The following is an excerpt from Chapter 9 of Volume III of The Mortgage Professional's HandbooK:
WHOLE LOAN EXECUTION
Brendan Teeley, Vice President, Whole Loan Sales & Trading
Mortgage Industry Advisory Corporation
PRICING OF NON-AGENCY LOANS
Funds issuing non-Agency mortgages require a lower LTV, since the loans are not insured by the U.S. government and any losses incurred during the default period are born directly by the investor which owns the loan. Non-Performing Loan (NPL) expenses include deferred interest, default interest, attorney fees, court fees, maintenance fees, and more. Therefore, the equity in the property must be sufficient to cover all fees for foreclosure plus the transaction costs associated with re-selling the property on the retail market. Alternatively, the seller may dispose of the assets via a bulk sale to other funds that specialize in distressed assets. In the mid-2010's, the market for these NPLs priced out at 65 percent or less of the current value of the property. This level represented a significant increase in market values of NPLs from the early stages of the 2007-2008 market contraction, when NPLs typically sold for 30 to 45 percent of the property value. Banks do not typically hold non-accruing assets, including non-performing loans, on their books. The secondary market will purchase the NPLs, allowing the bank to recapitalize.
Pricing of any asset is a relatively transparent indicator of the risk involved in the investment. The lack of mortgage insurance, any government guarantee, or subsidized capital drives the yield required by the secondary market higher in an attempt to normalize risk and reward. To put it another way, what would an investor have to earn from his investment to make it worth his while to lend to someone that the Agencies would not lend to? This premium is a function of just how far out the loan is on the credit curve. The higher the perceived risk, the higher the yield the investor will require to fund the loan. As of late 2015, this premium was 50 to 150 bps. In the early/mid 2000s the premium could be as high as 650 bps, as lenders originated many loans that ultimately did not perform.
Note that yield is correlated with the market’s perception of risk. This creates an opportunity for portfolio investors which may have the expertise to safely originate loans for which the market imposes a high risk premium. Not only does this provide the opportunity to earn higher returns in portfolio; once the loans are sufficiently seasoned and the lender can show the actual performance of the loans, there may well be an opportunity to profitably recapitalize by selling those loans into the secondary market at a premium.
A loan’s value is a sum of all parts: LTV, Doc type, FICO, and so on. Any one factor can be a compensating factor, and any one can be a deal-killer. In the portfolio space, there is typically the ability to have flexibility in accepting one impairment, assuming the other two are strong enough to compensate. This is the underlying theme of portfolio lending: the ability to use compensating factors in underwriting a mortgage. In the 2000s, lenders such as BNC, Countrywide, New Century, First Franklin and Fremont compromised on all three criteria, providing 100% financing on investment properties, or 100% financing on owner-occupied properties down to a 580 or even 560 FICO, a credit range that is not generally lendable at all in today’s environment.
A large Midwest bank has a footprint in a major California city that has a large concentration of borrowers that are typically self-employed, and whose tax returns do not reflect their cash receipts. This bank took the time to understand the borrowers and the market, including the the very strong real-estate values in the city, and the fact that actual bank deposits illustrate a much stronger cash flow than the tax returns would leave a lender to expect. The combination of deeper understanding of the borrowers’ cash flows, the exceptional real estate values, a maximum LTV of 65, weighted average LTV of 61, and strong credit scores allowed the bank a high degree of comfort with the credit risk.
The bank built out a set of guidelines that allowed them to originate hundreds of millions of dollars of loans to this clientele, with not one single 30 day late payment. MIAC was able to identify buyers of these loans on the secondary market. Buyers were able to get comfortable with the underwriting and loan characteristics once the entire story was communicated, and as a result we were able to develop counterparty relationships with investors which would purchase the whole loans from the bank. The creation of this market improved liquidity for the bank, showed bank regulators that the loans were marketable, and provided the buyer a loan portfolio with an above-market yield.
Read the rest of this chapter in The Mortgage Professional's Handbook!
Brendan Teeley is the Vice President, Head of Whole Loan Sales and Trading at Mortgage Industry Advisory Corporation, (MIAC). Mr. Teeley’s expertise is in financial product sales and services including residential and commercial asset sales, trading and origination of whole loans. Mr. Teeley brings deep experience from over 15 years of real estate finance, including loan origination and secondary asset sales.
Prior to joining MIAC, Mr. Teeley was a Senior Associate at Avison Young Capital Markets, working on the whole loan desk brokering a spectrum of mortgage assets. His clients include banks, funds and sophisticated mortgage asset investors.
Mr. Teeley also sold for the whole loan sales desk at Cantor Fitzgerald. Prior to Cantor, Mr. Teeley was consistently the top producer at AXA Equitable, building a successful securities, qualified plans, and insurance business by working with C-Level executives and Treasurers. At Wells Fargo Home Mortgage, he worked as a Sales Director, increasing origination in excess of 40%.
Mr Teeley is a graduate from the University of Michigan, Ann Arbor.