Notes: Foreclosures and 2008 Subprime Mortgage Crisis

[Chavel Diaz Jr]

Hi BP Community,

As I start my journey researching, learning, and investing in notes 2 quick questions come to mind.

1. What are the ramifications should you own the note, aren't able to modify it/get it performing again, can't get the deed in lieu, only left with starting the foreclosure process, and during the process the occupant declares bankruptcy?

2. How did the 2008 Subprime Mortgage Crisis affect Note Investing, whether buying, selling, or your inventory on hand if you were carrying notes at the time?

Thank You in Advance for any and all your responses....

Chavel

[Dion DePaoli]

A borrower who files bankruptcy has protections under the bankruptcy law for debt collections.  The creditor is automatically stayed (ordered to refrain) from attempts to pursue any form of debt collection activity.  The repayment plan devised and approved by the court will deal with outstanding creditors and their repayments.  The mortgage debt can be discharged as a function of the plan which means the debtor no longer personally owes on the debt.  The debt can also be serviced by the plan where the BK plan structures dealing with the past due amounts and the borrower would have to service the debt moving forward in time.  Failing to pay on the debt moving forward is a default.  The enforcement remedy is foreclosure.  Failing to service the BK plan is grounds for a dismissal which cancels the plan and releases the automatic stay.  BK's are not a bad thing as a mortgagee but there are rules on how to work with accounts seeking bankruptcy relief.  

Prior to the crash the segment of distressed debt we have now in regards to loan inventory in the secondary as well as service providers - such as Mortgage Servicers all emerged.  Prior to the crash we still had defaults but those defaults where dealt with in more of a debt collection setting rather than what we have today in high touch distressed debt servicing.  Most mortgage servicing in the market was what we could refer to as 'standard' where the servicer dealt with performing and delinquency.  The shear number of defaults allowed specialty servicers to open up a new sub-class of servicing.  

In the years following the crash we saw real property values erode and fall.  In some markets, they fell a lot.  This was problematic as it created pricing issues with the distressed loan as controversies over RE value where barriers to sale in the secondary.  I remember between March and April of 2009 where we have a very large exposure in to defaulted loans (10's of millions) and what seemed like overnight within those 30 some days we lost 15% of value across our portfolio.  Poof, it was just gone.  That also wasn't the end of the decline.  We still fell, just by more of a gradual sort of decent.  That created a lot of issues for fund managers, I was one of them, as much of that private equity was leveraged with institutional debt.  The value loss created losses in the private equity recovery and in many cases the debt positions didn't make it out whole either.  This was on top of redemption requests coming in from investors and regulators wanting to audit everything you did.  

Over the next couple of years many players entered the market and failed.  A small few, managed to enter the market and start to do better.  Really as a function of stabilizing RE values.  A lot of that RE value stabilization came around as the banks slowed up their selling of defaulted positions, increased their reserves to deal with the default and could get their heads above water and off the regulators lunch plates to focus on future business.

Much of the craze we have now, especially that in the more private street level investor market is very recent.  Within a couple of years.  It wasn't until more recently that one off loan trades started to become viable.  So much of the barrier for private street level investors was they just didn't have enough capital to play ball.  

Make no bones about it, our fund lost money.  In fact, the game was not about making money but rather mitigating the losses.  It was brutal.  

The market changed forever in those years.  It seems at times we seek to re-live some of the mistakes that lead up to that event but the path and pressure comes from different angles now.  We are not out of the woods yet and we have potential in some markets to dip again.  We have just as many abuses as we did before only we have new and inexperienced players trying to carve out a place for themselves.  Carpe Diem.