Do Performing notes always come with a low discount?

[Cameron York]

I am learning and integrating myself into the note investing business and up to today, I have always seen performing notes as very tight gripped by banks/investors and usually have an incredibly low discount (due to the obvious reasons including that no one wants to give a discount to a sure thing regarding monthly income). So my question is, is this true? Typically, how are the discounts for cleaner performing notes? And what is the point in even investing in it if is true?

[Mike Hartzog]

A focus on percent discount is missing the point. Buyers of performing notes are buying an income stream which provides a certain yield on invested capital. So let's say you were looking for an 8% annualized return on your capital. You could achieve that by paying 100% of UPB (unpaid balance) on a note with an 8% rate. You could also achieve the same thing by buying a note with a 4% rate at a discount to UPB. You will need to do some financial math to determine how much of a discount is required to achieve your target yield.

There are other factors which drive performing note pricing as well. If yield were the only consideration, life would be simple, but unfortunately we must also consider risk. For example, a loan with a UPB which is 50% of the collateral value (50% LTV) is much more secure than one with a 90% LTV. The quality of the collateral, as well as how quickly and cost effectively a foreclosure can happen in the state (where the collateral property is located) will also influence the value of a note. Borrower credit score and the borrowers payment history of the loan are also key factors.

Experienced note buyers will have a target yield in mind and will work to find notes which can deliver that yield at a level of risk they are comfortable with.