Loan Mods: Check Licenses
As every mortgage banker knows, it takes a license to lend in a state, any state. But what if your firm only services loans? Does it need a license? And what if you happen to manage one of the dozens of new vulture funds popping up to buy delinquent and subperforming mortgages - if you purchase a loan and then modify it, does that count as an origination and if it does, do you need a license?
Welcome to the new reality that loan modification firms and investors in nonperforming loans are facing. After two weeks of interviewing players in the NPL market the consensus seems to be that roughly 20 states require mortgage firms to carry a license of some sort if they're engaged in the monthly practice of collecting (or trying to collect) loan payments.
"It all depends on where your loans are," said George Ostendorf, a former executive at Hanover Capital, Chicago, who now plies his skills in the NPL market. "It's a real gray area. Some firms might be exempt if they have a relationship with a servicer. And some states are ambiguous." But the servicing piece of the puzzle may not be the real problem for vulture funds. As Mr. Ostendorf noted, the issue is more philosophical: "If you attempt to restructure a loan it can be argued [by the states] that it's an origination, a new loan." And if it is a new loan that means the NPL investor (vulture fund, whatever you want to call it) needs an origination license.
Jon Daurio, CEO of Kondaur Capital, an NPL investor based in Irvine, Calif., recently found his firm on the wrong end of a cease-and-desist order in Georgia for engaging in what the state called "mortgage broker/lending activities." Kondaur wasn't funding loans there but it had purchased some NPLs in the Peach State.
Kondaur, noted Mr. Daurio, is licensed to service in "all states - except Georgia." Kondaur, though, didn't have an origination license either. Hence, its problems and the C&D order. But Mr. Daurio - who cut his teeth on the subprime industry of yesteryear (the B&C niche that existed prior to the Wall Street-fueled debacle the nation is now dealing with) - has learned his lesson. Kondaur is in the process of getting licenses to lend in all 50 states.
What's at stake for Kondaur? Mr. Daurio estimates that there are 10 million "scratch and dent" loans that are available for purchase, that is, if only some of the sellers would be willing to part with mortgages at a price Kondaur wants to pay.
Currently, Kondaur has 2,000 whole loans in its portfolio. With backing from hedge fund Pequot Capital, Kondaur has the capacity to hold 10,000 loans, which (depending on the average note size) could total $1 billion. (Mr. Daurio noted that even though Pequot is shutting down some of its funds, Kondaur's investment money is secure.)
But, getting back to the issue of licenses - without the proper approvals an NPL investor can find itself in hot water with the states. In its recent IPO filing vulture fund, PennyMac of Calabasas, Calif., recognizes the issue, telling investors that its failure to obtain the necessary "licenses promptly or our failure to satisfy the various requirements or to maintain them over time will restrict our direct business activities."
One way to get around the licensing problem is to use a subservicer but not all NPL investors want to do that especially in a business where they're seeking high returns by purchasing notes on the cheap, cleaning them up (either through modification or foreclosure) and then selling them into the secondary market or maybe even through securitization (if that business ever returns).
But the key to licensing is passing the appropriate background checks and then obtaining bonding from an insurance firm that writes such coverage. And therein lies the problem, several NPL investors told me. In the old days, prior to the nation's financial meltdown, a $100,000 bond could be easily obtained by a company making a 10% downpayment and carrying a note for the balance. But several bond insurers - including American International Group - have stopped writing coverage or greatly reduced their business. "That means I have to put up the full $100,000," said Mr. Daurio.
Thanks to seed money provided by Pequot (the subject of an SEC probe), Kondaur can afford the barrier-to-entry. Smaller players may not. For now, one of the biggest problems facing the NPL sector is the unwillingness of sellers to let go of product at a price firms like Kondaur find desirable. "Right now we're in a bit of a trough," said the Kondaur chief. "No billion-dollar portfolios are changing hands but we're looking at several smaller portfolios." And you can guarantee that after what happened in Georgia, Kondaur has its licensing in order.
Paul Muolo can be e-mailed at Paul.Muolo@SourceMedia.com.