December 17, 2010, Reuters
Trading in toxic mortgage loans will likely jump in 2011 as more banks unload the assets, with large investors such as The Carlyle Group joining others already entrenched in the market, investor sources said.
Industry chatter has volumes nearly doubling in 2011 to about $20 billion, according to Jason Kopcak, head of whole loan trading in New York at Cantor Fitzgerald, which brokers the sales of distressed assets.
"We’re starting to see some larger packages come out," said David Spector, chief investment officer at PennyMac Mortgage Investment Trust (PMT.N: Quote, Profile, Research, Stock Buzz), the Calabasas, California, firm run by former Countrywide Financial President Stanford Kurland.
This trend will last for at least 18 months, said Spector, adding: "I just see a large amount on bank balance sheets and it will take a while to work through that inventory."
While volumes represent a fraction of the 5 million of troubled home loans, a pickup would be a meaningful step in resolution of the housing crisis, analysts say. As sellers offer steep discounts and the loans are not tied up in bonds, buyers say they have greater flexibility for work-outs such as short sales or deeds-in-lieu of foreclosure, or to foreclose.
Their risk is paying too much in a market where foreclosures are depressing prices and carrying costs erode margins. The assets are illiquid and could lose value quickly if the market takes an unexpected turn.
But with a housing bottom in sight, opportunities are attracting new players to the "non-performing loan" market dominated by a few investors, which include Arch Bay Capital and Kondaur Capital.
Private equity firm Carlyle Group has recently shown its hand in funding trades, or bidding directly, two sources said. Another noted the market is abuzz about the entry of bond fund giant Pacific Investment Management Co.
DoubleLine LLC, the firm started by mortgage veteran Jeffrey Gundlach, is considering such investments next year if more sellers step in at reasonable levels. "That will become more common in 2011," he said on a conference call from the firm’s Los Angeles headquarters this week.
Having stabilized capital after the financial crisis, banks are in better position to accept the distressed prices that investors are willing to pay, Kopcak said. Prices are "far superior" than they were in 2009, but well off June’s peaks — at 70 percent of a property’s current value — in anticipation of some home price drops and more selling in 2011, he said.
Now at about 64 percent of current value, prices could fall toward 60 percent, Kopcak said.
Among banks expected to ramp up sales are Bank of America Corp (BAC.N: Quote, Profile, Research, Stock Buzz) and JPMorgan Chase & Co (JPM.N: Quote, Profile, Research, Stock Buzz), said Kopcak, who added that it is "well-known" that the former recently tested the waters with $1 billion of distressed assets.
"They are obviously getting ready to start selling," he said. "And we’re seeing a lot of super-regionals getting ready to sell, as well."
Spokesmen at Carlyle, Pimco, Bank of America and JPMorgan declined to comment on purchase plans or asset sales.
Citigroup Inc (C.N: Quote, Profile, Research, Stock Buzz) and Wells Fargo & Co (WFC.N: Quote, Profile, Research, Stock Buzz) have been active sellers in 2010, when $10 billion to $12 billion of non-performing residential loans have traded, Kopcak said.
Smaller buyers, such as hedge funds that control between $2 billion and $7 billion in assets, are starting to compete with larger firms.
The resumption of foreclosures after discovery of legal processing errors at mortgage servicers — which added costly delays for investors — will also improve demand, Kopcak said.
Investors profit by either selling a foreclosed property or bringing the borrower current on payments. Given the low prices on the loans, investors can accept short sales whose proceeds don’t cover existing liens and still profit.
Some loans will be fixed and resold, marking a rebirth of the re-performing loan market, PennyMac’s Spector said.
For Kopcak, growth in distressed loan trading signifies a far more orderly mortgage market than the one in disarray at the peak of the financial crisis. The same is also happening with commercial real estate loans, where trading in small pools has picked up this quarter, he said.
"This industry has evolved dramatically from three years ago," he said.