Discount Assets Come with Coupons

JAN 15, 2013 2:56pm ET

WE’RE HEARING…it’s becoming clear that investments based on the backlog of discount assets won’t last forever and investors need to be prepared for it.

In the interim, though, there is still money to be made in this area.

Carrington Mortgage Holdings executives Rick Sharga and Wes Iseley tell me that while distressed loans are going to be on the radar for some time, it’s no secret that many servicing players who have been doing more specialized work have been positioning themselves for an eventual return to a more balanced market. They might be doing this by also running a more traditional servicing operation, an origination arm, or both.

But let’s not get ahead of ourselves. Before servicing work stabilizes, it still has at least one good surge ahead of it.

In fact, the Carrington executives tell me that while they can keep up with demand now, it could still grow to the point where they can’t. With the market for large mortgage servicing rights pools heating up, work levels could reach a point where providers are completely booked.

Because the barriers of entry are high they do not believe a lot of new players will enter the space this year, but they do believe the situation could spur some purchasing of existing shops.

Another investment activity expected to persist for a little while lies in underwater performing loans that can be bought at a discount, according to Bayard Closser, president of a closed-end fund investing in whole loans of this type.

Closser tells me the market still looks good for a deep discount buyer of whole mortgages and, based on inventory, there are another three to five years ahead during which to acquire assets. He tells me the market is benefiting from the “Goldilocks effect” in which it is recovering, but still running at a pace where sales are taking place at a deep discount. This makes it “just right.”

But he acknowledges the opportunity will not last forever, which is why the fund has a closed-end structure to protect investors.

“We think that we’ll have a window to operate in,” he said. “We can’t really forecast this type of return, but we believe the dividend will grow and continue to be accretive.”

The fund outperformed its benchmark during the past year, when it generated a return of 12.95% (or 7.91% after the fund’s 4.5% maximum sales charge) compared to 2.59% on its benchmark, the Barclays U.S. mortgage-backed securities index.  It returned a 4.01% annualized dividend at yearend (3.45% after the sales charge).

Bonnie Sinnock is managing editor of National Mortgage News and editor of Origination News. She has been covering the mortgage industry since 1995.

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