All Forum Posts by: Dion DePaoli

Adding interest to a loan would be compounding.  Not typical among mortgage/dot notes.  Again, default terms may, as Bill mentioned as well, provide different terms.  The moral of the story here is with the variety of jurisdiction and the variety of note language among the differences between funding in cash and equity the notes will be less homogenous than what most tend to think.  It is not one size fits all.  

Running the SOL doesn't specifically unsecure the note.  It does however disallow collection attempts on the debt.  In that sense, it is similar to a BK discharge.  A debt that is discharged does not automatically mean the lien is removed or unsecured.  The lien may still be enforceable as a cloud on title providing for some potential collection.  This of course is barring counter-claims to quiet title.  There are two different ideas at work, the collection or pursuit of collection of a debt and the validity of a lien.  We can leave some of that for a latter discussion.  You should be relying on legal counsel and a licensed debt collector and/or servicer to engage on these matters to ensure you are compliant.  

Just to add the additional idea of lien stripping.  Stripping is the legal act, usually order by court, to remove a lien from title.  That is the removal of that lien, that is all.  Lien stripping and collectability are not the same thing.  A lien can be stripped and the debt still collectable.  A debt can be discharged by court or statute and a lien may still be valid.  (Until successfully challenged)  A discharged debt being uncollectable has more to do with the pursuit of collection and less to do with equitable recovery of a lien.  We will quickly voyage down the rabbit hole here so that is probably all the commentary needed.  

As we have pointed out, these long term defaulted notes pose risks to investors that they do not fully understand.  The condition of the file greatly adds to that risk as most are skinned down to bare bones and the buying investor doesn't know any better.  The success rate of second lien default collections can be somewhat understood by virtue of authentic secondary market pricing.  Unsecured defaulted debt trades for around 2% of unpaid balance (not total due) and secured between 3% to 5%.  In that sense, worrying about defaulted interest accumulation is somewhat a moot point.  If you can collect $3,200 on this loan you would have hit a home run.  Like baseball, most players do not hit home runs at every at bat.  Some don't hit any at all.  

There's my buddy @Bill Gulley!!

As I typed others posted.  Good stuff.

As to the idea that all or most of the loans reviewed are in excessive default terms - that is indeed the problem with the second lien street level investor arena.  They are, for now better description, - junk.  

As what is being pointed out here is common practice among the various state jurisdictions is going to vary.  Interest arrears can be limited especially when we start talking about these excessive defaulted loans.  

Eric, in response to:

- Statute of Limitations
SOL is slightly different in different states.  The tolling of the statute can commence from the day of the last payment or from the date of acceleration.  In some states the interpretation of the SOL is pro-borrower and others pro-creditor.  There is no distinction for a loan in collections vs not in collections.  All debts are in the process of being collected, some debtors pay and some do not.  The out reach idea - you misunderstand what that means - No.  In some states attempting to make contact to collect an expired debt will get you in trouble.  

As further cannon fodder on this idea, these second liens that are many years in default give rise to a lack of continuity of collection attempts.  A debt that is in default needs to continually be attempted to be collected or it may become stale giving additional defense to the borrower. This includes continually validating or making demands on the debt.  Often times all collection attempts on these loans have been halted at some time in the past.  Also, these files are usually stripped of all servicing records and the aforementioned correspondence making it more difficult to deal with counterclaims and defenses.

In regards to the calculation of the payoff amount you are understanding amortization.  
The loan:
Original Balance = $73,200
Interest Rate = 13.75%
Amortization = 300 (months)
Payment = $867.18

UPB = $64,000
Remaining Payments = 164

So the interest accrual is the interest due for payments 137 to 197 which is $41,172.83.  Using 5 years or 60 payments as the default term.  

As I mentioned in my first post, interest is not a fixed amount in amortization.  Nor is principal.  You are basing all of your presumptions on this this idea incorrectly.  $733.33 is NOT the interest due on every month.  $733.34 is the interest due for 137th month.  Interest due for 138th month is $731.79.  Interest due for the 139th is $730.24.  And so on to where the interest due for the 197th month is $602.01.

If you wanted to calculate it by hand:
1.  UPB*(Rate/12)=Period Interest (137th period starts)
2.  PMT-Period Interest=Period Principal (137th)
3.  UPB-Period Principal=Beginning Balance of Next Period (138th)
4.  Repeat 1-3 until the current loan period (197th)
5.  Sum the output (60 numbers) to find arrears.

All your math did was find the interest for one period, specifically the 137th period as dictated per the UPB.  

This would be pre-acceleration interest.  Essentially in order reinstate the loan the borrower still has to come up with $52,030.80 which is all 60 missed payments.  This can be at the lender's discretion allowing for a reinstatement amount suming to a lesser amount.

If we were to use the $733.33 for the default term we would have an interest due of $44,000.  While this may be a logical conclusion it is often seen as unjust enrichment to the lender as the lender would not have collected the additional $3k in cash.  

These matters are subject to court discretion and local jurisdiction.  Some jurisdictions have specific people (referees) or process in the complaint to calculate and affirm the interest due.

If the loan was accelerated, as I mentioned before the accelerated interest may be different than that of the note rate. Additionally, a note may contain language which calls for interest due from the last period due through the successive periods but often times that can be challenged as I mentioned. 

Anyway, so the payoff total would be the sum of those two numbers plus any advances and fees.  So before fees and advances we have a balance due on the loan of $105,172.83.  ($65k+$41k)

The late fee is a constant since the payment is a constant at $17.34.  In that case missing 60 payments would add $1,040.40 to the total.  Often times the full term of missed payments is not assessed.  

It is true you should be able to calculate all the figures provided you have all of the data.  In this particular case you need to obtain the advances that were made and understand what is allowed/common in the jurisdiction of the subject property.  That said, described here you can calculate most of it.  

No, negative amortization doesn't occur when a loan is in delinquency or default.  A loan balance can only increase if the loan specifically calls for negative amortization or through a modification.  

The late payment fee described is 2% of the payment amount or $17.34.  

The calculation for the interest arrears is based on the amortization schedule so the date of the Next Payment Due is needed to calculate it since interest is not a fixed amount per period in a amortization schedule.  Your equation is not proper to find the interest arrears.  You can use excel to recreate the amortization schedule and sum the unpaid interest with the proper dates or there are some amortization schedules online if you don't have excel.  

The late payment fee is per payment until such time as the loan is accelerated.  Often times only applied 'if' a periodic payment is made (as opposed to an accelerated balance) - as in that payment was made and 'is' late.  Missed payments are not made and often times the late payment doesn't get added in.  One should still look to the note for confirming any terms with regards to the application of a late fee.  The contract will typically prevail.

Interest arrears is also governed by the terms within the note and local jurisdiction of the subject property.  Interest due prior to acceleration and then interest due after acceleration will both be addressed in a properly structured note.  Some notes call for default interest different than the stated note rate after acceleration.  Not all clauses in all notes are the same.  

Buying a loan that has been in default for 5 years could very well be a losing battle.  You need to check the statute of limitations on debt collection for the state of the subject property.  Many states are 4 years and attempting to collect after the statute has run is against the law.  The same statute may also limit the amount of interest accrued.  

If you really must know I would suggest asking the seller to provide the payoff statement for the loan.   That is a reasonable request for due diligence. 

Great topic to start and frankly, it is probably time we embark on the discussion. I think you will find that not many note investors around these boards were affiliated with note investing during the last recession. So that may act as a barrier to some level of participation. On top of that, I would suggest the common narrative of the leading causes of the last recession are mostly barstool banter. As such we should look at what happened in the last recession and from there attempt to extract what may be important to consider when understanding a portfolio in today's time. Brace yourself, I am going to put BP servers on over drive here.

Let's first start by narrowing the vintage of mortgages which contributed to the crash. The notable years of originations range from 2003 up to 2007. We leave off 2008 forward since the crash itself really started in 2006, became known in 2007 and was at large in 2008. We start off in 2003 as that is when performance nudged past typical default rates and took us through the crash. Oddly enough, 2000 vintage loans had higher default rates in near term than those of 2001, 2002 and 2003. Within 60 months of origination 5.6% of 2000 originations had defaulted. However, the other 3 years had rates less than 3%. We will, for the sake of this discussion, simply set that aside as an enigma and move to the vintage years I mentioned.

So as we just learned, running up to the vintage of concern we had very manageable default rates. 2003 also benchmarks one of the last year where more mainstream mortgage products dominated the market. As we started to progress through 2003 mortgage products started to include exotic features away from standard fully amortizing loans. Not to say that products such as interest only had not previously existed but rather the share of those products in the market started to grow rapidly. To that extent, there happened to follow an erosion borrower equity by both down payment and pay down through periodic payments (fully amortizing). In 2003 & 2004 we still made 90% CLTV (just under actually) loans, however those loans required full amortization. As we progressed through the years we pushed the CLTV envelope to a point where in 2007 median CLTV was closer to 98% than 90%.

To help understand that impact for those unfamiliar, a loan in 2003 at median 90% CLTV would be closer to 70% CLTV in 2007. Clearly insulating those loans from the market declines in RE value in 2007-2008. Adversely, the worst performing vintage in terms of default, which is 2006, would go from a median CLTV of around 95% to 110% after 4 years. So if you were to graph the median CLTV of each vintage year over time you would see 2003 & 2004 arc downward toward a lower CLTV over time thanks to paying down principal thus earning equity. While 2006 & 2007 would arc upward increasing the median CLTV over time. As one might be able to extrapolate, 2007 median CLTV exceeded 100% within a year.

This data suggests that the programs deployed in the market greatly influenced the erosion of equity which was then further exaggerated by the decline in RE value to follow. Programs such as interest only and negative amortization rose in popularity and frequency which put the upward trend on steroids.

This is then the last place where the typical narrative will fit into the actual data. That narrative being, sub-prime borrowers caused the crash, per se. To put it simply. In fact, in stark contrast to that idea, the 2003-2004 vintage of sub-prime loans is actually the best performing segment of loans within the 2003 to 2007 vintages with a default rate below 6%. In the same timeframe from origination 5% of 2003 & 2004 loans defaulted whereas within a similar timeframe from origination the 2006-2007 default rate was 20%. For all intents and purposes, the borrower’s credit worthiness was relatively the same among the good and bad segments. The difference was in the program and the ability for the borrower to earn equity over time.

So the point of all that data conversation was indeed to cause us to pause on the idea that sub-prime borrowers were in fact the major culprit in the mortgage crash. The fact of the matter is, the same sub-prime borrower is successful in 2003 and unsuccessful in 2006. This idea points us to the more prevalent drive of default and thus value decline – lack of equity.

I won’t dive back into a bunch more data but as we progressed from 2006 forward defaults spread into conventional conforming loans. While there is some level of affinity to local market conditions such as employment and wage, those too have mostly been speculative whereby equity or lack thereof seems to account for almost 95% of all defaults across the entire spectrum of vintage.

If we accept this idea, we can then turn and look to the post-crash recovery and the actions taken which should drive us close to a point where we are now. Most loans in the US were originated for the purpose of securitization. Now, that said, most folks don’t fully understand what that means or what that market “actually” looks like. We understand there are loans that are securitized and loans held in portfolio and it probably ends right around there. Interestingly enough, there are two separate versions of securitized loans – public and private. Commonly we think Fannie Mae and Freddie Mac securities when the idea is mentioned. Those are indeed the major loan pool security makers. They are the “public” securities. Where public is a reference to the label of the issuer of the security. However, lesser known is there was and is a good sized private security market. Those would be securities issued by the private banks we all know such as Bank of America, Wells Fargo, Chase and you get the idea.

So to be clear, Bank of America can both originate and sell loans in to Fannie Mae which eventually get pooled into a security plus originate and pool those loans into a private security and sell the security itself. As long as there is a market consisting of investors who will buy into the private security those securities will be made. And therein lies some of the issue.

As we all know, Fannie, Freddie and Ginnie (FHA/VA) help define dominate underwriting guidelines. They are all also large entities which do not move quickly – which in the case of responding to market conditions can be seen as a good thing (conservative) or a bad thing (opportunity cost). In the same vintage years as we have been discussing in 2003 we have roughly an 80/20 split of the security RMBS market. (Residential Mortgage Back Security) Guess what happened in 2006…go ahead, you can probably predict it. 60/40. That's right, private label securities rose from 20% of the market to 40% of the market in around 3 years. Thus the public security market shrunk. Just as a tid bit of history, Fannie Mae was created with Ginnie Mae in 1938 to only buy FHA, VA and FmHA loans. In 1970, Fannie Mae began to purchase privately originated mortgages. Point is, in my opinion, while not perfect, they certainly had a lot of practice and over time developed prudent underwriting standards to protect the market including borrows and investors. In 2002 forward, we let the market share of private securities erode those standards. The above erosion of the median CLTV along with the exotic mortgage products are the constructs of that private security market. To that degree, the public entity underwriting guidelines ("conforming loans") were eventually seen as too restrictive and thus sub-prime and exotic mortgage products emerged and rose greatly in the market.

This is all important, in my opinion anyway, to those newbie investors who seek to buy the currently distressed loans at large because I don’t think most ACTUALLY understand who, where or how the loan they purchase or want to purchase came to be. What the driving force was of the origination and even worse – the servicing directives on those loans leading up to their purchase.

Most of what is circulating around for private investment is the private security driven market. NOT the public security driven market. That is important to understand as the incentives for modifications and delinquency and default treatments are grossly imbalanced between the two types of entities. Without getting into a tirade of details, private security driven mortgages loans ‘seemed’ to have preferred to preserve principal balance and lower rates as a response to market decline and borrower hardship opposed to their public counterpart which was given specific directives to reduce principal and consider lower rates through HARP and HAMP, etc.

So, now that we have come to current times, what can we expect and how can we take action to protect and preserve our capital as private investors picking up the pieces of the mortgage crash?

Well, as hopefully we learned above two simple lessons: (a) Equity is good for everyone and (b) avoid exotic and overly ambitious loans which do not afford the borrower full amortization and a clear and short term path to earn “real” equity.

I think (a) is pretty easy to understand but I fear it is often overlooked in practice. As a distressed loan buyer you want to give your borrower any equity you can spare. Think of it as their buy-in incentive. Even if it is a sliver. If you seek a reinstatement modification try and avoid modifications which come in at par or above par keeping the borrower in negative equity. Equally, in honorable mention because this is BP and we have seen them on the boards here – stay far away from Contract For Deeds or Land Contracts or any newly originated or modified loan which puts the borrower in negative equity. We as investors often consider our equity to investment but gloss over how to convert any of that into borrower equity. It’s not easy but bring it to top of mind and chances are you will see better reinstatement performance or long term performance from your loan investments.

There is a saying and I like it a lot – “pigs get fat and hogs get slaughtered”.

Now (b) probably has its issues with converting into actual practice. As such, I will share the magic that isn’t – after all, if you made it this far in this thesis you deserve something more than a simple door prize. When setting up treatments for your loans, mainly those which seek reinstatement be (a) realistic – if the borrower can’t afford to make payments do not act like they can. Low debt to income ratios are your friend. Additionally, (b) short term amortization is probably your commonly overlooked resource. We spend so much time trying to figure out how to buy a 30 year instrument we overlook that it is in fact a long term investment. When given a chance to treat a loan contemplate treating the loan with principal pass through. What I mean by that is, look to shorten amortization terms. Offer forbearance of principal only instead of interest only. Contemplate treating a loan so that it can rapidly earn equity and pay to zero over a shorter time. Now, notice how we are not bringing into the field of view balloons. Be cautious of creating a balloon event. Future credit markets may very well be tight, we can’t know for sure. Instead, take that discount you received and convert it to borrower capacity to earn equity. You can do this and not erode your yield. Shorten the term and raise the rate. Give adequate payment relief. To put it metaphorically speaking, people will try harder to make things work when they can see the end result in view, like paying to zero in 10 years instead of 22. You will likely be surprised how much better your loan performs and gains in value in the secondary as a result of such ideas being put into practice.

To speak to the non-performing loans of the market – there is no real secret here. Bid them correctly and set aside proper reserves to disposition the asset. Do not use DIL’s and Shorts as your primary disposition strategy. They are iterations but always plan to foreclose and anything short of that is simply benefit to you. If you can reinstate and the borrower is capable to reinstate, refer to the above. I do think there is more of an opportunity now than earlier post-crash to reinstate and if the market fades again borrowers who have earned equity will be more likely to work harder to keep it.

In regards to second liens, still not a personal fan. Do note the above CLTV median erosion put second liens in first loss. None of that changes. Personally I would never consider an asset without equity and even in second position with equity your position can be jeopardized if you are not careful. Cavet Emptor.

In regards to recession proofing your portfolio – I was fortunate enough to stumble through the crash minimizing the big red numbers in the funds I managed. I saw many funds come and go post-crash. Every second lien fund I knew has since gone out of business. The NPN only funds mostly failed with those surviving being born after 2012. The legacy costs of the assets were simply too much to capitalize. As such, I think having cash flow present in the portfolio is important.

In summary, I do think there is another adjustment coming our way. Some markets will be more affected than others. That said, loan level performance is exactly that, loan level performance. Putting forth good fundamentals in your loans with ensuring borrowers can earn equity; proper allocation of needed advances are set aside and try remaining objective with your loan treatments as opposed to forcing a loan to bend to your will help weather the storm.

I think more street level private investment helps turn around some of the previously blighted asset situations and areas. As such, stay nimble and opportunistic as an investor it is what sets you a part from your institutional competition. Good luck.

The IRS has 120 days after a non-judicial proceeding to redeem.  They would have to redeem like any other interested party and would pay statutory interest which today is around 1%.  Further, there is an overlap of time, which I can't remember all the details, but to some degree as long as the tax payer has a right to redeem the IRS is still in play.  This prolongs the redemption rights of the IRS.  

If the IRS, in its sole discretion, decides the property has value to recover a sufficient amount of that tax balance, whatever it may be, they can redeem and take the property and then sell it to recoup.  Further, they can do so with a limited interest and redeem the entire property.  So if the tax payer was 20% owner, they can redeem and take the entire property not just the interest of the tax payer.  

Failure to notice the IRS, which is somewhat related to failure to discharge prior to foreclosure, will result in granting the IRS redemption well past the foreclosure action since their right to redeem can not be withheld.  So what I am saying is, it is a bad idea to play "chicken" with the IRS in hopes of gaining a leg up on other bidders at auction.  The IRS may not redeem all but that doesn't change the fact that they can redeem at their will.  Certainly if the OP thinks there is an ample opportunity to make a gain, it is logical to some extent to think the IRS may too think the same.  Plus, like I said, there is the issue of a potential insurance claim.  

It is more prudent to know what you are playing with than to assume and be wrong later.    

Even from a senior position you will want to seek a discharge from the IRS prior to foreclosure.  It's not clear where the property is located or what foreclosure process the subject property has to go through but for both judicial and non-judicial it is best to seek the discharge prior to the action.  There are steps and forms to fill out and turn in and you need to do it granting them enough time to respond properly.  Usually best to make sure you have the proper certificate from them to discharge the lien.  

I suppose there "could" be an investigation into the fire damage and any potential insurance claims.  Might have to satisfy their inquiry for such.  In general, they are not out to stand in the way of superior claims just merely to collect on any equity due the taxpayer who the lien is against.  

If you follow the proper steps: (1) seek lien discharge; (2) obtain certificate of discharge and waiver of right of redemption; (3) begin foreclosure; (4) complete foreclosure sale; (5) pay off taxes - you will have the best chance at your predictable outcome of taking title to the property.  Until they issue the discharge and waive their right of redemption, they can redeem.  You wouldn't want to have them redeem after you pay for the foreclosure and payoff the taxes, that might not be an attractive gain.  

In regards to the contract request, not sure too many folks will bother with that.  Just as a highlight, the property has fire damage, was there insurance in favor of the lender which covers such damage and will that claim transfer to you or should some of those proceeds be used to demolish and clear site or clean up site; will you be indemnified for any future liability if not, etc - point is, I would worry more about your not so common deal rather than trying to find sample contracts of more common deals.  Good luck.

The note is either been modified or has been placed in forbearance.  You should be able to ask and get a copy of any agreement entered into.

Brandon,

Priority in title is determined by time of instrument recording and what, if anything, is prior in time to that event.  "First in time, first in line".  At the closing you should be receiving a Lender's Title Commitment which will insure your priority in title.  Post closing the commitment will be processed and turned into a policy.  

In regards to other potential issues that may arise or be present, they are too numerous to dig into without more specifics.  While you mention the borrower is a contractor the nature of the transaction is not exactly clear.  Is the contractor buying property that needs repair or is he buying vacant lots and building from scratch?  How much construction will be needed and thus how much money in capital will be given to the contractor during the construction process?  

Larger construction jobs will often have a draw schedule which allows the lender to manage and stay involved in the building process creating checks and balances to ensure that construction progresses prior to giving all the capital to the contractor.  This also reduces the interest the contractor pays as only what has been issued as a draw is subject to interest.  For instance, if the contract needs $100k, perhaps he draws down the $100k in pieces such as $40k, $30k, $30k.  

 You will want legal counsel to help you draft any documents you use to ensure your interests are protected.  You will use a security instrument to lien the property (or hold in trust) and a note is the promise to pay.  In addition you will eventually need a satisfaction and release document.  Any other documents during the life of the loan should also be considered such as draw down documents as mentioned above.  

Loan servicing should be considered by you.  Will the borrower be paying you directly or will you place the loan with a servicing company to handle proper paperwork and accounting?  If you choose to handle it yourself you should ensure you are prepared for the administrative burdens of doing so.  

If you want to ask some more pointed questions or point out other specific concerns it might be easier to address those.

Well sure, if the note is lost you will need a Lost Note Affidavit.  

More importantly Tony, you really should be asking about that question before you own it not upon selling.  It's not good to not know whether you actually got a note or not.  As to fixing it, the LNA is the fix.