It seemed like a sure bet: with the nation’s banks and securities firms saddled with hundreds of billions of dollars in delinquent loans, a fortune might be made by bottom fishing for these assets. After all, desperate sellers might be willing to get out from underneath their toxic mortgages at any price. Right?
Not exactly. Four years after the mortgage and housing markets crashed in earnest, it appears that not only are banks and securities firms in no hurry to unload their nonperforming mortgages—at least in any discernible way—it looks like few vulture funds are thriving.
In fact, some have gone out of business or returned their seed money to investors because they felt the returns—in the high single digits—aren’t worth it.
To executives who play in the NPL space the story is all too familiar: banks won’t sell cheap enough because new mark-to-market accounting rules allow them to treat nonperformers liberally, which makes it easier to hold troubled assets. In short, the great fire sale of toxic loans has yet to occur with only a handful of large banks even admitting that they’re even selling.
This select group of sellers includes Ally Financial, Citigroup, JPMorgan Chase and Wells Fargo.
As for the actual buyers, obtaining detailed sale information—as I’ve noted in this column before—is difficult, to say the least. Most buyers of NPLs, with the exception of the publicly traded PennyMac, are private hedge funds, who are under no pressure to admit anything. Last week, for instance, when rumors began to mount that Arch Bay Capital, Irvine, Calif., might be for sale, the company did not return phone calls. When a story finally appeared in print on the National Mortgage News website Arch Bay general counsel Gene Clark would only say that “we’re not being sold” but refused to answer questions whether an offering book had been issued on the firm.
One investment banker and two other sources confirmed that an offering book had, in fact, been issued. But why would Arch Bay want to exit if the prospects for NPLs still look good?
No one is suggesting that Arch Bay is in trouble, but at least two other NPL firms are facing challenges, including Kondaur Capital of Orange, Calif., and G8 Capital of Ladera Ranch, Calif. Until a big layoff earlier this year, Kondaur was cash flow negative and then last month dismissed its CEO, Jon Daurio, without saying why. (The firm’s backers, sources said, are unhappy with its returns.)
G8’s chief acquisition officer, Daryl Schwartz, recently resigned but declined to say why. However, he hinted that the firm—a buyer of both residential and commercial NPLs—“has some challenges ahead of them.” G8 executive Kurt Mullen did not return telephone calls about the matter.
Jeff Freud, who runs LoanMarket.net, a loan auction website, believes he knows why many NPL firms are struggling. “It’s all about the 'tail,’” he said, explaining that the “tail” represents NPL loans bought in the secondary market that are hard to get rid of.
He and others note that when an NPL portfolio is bought by an investor, 60% to 70% of the notes might easily be disposed of—and at a decent profit. But it’s the more toxic loans—the ones that cannot be flipped or easily cured—that drag down or erase the profits on what Freud calls “the low hanging fruit.” The tail, Freud explained, “means you can’t sell it at a profit.”
But are firms like Kondaur, G8 and Arch Bay being hurt by the “tail”? No one knows for sure since they won’t discuss their returns. In the mean time, the nation’s most well-known NPL firm, PennyMac, is downplaying the fact that it’s a vulture fund and is now actively originating mortgages. “When you write about us, refer to us an opportunity fund,” a company spokesman said.
