Note Underwriting/Proforma Question

[Jonathan Orr]

Hey BP community

I recently was introduced to an opportunity for purchasing performing and non performing notes (1st and 2nd position).  I have little knowledge about it and wanted to know if anyone had good advice of what to look for when evaluating whether it would be a good financial decision or not.

Also, if anyone has recommendations of possibly any excel underwriting or pro forma for it for purchasing notes that would be huge help.

Thanks! 

-Jonathan

[Dion DePaoli]

Jonathan,

Let's back you up to the starting line first.  A property owner gives a mortgage to a lender as collateral to secure the sums loaned.  The mortgage does not entitle the mortgagee to the property but rather to the sums due under the note.  

The first step to creating an analysis is understanding what you are analysing and how it delivers money back to you.  At origination the note is setup with a loan amount, interest rate and number of payment periods spread over time.  So the most basic of analysis is an amortization table based on those note terms.  A borrower who does what they are obligated to do pays each period and the loan is treated as described in the note.  

If you buy a loan at par you will pay whatever the balance of the loan is at the time of purchase.  The yield back to the investor is the actual note rate.  If you pay a premium for the loan, you will pay more than par and the yield back to the investor will be less than the note rate.  If you purchase the loan for less than par the yield will be greater than the note rate.  Most folks here are buying distressed loans so some level of discount is present.  

When it comes to borrowers making payments there is really only one of two options applicable.  They paid or they did not pay.  Partial payments from a borrower do not pass through to an investor and do not count toward advancing the payment due date for the loan.  This is important because we need not bother with analysis of payments made on the loan for less than what is owed under the note.  

The next idea is the consistency of those payments.  Loans can be current, delinquent and defaulted. A loan in any of those states can actually be considered performing.  However, only a loan in default is considered non-performing.  Generally for a defaulted loan to be considered performing there are payments coming in currently but the loan is past due by 90 days or more.  

Loans made to a consumer for primary or second home property have to be 120 days past due before demand can be made on the note.  A borrower who is in default long enough for demand to be made is entitled to reinstate the loan from default status by making the past due payments.  So, just because the loan fell into default doesn't mean foreclosure is imminent.  

Further, just because demand is made and foreclosure filed doesn't preclude the borrower from redeeming the property from the loan.  All interested parties have a right or equity of redemption.  That is, a loan in default, where demand has been made, automatically gives parties with an equitable interest a right to protect that interest in the real property by paying what is due under the note.  Foreclosure is the process by which the right or equity of redemption is terminated.

The point to all this is to expose you to the concepts that are involved in the analytics of note investing.  This is no way an exhaustive list.  What a newbie shouldn't do is jump in without some level of understanding of these ideas in hopes of acquiring the real property.  Additionally, understanding these basic ideas is paramount to being able to begin to financially evaluate a loan.  First we must understand what is due under the note, then we must understand how the borrower or other interested parties can redeem before we jump into throwing a bunch of numbers around.

The math involved in loans is not overly complicated.  The modeling of the loan is.  The newbie hangup tends to be not understanding how and where a loan can be reinstated or paid back.  There are some other threads here which dig into into some of these ideas.   I suggest poking around to become more familiar the mechanics of a loan before leaping into the math.  Good luck.