Liquidity, compliance, transparency and leverage drive mortgage whole loan trading to higher volumes in 2013 into 2014 and beyond.
David LeBlanc, Managing Director at DebtX, joins the broadcast to discuss whole loan trading trends.
Welcome to Mortgage Market Today. My name is Louis Amaya. Today is February 24, 2014. According to a recent Bloomberg article institutional investors that have historically been focused on purchasing real estate have shown a greater appetite for non performing loans in recent months. The decreasing margins in real estate acquisitions have moved firms such as Starwood Waypoint and Altisource Residential to purchase hundreds of millions of dollars worth of nonperforming loans in 2013. Loans sales are expected to increase the share as a result of new regulations forcing depository institutions to shed their bad loans to avoid increased holding cost and reserves. According to a recent mortgage banker's association report, there are still 2.2 million loans that are 90 days plus delinquent or in foreclosure.
Joining in for the broadcast today to discuss whole loan sales is David LeBlanc, managing director of capital markets at DebtX. David is responsible for market capital sales and other strategic corporative initiatives. David has a established extensive relationships throughout the secondary market including commercial and investment banks, hedge funds, opportunity funds and other institutional investors. David has priced and placed over 8 billion in distressed and performing commercial and residential real estate in corporate debt in the secondary market. Whole loan sales up next on Mortgage Market Today.
David thanks for taking the time to participate in the broadcast.
Hey, good morning! Thank you for having me Louis.
Before we get started in the specific questions regarding whole loans and NPL trades, why don't you gave us a brief explanation of what and who DebtX is?
Sure, sure. I think that the best to think about this, probably as a market place for commercial and residential whole loans. So no hard assets, no commercial real estate, no residential real estate, only financial instruments primarily commercial and residential whole loans. So if you think of it, think of it like this, on one side, we have the financial institutions that are looking for liquidity for their positions along with highest price and then on the other side of the trade, we have the institutions, the funds, the banks, the opportunity funds, the hedge funds and the like that are trying to acquire assets. We operate globally. The US is the biggest market but we also have presence in Europe, Latin and South America, Asia and also Mexico.
Interesting. I am sorry. Go ahead.
Nope, go ahead.
I was, you know, the whole market has been, you know, I would call variable in the last few years in the sense that we have seen the market grow and then shrink and grow. There has been a lot of activity in 2013 particularly as a result, I think of some of the regulations coming down for the institutional depository holders level servicing. So what have you seen, the whole long market due in the last few months or the 2013.
Well, I think the residential market is just now starting to blossom. So the commercial market, a couple of years ago, really exploded with the predominantly government activity. This goes back to say 2008, 2009, 2010. And as the government activity started to fade, the private market activities started to expand. I think that the residential sector is probably a few years behind the commercial sector and you may be right. It may be partially because of some things that are going at the government level but certainly last year in the residential, speaking of residential whole loans alone, last year was the busiest in recent memory. I think this year is probably going to be even busier. Last year was driven, I think predominantly by government activity but I think that the government activity is going to be overshadowed this year by the private market activity.
That is interesting so as far as the changes you have seen from last year, is there anything else other than more institutional sellers versus government sellers?
Well I think the market can be characterized probably by three things. One is liquidity. Two, transaction velocity and then three, pricing. In terms of liquidity, the market is as liquid as it has ever been. So just in the last couple years, not only do we have billions and billions of dollars of equity capital that has been raised, but financing for these participants is easier than it has been since the crisis. So you have billions of equity capital that has been raised, easier access to leverage and that tends to impact prices. So over the last year, I was thinking increasing prices, increasing access to capital, increasing access to leverage, and increasing transparency which is frankly driving transaction volume.
When you think transparency, what exactly do you mean?
Well for market players, it is easier than ever today, to -- how do I say this? There is more transparency in the market today than there has ever been, particularly on a residential sector. So for example, we have a pricing and analytics group along with the trading group and we see so many transactions, kind of on a daily, weekly, monthly basis. We can tell you where product is going to trade. It was not so long ago where transactions were so few and far between, if there was a portfolio on the market, you did not really have a lot clarity the way that portfolio would clear. That is not the case today, there is very good data available to market participants. Some, they have to pay for other information as available for nothing. That gives you a really good sense of where these portfolios are going to clear. I think that this additional transparency gives market players comfort, more comfort certainly, than a few years ago and more comfort in the market gives you confidence to transact.
Got it. So what is the size of the market? What was it in 2013? I know 2013 was larger than 2012, but can you give us a sense of what 2012, '13 and what you anticipate '14 be?
Oh boy! That is a really good question. Residential only, I would put the number somewhere between 40 and 50 billion and I think if I am off and I am probably low. Last year, maybe 30. The year before that, I could __07:52__ some numbers below that but I could not really __07:55__. That is residential only. I think the commercial market probably peaked a couple of years ago and this is trailing down.
And who are the buyers and sellers that are most active and also if you can tell us, is there room for the smaller investor, someone who maybe just has $20 to $50 million to play in this space?
That is really a good question. In terms of the sellers, I think the largest seller of residential whole loans is the FHA and then we are talking about probably the top 10 banks. Those two categories are by far the largest. We do a lot of transactions with smaller banks. Those transactions tend to be lot smaller, the numbers are a little bit higher, but overall, it does not catch up with the volume of say FHA and the top say 10 banks. On the bright side, the largest institutional financial players in the world of the large hedge funds. Some of the large banks have propriety capital desks, some of the large private equity firms have allocated capital base. I think when you start getting into smaller bounces say funds with 5 to 50 to 100 million under management, they have a difficult time participating in the primary sales. The primary sales tend to be say 100 million plus, where we see those parties participating in the secondary sales, which is another area of the market that started to accelerate, so just to give you -- for example, if fund A picks up the portfolio of 500 million, they may have exit strategies already in place for a good portion of that, but one of the parts of the market that is starting to emerge is the secondary trading. So that 500 million may not necessarily find a permanent home. They may turn around and flip out small pieces of that to smaller funds and they may flip out performing portions of that to banks and the like. So we are seeing this secondary, secondary market developed as more and more players are starting to get interested in the space. And that is, I think where the smaller fund tends to participate.
Interesting. And do you handle those smaller trades on DebtX or do you primarily just work with the larger players?
Generally, the larger players -- or the answer to the question is yes. Generally, the larger player is on the sell side and the smaller player is on the buy side.
Got it. So how large are some of the trades that you have seen in the last few months? We hear deals in the marketplace and we hear rumors, some fairly sizable trades have gone down. Can you give any color on those size?
Those are certainly are the headline grabbers and if they get larger, they get more headlines. So the very large of the large can be anywhere between let us say a 100 million is small in the residential world, so 500 million plus. Generally, those trades are institution to institution. They get some headlines, they become, they are going to be more common this year and then as the large positions are traded, they will probably trail off a little bit. The positions that we are most actively involved in are called at the 50 million, the secondary of the secondary trades where you have a large fund or a large bank on one side and they are peeling off a small portion of the portfolio and selling it to a smaller fund and it could be reasons like profit-taking, it could be reasons like capital allocation, it could be reasons like they wanted to tighten up the geographic focus. Really anyone of those but you are actually right that tends to be a market that is more active for us. I would say for your listeners out there, it really is in a moment pop business. It is not like the Brix and Mortar real estate where you buy one property or two properties and really bootstrap up from nothing, it really is a marketplace where 99.9% of the participants are, they are all accredited investors and most you would deemed to be institutional investors and it is just a question of size. So in this market say at 10 million or 15 or 20 million dollar fund would be deemed small, but certainly not mom-and-pop by any stretch of imagination.
You know, I have mentioned into an article that came out last week, I think Friday last week, Bloomberg mentioning that a lot of the funds that initially have raised capital and above a lot of real estate are moving towards the acquisition of NPLs to acquire real estate now because the market real estates has gotten so tight and the margins have shrunk with so much competition and you know, we have always spoken to investors and told them, hey if you want real estate, buy an NPL and roll it. Are you seeing a lot of those players that historically purchased real estates and now buying NPLs to make that real estate play?
Absolutely. The only difference I would say is that they have actually been in the market since most of them have actually been in the market for a few years. That the new participants are the financial buyers migrating into the space in just in search of deal, but you are 100% correct. Anybody that is large in the commercial real estates based or in the residential space is at least dipping a toe into the NPL market. I think the only difference is that today's headline, it might actually be about somebody that has got probably more experience and is not really a new entrant, they have actually been around for a while, they just have not been involved in anything that grabs the headlines. But you are absolutely right, the crossover buyer becomes more active in the space as the pricing of commercial real estate goes up or as access to financing improves or any number of other factors.
Do you see any risk in larger institutions or avoidance of institutional sellers namely money centre banks where they are very tied in with the government in selling to funds who are trying to convert the loan to real estate. I guess the question is, do you see any avoidance of sellers at this point say, there is too much risk in selling a loan to someone who just wants the real estate does not really want to work with the borrower.
No, as a matter of fact, I think that the sell siders are realizing that now is the time to sell. The sell siders are realizing the price has never been higher, that access to financing for the buy sides is strong expense since the crisis. Now, if you are a seller, now is time to sell. I think that it is a little bit of a common misconception is that somebody that buys residential whole loans will automatically go after the real estate, I think that if you talk to 10 folks, they will probably give you 10 different strategies but I think as many times as not the strategy is to convert a nonperforming loan into a performing loan and frankly we see it all the time because one of the resells that we do for the larger institution are loans that two years ago were nonperforming. They are now performing and I can sell them at 25 point profit.
Interesting, you always hear this rumours going around that there is certain avoidance but at the end of the day, I think even with that the FHA sales, price seems to be king. Would you agree with that statement?
I think price is critically important. I think that liquidity and transparency are right up there as well. I think that whenever you have liquidity and transparency, you can give a seller comfort and a market price and I think that is what we are seeing today, but it certainly starts with price.
So what are the pricing ranges for a distressed loan and as well as the performance. I know there is a lot of trading on the performance side as you mentioned. Where do you see these prices come in these days?
Well, that is a really good question and I guess it is sort of like it is said, well how much does car cost? And then you launch into these, the 30 questions about, you know tell me about the car first and that is kind of how I going to have to answer this because different loans have had different characteristics. So let us say that, the most important characteristic is collateral value and loans today are trading tighter to collateral value than we have seen since the crisis and then there is secondary factors that are also important geography, borrow status and the like, but I think of it as heavily driven by the underlying collateral value and trading very, very tight to that underlying collateral value.
So you know as would expected, okay there is percent of underlying collateral value, NPL survey in the 60% to 80% obviously, it is region and value bucket driven, but where do you see some of this trade?
Yes, yes, yes and yes. And in some cases significantly, your range is very accurate, a little bit low in some cases, but you are absolutely right. It depends on the region, it depends on a whole bunch of characteristics, but yes absolutely and in many cases, north of what you have described.
You know one of the states that is always interesting is in California. I am in San Diego and real estate values have just came screaming back over the last couple of years. We have seen default timelines in the state, extended out dramatically with the implementation of the homeowner bill of rights, however, I do not really see that impacting or I do not know, I guess the question to you, do you see that impacting whole loan sell prices in California? To someone I have seen it really does not seem to bother investors. They are just locked in on what the values are going to be doing over the course of next number of years. Have you seen and then with other states too, the extended timelines, to move up for closure to the default process along to the default process. Have you seen that impact pricing?
Well if it is impacted, it has only gone up. And I think it is more of a function of kind of globally what we are seeing and how that impacts, how an investor looks at a particular state versus another state. You bring up some excellent points. It is conversations that were certainly a part of any trade, but generally speaking we have seen prices increased, call it 10 to 15 points over the last year or so. So I think as you have got these states specific, I am not going to call them issues, I will call them things to think about as you are doing your acquisition analysis, there is an overriding assumption that property values have and will continue to increase, it is driving pricing. Does it makes sense?
You know I totally agree. On the real estate side, I know with institutional sellers, auction has really grown over the past two to three years and I am talking individual auctions like auction.com type of format.
Where they are selling real estate one off. But does that model work for loans and I am guessing they probably does not because of the type of investor that you have to have. You know, you have be a more sophisticated investor to purchase loans than real estate how I imagined not specificated, but there is a whole different infrastructure required and generally they have been bulk. But do you see this auctions sites making in roads into selling one off notes?
I tried to think how best to answer. The shortest answer to that is no. The short answer is that if it was a good model, it would have taken off the same way that it took off for RAL and we just have not seen that. We see trades from time to time, but not enough volume to suggest okay this is the viable model moving forward. I think if it where we would have seen that part of the market take off like we have seen it do with RAL and on the RAL side, I guess it is sort of, you know, some people would tell you it is great and other people will tell you that the notes rate is too high.
We have seen values increased pick on Michigan now. So we have seen values increase over the last 12 months, it is definitely in Michigan and there seems to be a lot of investors, small investors, that are focused on the first main type of loan products and as a result, we have seen that the values increased, I think. Have you seen any sellers selling redemption paper in a big way? You know selling the rights to the __22:23__ speed that for the foreclosures seller, it is a paper trade, but basically, the buyer just hold on to that redemption and waits for it to convert to real estate. Are you seeing any of those types of trades?
Not in any sizable volume, let us say that. You hear about them from time to time, but frankly not enough to create a huge bleep on our radar. Does that make sense?
Yup, what is your most popular product that you sell through DebtX?
Oh geez, right now frankly it is anything with cash flow. Anything with cash flow followed with closed second by anything that is a quality asset in a recovering market and that would be performing commercial real estate that would be quality single family real estate loans in a recovering market, anything where investors think that they can monetized in a fairly short basis. Most of the time, access to financing is a little bit easier with those types of characteristics as well which would help with the pricing and yield requirements.
Are the messrs who are buying cash flowing assets, are they buying for hold? I mean are they going to hold it indefinitely just planning for the cash flow? Or they planning on liquidating, I mean what is the exit strategy for some of these buyers?
That is really a good question. On the performing side, it really depends, we sold a lot of banks. This market used to be, the trade was a bank on one side and a hedge fund or an opportunity fund or a vulture fund on the other. And the way the market works today is that you might have a bank on one side, an opportunity fund in the middle and then two years later, a bank on the other side. So the opportunity fund holds the asset. The price is good, the asset values go down, borrower defaults, asset values go up, hedge fund reworks the paper, holds it for a year for some season and then sells it to a bank. In that particular case, there might hold to maturity for the bank. If it is a performing fund, buying the paper, it might be a two-year hold and then they sell to somebody else. So the market has changed from predominantly a buy and hold and figure out what to do with the real estate, if you have to foreclose two more of the trading market.
where I can foreclose, I can modify, I can hold for some cash flow or I can hold for some cash flow and two years from now, sell it to somebody else if I so choose.
Are you seeing more nonprofits participate in the acquisition of whole loans?
From time to time, it is very, very, very portfolio-specific and from time to time, yes we do see that.
So what about commercial real estate in performing. Let us touch on that a little bit. You have mentioned that the commercial market really peaked a couple of years ago as far as the stress. I believed that the stress, NPL trades, how do you see the residential marring that process and for how many years out?
That is a really good question. If I could forecast that, I get lot of people who want to talk to me. So to clarify, the commercial side a couple of years ago, it maybe last year as well, we saw some really, really large trades. At the end of 2013, there is a large trade or two but buying large, the definition of large has become smaller, as institutions start to rid themselves of their problems. On the residential side, I think for various reasons, the market has lagged a little bit, so last year was really the first year when you saw billions and billions coming out of a particular seller or two and 2014 is really starting the same way, if you have insight into the sales or in market for example right now, then probably half a dozen to 10 or 12 very large residential sales going on as we speak. Large sales meaning, 100 million to a billion plus, right, and you would not have seen that a couple of years ago. So I think what will happen is that we will have a year or two of that sort of activity and then slowly but surely, the definition of large will begin to shrink. So if large today is a billion, next year, it would be 500 million, and a year after that, it will be 250 million and so on and so forth. In terms of actual numbers, it is really hard to tell. I think I am at 40 to 50 this year. If I am wrong, I am probably low. Next year, maybe about the same. A little hard to tell though.
And what is the, I am going to guess that it is pretty high with the demand for a product right now and you have mentioned that a lot of money has been raised.
From top. It really is. It is off the charts of the whole. We do a lot of trades and I sit around with the traders and we talked about both side of the market. The product that is coming on the market in a particular time frame and the demand, to try to get a sense of the relative supply demands and they are always parts of the year where you kind of worry. There lots of products on the market. You kind of get concerned whether or not the demand will be there and I will tell you that we have not seen anything close to supply, to satiate the market for at least the last 18 months. It is 100% sell side constraint market right now. It is a seller's market. I think that the acceleration of some of the sales that you are seeing here in the fourth quarter of 2014 tells me that many of the sell siders recognized that it is a seller's market.
And do you think in 2014, you have mentioned, will not be the biggest seller in 2014 like 2013.
No. I think the private side will. It will be closed and this is just a forecast, a guess, I guess. I think that there will big seller but it think the private sellers will be a little bit more.
We are just about out of time, but I would like to ask anything, any insight or forecast for 2014 that you would like to provide to the audience that we have not already discussed.
I think it is going to be continuation of the trends. I think it is a great place to be. I think that buyers are going to see plenty of products. I do think it is a sellers market. That said, I think that focus of allocating capital base or getting solid risk adjusted returns. I think we are going to see a continuation of the first quarter which is more and more product and it is a great time to be in the space.
Excellent. David, thank you so much for participating. Wealth of information and very insightful, so thank you for the time.
Well thanks for having me Louis.
Alright, we will talk to you soon. Bye, bye. That is it for this broadcast. This year's attendance to the 5 Star's Government Forum, more critical than ever on March 25, leaders in the housing and mortgage servicing industry will engage with government officials and regulators in a meaningful discussions on housing and mortgage policy. Again, that is on March 25th in Washington D.C. Mortgage Market Today is on the web, via LinkedIn and Twitter. Please subscribe via iTunes for quick and easy download and listening. Today's show was sponsored by iServe Companies. We will talk to you next time.
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