Non performing notes and the unique opportunity for the smaller investor

non-performing-loansThe non-performing note market is not even close to drying up. In fact, another billion dollars’ worth at a time keeps hitting the market over and over again (several times per year), and in 2015 alone, banks and GSEs such as Fannie Mae and Freddie Mac sold off $13 billion of the stuff. In the wake of the financial crisis and its far-reaching tentacles, hedge funds and private equity firms who buy directly from these sources have purchased approximately $147 billion in non-performing loans. They, in turn, then resell pools of these loans to mid-size firms who, in turn, resell again to smaller firms. (This is going to be going on for quite some time yet– at least another 5-7 years– because banks cannot afford to keep these bad loans on their books as per provisions of Dodd-Frank which impose severe penalties on banks whenever their holdings exceed 7% delinquent debt.)

The unique opportunities for the smaller investor are in the loans these firms don’t want, which are contained within these larger pools they’ve bought. Because they have to buy the whole “package” of loans as part of the deal (they have to take all or nothing) at the time they acquire these portfolios, there are always loans within the package that they don’t want and/or just don’t have a tolerance for. So, then they “carve off” and sell these loans in smaller lots and that’s where the unique opportunity is for you and me.

You can carve your own niche by focusing on these types of loans (the “don’t wanters” from the large equity firms)– which usually call for “specialty workout situations”– and then crafting solutions that can get the note re-performing. You have a lot of room to work here budget-wise because you are buying at such a steep discount (somewhere around 30-50 cents on the dollar is the current range) so you can do things like use your specialized knowledge to get certain liens or encumbrances removed, reduce the mortgagor’s payments to something they can afford (called a loan modification) and/or even offer to reduce their principal balance to get them paying again (people who have “emotional equity” in the property having lived there a long time are oftentimes amenable to these kinds of workouts) and still turn a sizable profit because you acquired the loan so cheaply. If all else fails, you can foreclose (alternatively you might negotiate for a deed in lieu) or evict, depending on the situation, acquire the property and sell it off at a substantial profit. This is all very doable because you did your homework on the front end of the transaction and ran all of the numbers accordingly.

If you so choose, you can then sell the re-performing note to an investor at perhaps somewhere around 65 cents on the dollar and it would still be a win-win all because you bought at such a steep discount and architect-ed the deal.

Another possibility is that you could hold on to the re-performing note and if the payments are steady for a couple of years, you now have a “seasoned” performing note which you could either keep or resell  at somewhere around 80 cents on the dollar.

I’m just scratching the surface here, just trying to give you a glimpse of the nature of the non-performing note market and the tremendous profit potential therein for people with specialized knowledge. If you’re interested in working this market, the rewards are enormous but I would get started now. With distressed property sales now down to just 9% of all homes sold, the REO market has effectively dried up and notes are the new way to acquire bargain properties because, generally speaking, banks don’t foreclose anymore because they are overwhelmed with bad loans and by governmental stipulation they must divest themselves of these toxic assets quickly, so they sell off these large pools to the hedge funds.

Again, the window is perhaps 5-7 years out, so now is the opportunity of a lifetime for the deal architect. That can be you if you know what you’re doing, but it’s going to take some time to get up to speed if you’re starting from scratch so you will need to start now if you haven’t already. If you want to get serious about pursuing this market, you may want to check this out.

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