Participants at the National Mortgage News roundtable in New York see a few years of healthy activity left for the distressed mortgage market despite the slowdown in foreclosures and shadow inventory.
Participants at the exchange, which occurred at NMN’s fourth annual Distressed Mortgage Portfolios Forum, included Rick Sharga, executive vice president of Carrington Mortgage Holdings LLC; Reeves Ambrecht, managing director, The Debt Exchange Inc.; Jeff Levine, managing director, Houlihan Lokey; Mark Fogarty, editorial director of the Mortgage Group for SourceMedia, and Amilda Dymi, managing editor of Mortgage Servicing News.
They spoke of a discernible difference the performance of residential and commercial mortgages, with Ambtrecht saying the fundamentals on commercial deals have gotten better. In his answer he said, “I’m not sure what the direct correlation is. What I will tell you is that it seems like we’ve seen across the board, for commercial real estate assets compared to residential assets that are distressed, we’ve seen the commercial ones bid up by investors to the extent that fundamentally, things have gotten better.
“It seems like it’s a clear exit strategy, whether it’s restructuring the loan or foreclosing. That’s where we’ve seen the better pricing come just as a percentage of the current market value of the collateral. What is interesting is talking about price and yield and the discrepancy about what banks are willing to let it go for now compared to a couple of years ago.
“I think 2013 will be very similar to last year, but in the next couple of years when loss shares start maturing, you’re going to have a bunch of commercial real estate that is maturing as well come up for refinancing, whether it’s amongst banks, pension funds, life insurance companies. It’s going to be interesting to see where price goes because I don’t know if capital is going to trump that or not. It’s going to come back to supply and demand.”
LEVINE: I would echo those sentiments. There’s going to be a lot more supply coming to market on the commercial side of the house than the residential. It just historically has a longer life cycle. Banks could do the extend and pretend renewals on commercial loans much easier than you can on residential. The benefits of the economy picking up should support pricing, as well as yield requirements have come down from the investor side. You have the same general theme. But the issue will be supply and demand as well as servicing capacity. There’s been much more servicing capacity created on the residential and special servicing side than on the small to midbalance commercial.
FOGARTY: We saw the commercial market tank after the residential one. You’re saying now they are performing well. So they’ve come back quicker than residential?
LEVINE: I think so. Part of that could also be the consumer laws. You had much more support via the institutional investors that did not want to renew the maturities and push them immediately into foreclosure. But also you don’t have consumer laws applying to commercial loans. You don’t have the foreclosure moratoriums and the robo-signing issues to deal with on the commercial side. You have many more options to deal with and working out those loans.
SHARGA: That’s a great point. The consumer foreclosure recovery on the residential side should happen a lot quicker. But the fall should have been a lot more severe and quicker as well. So preventing that more dramatic drop-off has just extended the cycle by a number of years and we really didn’t see quite as much of that on the commercial side.
FOGARTY: According to Trepp, commercial mortgage delinquencies are 9.5%, which is still pretty high. Residential right now is at 7.25%. So it’s definitely on the way to recovery, but is going rather slowly.
FOGARTY: Who are the biggest investors in nonperforming?
AMBRECHT: You’re going to have different investors, whether it be residential or commercial. It seems the biggest investors are still the funds, large debt funds who are not interested in purchasing a deal on the one-off basis, but instead looking at large residential portfolios or large commercial real estate portfolios where to some extent they can use leverage and maybe have a different underwriting approach compared to an investor looking at a smaller deal on an unpaid principal balance perspective.
LEVINE: You have probably five or ten funds who probably dominate 80% of the market, predominantly residential, a little bit of overlap between residential and commercial. We’ve seen the investor base evolve now because of the securitization market coming back. So you can now multiply that capital via leverage. And so the investors that provided the capital to these opportunity funds are more long-term investors, opportunity investors looking for higher returns but willing to put their capital for a much longer period of time, sovereign wealth nations, and endowments. Those are the traditional investors in those funds. Versus on the short-term securitizations that are now coming to market on the reperformers and nonperformers, those are going to money managers, insurance companies, even banks and REITs. REITs can now get repo financing against those same securities, so you’re now able to borrow at a much lower cost to support the trade and that’s quite frankly, combined with higher confidence in real estate prices, contributed to the dramatic recovery in pricing.
SHARGA: Are you guys seeing any money coming in that normally would have gone to Europe that’s decided the U.S. market is a better hedge?
LEVINE: We’re seeing the same hedge fund clients that sponsored domestic funds are now spending their time in Europe, both on the residential and commercial side. That’s our longer term trend and also our firm’s trend, as we expanded our operations in Europe on the distressed assets side, advisory as well.
DYMI: A report said commercial real estate in the U.S. is attractive to foreign investors. Despite the slow recovery, whatever is happening so far is good enough for them to find it attractive.
SHARGA: The same thing is happening in real estate when you’re talking about the actual assets. We’re seeing a lot of offshore money coming in and buying up U.S. real estate.
LEVINE: The distressed play, the feeling is the U.S. is in the later inning of the game. Europe is in the middle. On the performing side, the foreign investors coming just to invest in performing real estate, for sure. They feel the U.S. economy is recovered, people are filling up office buildings again, they’re willing to expand their manufacturing duties. The canary in the coal mine for me was the day you saw homebuilder prices jump, mortgage insurers be able to reissue capital, and new cranes show up downtown in the condo market.
FOGARTY: I hear a lot of that money is coming up from South America and a lot of it is cash. So, obviously wealthy patrons are wealthy investors. It’s also the only way deals will get done because the banks are asking for 50% to 60% down. Big projects, that’s a lot of money. So you have to bring the cash to the table before they’ll actually do one.
AMBRECHT: In Southeast Florida, that’s a very unique market in its own right, kind of like Manhattan.
FOGARTY: Who are the biggest sellers? Is it commercial banks? Obviously federal agencies would sell the most, but who is leading the private market?
LEVINE: Over the last 18 months, the most frequent sellers and the largest volume sellers have been the money center banks, those with large mortgage operations. These are GSE repurchases or portfolio loans they are clearing the inventories from the 2006-2009 vintage. As of late, HUD has been a very active seller, probably the most active seller of the three agencies to actually execute through their direct assets stabilization program and their neighborhood stabilization program.
FOGARTY: I think they’re in the process right now of selling 20,000 notes. Has this influenced pricing on the private market?
AMBRECHT: It does. We’ve seen a bunch of buyers who were traditionally not interested or willing or able, whatever the scenario was, to play in the private bank world. We’ve now seen cross-over. That’s helped out. Again, the market is that much more liquid with more capital.
LEVINE: It’s been a brilliant move by HUD to sell these properties. They got ahead of the curve because selling the properties is as much a servicing and loss mitigation play for them than anything else. They are now getting the properties into the hands of investors and owners who have more options to refinance, modify or restructure that loan that the HUD-servicing guidelines allow. While they’re monetizing potential loss today versus at the end of the foreclosure cycle, they’re getting better execution in our mind and actually solving some political and social agenda items as well.
FOGARTY: On the HUD note sales, do they have price in mind or do they just want to get it off of their books?
AMBRECHT: I’m sure they have some type of expectation, but ultimately they’ve proven to be sellers and the market is dictating what it is. So it’s a strategic sale in that regard. They’re not acting like a private community bank. They are sellers.
FOGARTY: I think they are going to sell another 20,000 units later this year.
LEVINE: Mark, you touched on something when you mentioned how the FDIC and FSLIC dealt with the asset resolution through previous cycles. FDIC was very innovative over the last five years in creating the current market for purchasing distressed assets.
FOGARTY: From failed banks?
LEVINE: Yes, from failed banks.
FOGARTY: There sure were plenty. To date this year, 16 banks have failed. The market’s getting much better. Last year, it was 150-200.
SHARGA: About the pricing that you were talking about regarding the HUD notes, the market established what the range is for NPL sales right now. It looks like the HUD notes are within that price range. It is definitely not a fire sale. What’s also interesting about a different angle on the HUD sales is that those notes come with stipulations—what you may or may not do with the disposition of that loan for a predetermined period of time. So, these are not notes for every buyer. If you’re model is too quickly dispose of the assets and go through foreclosure, the HUD program is not a good program for you because you’re going to be required to allow the borrower to stay in the property for a certain period of time to look at a loan modification program. There’s a variety of criteria that comes with these things as part of HUD fulfilling its mandate in terms of the housing market and consumer protection. It is a slightly different of flavor of note sale than what we’re seeing on the private side.
AMBRECHT: It seems to be that much more of a transparent sale as well. There are a lot of residential buyers that are very sophisticated and know what they are doing. It’s a transparent sale and they are putting their best foot forward. So when those are the ingredients put on the table, you are going to see pricing that much more transparent as well and you know what the range will be.
FOGARTY: Looking forward, obviously there is distressed real estate in every market, but the kind of bulge we’re seeing now, how long do you think it will take before we see the great majority resolved?
SHARGA: On the residential side, you’re looking at about a two-and-a-half-year window. At that point, it will feel much more like a normal market. That’s based on the notion that we’re going to continue to see below average delinquency numbers for the next couple of years and nothing bad economically happens between now and then. This recovery is solid, but it’s not a bulletproof recovery. It’s stable, but still a lit bit shaky. A bad economic turn could stop everything.
AMBRECHT: A rise in rates might curtail refinancing. If unemployment stays above 7%, you’re just going to have a drawback in the acquisition of homes and that may slow it down.
SHARGA: We’re already seeing refinancing numbers drop through the floor because rates are going up. If you’re sitting on a 5% interest rate and the new rate is 4.2, there’s not a whole lot of incentive to run at refi. Purchase activity is climbing a little bit, but not enough to offset that. Policy changes, what might be going on. Rates will definitely slow things down, but you will see a return of more purchase activity. Not enough quite to offset that refi rate, but certainly more than what we’ve seen over the last few years.
