It's Hard to Gauge Distressed Market

Depending on who you talk to, the secondary market for nonperforming and subperforming mortgages is either alive and well or it's a business where only a handful of deals are getting done - mostly government deals.

One thing's for certain: there's definitely a lot of chatter about what's happening in the marketplace except that no one (except maybe the Federal Deposit Insurance Corp.) wants to go on the record. As one hedge fund investor told me last week: "Who knows what you hear is for real or not? No one knows any more." (And yes, he didn't want to be named.)

We know for a fact that the FDIC recently unloaded a $1.3 billion package of loans (70% performing as of May) to Residential Credit Solution of Texas by letting the bidder lever up 6-to-1 and facilitating the deal by issuing both a note (which the government hopes to sell at some point) and entering into a profit sharing arrangement with the buyer. When all is said and done the government hopes to get back 70 cents on the dollar, which is a heck of a lot better than what nonperforming second-lien portfolios are going for.

For the past three months PNC Financial Services has been trying to sell a $600 million portfolio of nonperforming HELOCs that was originated by National City Mortgage, which the Pittsburgh bank bought late last year. (One source said it's actually $676 million.) PNC won't discuss the deal but bidders who have poked around the portfolio said a winning bidder was picked a few weeks ago.

In general, nonperforming seconds have been selling for pennies on the dollar. (Many of these HELOCs were part of 80-10-10 loan structures, a product that has now evaporated.) A key strategy for NPL buyers is to collect the minimum $1,500 second-lien "release fee" that the first-lien holder must pay in order to foreclose.

Will PNC ever pull the ripcord on the deal? Perhaps. Will we ever find out what it received for the portfolio? Answer: Don't think so.

One of the largest second-lien NPL auctions I've heard about came and went quickly. A large bank was toying with the idea of dumping $1.7 billion in seconds. A few days after we reported on the transaction a broker close to the deal said the seller had backed out. "They're going through the economics of it internally again," he said.

The broker, who did not want to be named, insisted the deal was for real. Others suggested, perhaps, that the size of the offering had been inflated or it was wishful thinking on the part of the firm trying to put it together.

Bidders and brokers alike agree that there's action in the market place - talk of offerings, bid deadlines set, and so on. But the problem is completing the deals.

The FDIC auction - part of its plan to liquidate "legacy" assets at failed banks - was a welcome relief. But some investment bankers insist the only reason the deal was completed is because of the government's involvement. Thanks to guarantees extended by the FDIC, RCS had to put up just $64 million in cash against a pool of assets worth $1.3 billion.

The biggest sticking point to deals getting done without FDIC assistance is the eventual writedown the selling firms will have to take. There's a growing chorus of bidders and investment bankers in the NPL market who believe that liberal of mark-to-market accounting rules promulgated earlier this year have allowed holders of ailing loans to put off the day of reckoning.

The only somewhat large (non-FDIC) NPL deal completed was the recent sale of $300 million in nonperforming mortgages by Wells Fargo & Co. to a hedge fund called Arch Bay Capital. None of the parties involved would confirm or deny the sale though it appears it did, in fact, happen. (The package included nonperforming subprime loans that Wells inherited via Wachovia.)

Arch Bay reportedly paid 35cents on the dollar for an NPL pool that some said was worth 20 cents, at best. "The problem with that transaction," said one West Coast-based bidder, is "that every seller will look at that deal and think their stuff is worth more which means unless they get their price they won't sell. Nothing is going to move unless we get past that mentality."

Paul Muolo can be e-mailed at Paul.Muolo@SourceMedia.com.