How Much money is needed to purchase a group of Bank Notes from a Bank?

[Patrick G.]

I did try to search for this, but maybe didn't use the best terms, so I apologize if this has been hashed out a few times.

I've listened to a podcast (real estate guys) and read some on BP about purchasing Bank Notes in default.

My general understand is this:
It is a great hands on investment, you can purchase Notes (aka loans) for pennies on the dollar, then approach the home owner who is currently in default and work with him to either keep the house by re-working the terms of the loan. Or you can work with him to sell the house and pay off the loan. Or foreclose. So there is great potential for profit.

However the main stumbling block to most investers seems to be that banks will generally only group a large amount of these loans into a 'lot' (group of similiar notes/loans) and sell the lot for a large amount of money.

For the average person wanting to invest under $20k, they only have access to 'left overs' at around 50 cents on the dollar. Basically a large investor will purchase the lot, and sell off the lesser wanted notes/loans individually to smaller investors for a profit.

Please correct me if any of the above is incorrect. That is my general, limited understanding of the process.

My question is about the lot, or the group of notes/loans. Has anyone had any experience about the lots purchased from the banks?
What is the typical face value of the lot?
What is the typical purchase price for the lot?
How many loans do the lots contain?
How similar are the loans as far as geographical region?

I do understand there will be a wide range of answers depending on banks, market conditons, etc.
But are will talking about 1,000 loans with a face value of $200 million being sold for $4 million? Or are we talking about 100 loans with a face value of of $10 million being sold for $1 million? Could an investor purchase a lot with only $100,000?

Thanks! And once again, I apologize if this has been beat to death, I actually don't have a million dollars to invest I'm just curious.

[Dion DePaoli]

Yea, not really on point to reality. That said, this is a common misconception that folks have. Let's address.

The performance of the loan will depend on the level of passive involvement from the investor. When a loan is performing, there is nothing to do but simply collect the payments. Not all that labor intensive. As loans erode into delinquency and default the level of action related to the asset increases. That workload can be allocated to a Mortgage Servicer or can be taken on by the Investor. Sub preforming loans and non-preforming loans will require the most work.

The disposition strategies are the same and have been the same for many moons. The concept of payment or performance is really simply. "A" they pay or "B" they do not pay. In the event a borrower pays, not much to do. In the event a borrower doesn't pay, much to do. Disposition the loan can be initiated by either the borrower or the investor. A borrower can sell the property or refinance the loan. No involvement needed if these events satisfy the debt. In the event the debt is not covered the option to take the payoff is up to the Investor.

I think the idea is pretty simple to understand, in regards to potential modifications and reinstatement. However the underwriting and restructure of the loan may not be as straight forward. It is possible to have borrowers who simply can't afford their house payment any longer. How will you determine that? New origination have a guideline for this in their asset and DTI ratios but modifications do not. Just because you shaved off $300 from the P&I payment doesn't mean the borrower will once again be a successful borrower. In addition, why only $300 and not $400?

To that degree, how do you get the loan to that new structure? Through principal forgiveness or through rate reduction or through amortization extension? A simply understanding of amortization math can lead that answer but what impact will each of these concepts versus the other on the current and future value of the loan?

Loan are put into "pools" not 'lots'. "Lots" is not the right word. A pool of loans simply means more than one loan. That is all. Whether the pool is $100k or $100M depends on who put the pool together. Additionally, loans trade as 'One Off's' all the time, so purchasing a pool is not a requirement to invest in a loan. The key to finding smaller pools and one off loans is finding a seller willing to deal at those levels. If you have a Billion in inventory you likely do not make too much progress trying to sell $100k at a time.

The newbie investor issue seems to be a lack of knowledge of navigating the mortgage secondary market and finding the correct counter-party.
The presumption that all loans trade at 50% or pennies on the dollar is highly incorrect and flawed. The price of a loan is dependent upon many things, which are not magic but quantifiable. The yield, the total return, collateral, credit and property defects can all also influence the value of said loan. Loans trade for premium 100%+ or par 100% or discount <100%. Loans trade in different lien positions.

A $20k investment for loans has it's limitations. To the extent of the example, a first lien $20k investment at 50% (into a $40k house) if the loan is non-preforming could be a large loss. The value of the real property and subsequent recovery from the collateral will struggle to catch up and costs associated with dealing with the default through foreclosure. A $20k investment into some second liens could yield a couple loans, first liens likely only one.

In the market there is downstream trading. Where larger investors sell down to smaller investors and the asset pool shrinks in size to match the investor level. A footnote to this, do not assume that the larger investors do not purchase and work the assets themselves. Downstream trading has its limitations. Sooner or later the price of the asset is highest best price for the asset and there is little to nothing to do to impact the dispostion expense or time of the asset so essentially everyone puts the same price on it. If I bought it for $10 and my bids are all $10, then I might as well work the asset and get the $5 profit from disposition.

Do folks here on BP have experience with some loan pool sales? Yes, a couple of us here do.

Has the seller of those pools been banks? Yes, sellers are banks, investment funds and private investors. Banks are not the exclusive owner/seller of whole loans. In fact there is a bit more market activity by non-banking institutions lately that banks.

Face value of a pool? Face value is not a industry term. I presume what you are asking is what is the UPB (Unpaid Principal Balance) of the pools. This can range from a small two loan pool for $100k up to a large loan pool exceeding $1.0 Billion. There are not too many loan pools that trade in one trade in the very high numbers. Typical market pools are geared toward the investors who bid on them. While undefined formally there is a little structure in the following manner $50M to $100M, $25M to $50M, $10M to $25M, $5M to $10M, $1M to $5M and less than $1M. The UPB size of the pool is one concept and the amount of deploy-able capital used to purchase the pool is another.

The purchase price of any given loan or pool depends on the loan or pool which is being bid on. Believe it or not, this is not really a guessed at number and actually is quantifiable, contrary to popular belief that everything trades for 30% or 50%, etc. I always like to point out that concept because those who say it don't understand the next part which is 30% of which number? (UPB or RE Value)

A loan pool can contain 2 loans or thousands of loans.

The loans geographic concentrations or exclusions will depend on the Seller of the loans. The seller can only sell loans they own. If a bank in Iowa sells loans, it is a safe bet they have Iowa loans and not New York loans. Different firms have different business footprints from local to national and all in-between.

A $200M pool sold at 2% for $4M is not a typical trade level. That sort of discount would be for some very bad first lien loans or some second liens that likely are not too pretty either. To answer bid levels is another long answer as it depends on many factors. Generically the price levels are based on credit grade, performance, collectable/enforcement and some other factors. For a NPN secured by a median home in the US in a judicial foreclosure state you could pay anywhere from 58% to 65% of RE Value. Pricing is fluid not stagnate so market influences those prices as well as asset characteristics.

There is also a difference amongst sellers in basic terms of being private, such as a seller financed note or institutional such as a institutional origination, say by Countrywide.

Can an investor, investor with $100k in loans? YES. That is sufficient money to buy some first or junior lien potions across all performance categories.