Buyers are finally taking a shine to "scratch-and-dent" loans and other nonperforming residential real estate assets, with sellers at long last happy to accommodate them.
Several major banks, including Citigroup Inc., GMAC Inc. and Wells Fargo & Co. have sold portfolios of nonperforming residential loans in the past three months, according to numerous buyers and companies that facilitate loan sales.
"Banks are aggressively attacking nonperforming assets," said David Tobin, a principal at Mission Capital Advisors LLC, a New York investment bank that is one of five advisers on loan sales to the Federal Deposit Insurance Corp.
"Prices are more realistic, buyers are more comfortable and the discount that existed last year because of the liquidity crisis is gone."
To be sure, the government's announcement Friday of major changes to its Home Affordable Modification Program could have an adverse effect on pricing if buyers are somehow forced to offer modifications, extended foreclosure time lines or otherwise are restricted in liquidating properties, said Derek Katz, a managing director at Mountain View Capital Group LLC, a Denver hedge fund.
Wells Fargo has no plans to sell Hamp loans. Teri Schrettenbrunner, a Wells Fargo spokeswoman, said the bank has only sold nonperforming loans that are 120 days past due and where the borrower either could not be reached or opted not to work with Wells on a loan modification.
GMAC declined to comment for this story. Citigroup did not return calls seeking comment.
Banks that have been recapitalized through the government's Troubled Asset Relief Program are selling off legacy loans with the intent of rebuilding their mortgage businesses with a cleaner slate. Though the government originally had planned to buy up illiquid assets from financial companies, banks had been loath to sell at huge discounts.
But sitting on nonperforming loans has strained banks' balance sheets, restricting lending. And many banks have put aside reserves over the past six quarters to mark down assets to prices where they could finally be cleared.
Jon Daurio, the chairman and chief executive of Kondaur Capital Corp., a Santa Ana, Calif., investment firm that buys mortgages, said banks have recognized enough income in the past year that they are now more comfortable taking haircuts on loan sales.
"They can now afford to take the capital hit," he said. "The government has taken steps to delay the true marking-to-market of loans in their inventory, and now when they sell, they can afford to take the loss."
The market for distressed loans covers a wide spectrum of mortgages, from performing loans that may have underwriting glitches and been repurchased from Fannie Mae or Freddie Mac, to loans where the borrower has defaulted. Many investors who bought assets from 2005 to 2008 got burned and were unable to sell.
The market for scratch-and-dent loans themselves is opaque because banks and other financial institutions do not want to "air their dirty laundry," Tobin said. "Nobody wants to see their underwear hanging on the clothesline."
Scott Everett, the president of Supreme Lending, a Dallas mortgage bank, said he was "stunned" when he recently sold a scratch-and-dent loan for 85 cents on the dollar — he estimated that it would have fetched 30 cents a year ago.
"It wasn't that the loan was any worse but rather that the market didn't want that type of loan," Everett said.
Prices vary depending on several characteristics, including year of origination (2007 was the worst vintage), location and borrower.
As bids for performing loans come in at 75 cents to 82 cents on the dollar, up from 55 cents to 65 cents a year ago, nonperforming first-lien assets are trading at 60 cents to 70 cents on the dollar versus as low as 35 cents to 40 cents a year ago.
"We've finally gotten to the point where sellers are getting optimal value, and the buy side has the opportunity to make strong returns," Katz said.
Some buyers have incentives beyond "buy low, sell high."
Many private-equity and hedge funds were formed last year to take part in the Public-Private Investment Program,, which was supposed to have involved the government in providing liquidity to facilitate toxic-asset sales.
And special servicers need to buy bad loans to feed their shops.
Other buyers are banks trading the toxic loans they originated to buy more recent loans.
"The loans written since 2009 have been really clean loans, so banks are cleaning up their bad debt and buying performing," Everett said.
A possible bottoming in some of the worst housing markets (Phoenix and Las Vegas, for example, but not Florida) has been bullish for sentiment.
Kingsley Greenland, the president and CEO of Debt Exchange Inc., a loan-sale advisory firm, said prices have gone up about 10% since late 2008 and "volumes are up substantially" since the first half of last year. The housing markets "are no longer in free fall," he said. "Everybody feels we're at the bottom so prices have bounced back up."
There is no guarantee that housing prices will not fall further. "When you're dealing with the resolution of an asset that could be worth less a year from now, you're obviously not going to make money on it," Daurio said. "Time is not necessarily on our side."