of home values. With the foreclosure moratoria expiration in September 2021, courts are back to work on the backlog of foreclosures – more inventory coming to the market will continue to put downward pressure on pricing.
Furthermore, according to Black Knight’s first look at September 2021 Mortgage Data, approximately 1.2 million homeowners (who are not yet in foreclosure) remain 90 or more days past due on their mortgages. Many of these borrowers are in active forbearance plans and will soon have to either reinstate their loans or sell their homes. If even a small percentage of these one million plus homeowners decide to list their homes, the increase in inventory will be reflected in lower home values.
For an excellent article including data, charts and forecasts from the top experts, read Norada Real Estate Investments article: Housing Market Forecast. Founder Marco Santarelli does a great job consolidating data from around the industry.
Latest Housing Market Data & Statistics
More Inventory on the Way: SFR & Charged-off Loan Portfolios
As explained above, The Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) provided financial reporting relief for troubled debt restructuring (TDR) accounting model by lenders and the adoption of the current expected credit losses (CECL) model by financial institutions. With the most recent extension approved through January 1st, 2022 – banks will soon be required to come to terms with their “bad debt” and begin liquidating non-performing loans to the secondary market.
With the logjam of distressed debt soon to be unleashed, 2022 is expected to see an increase in inventory that will bring NPL pricing back to reasonable levels and an influx of opportunity for note investors to help a new round of borrowers that have been failed by big banks. As always, we’ll see how the market develops – stay tuned for more.
Some additional information from Mission Capital regarding the adjustment to bank portfolios that will re-designate loans to be properly risk rated: