The recent carnage in the subprime mortgage industry and the regulatory pressure on banks to dump risky assets promise to flood the secondary mortgage market with delinquent loans.
Some major players in the mortgage market are taking positions to pick up the pieces. "There are opportunities coming daily into this market to buy these assets at good returns" and nourish them back to health, said Keenen Dammen, president of the investment capital group of GMAC-Residential Funding Corp., a Minneapolis-based unit of General Motors Acceptance Corp.
Late last month Mr. Dammen's outfit, one of the top 10 servicers of subprime mortgages, took a 46% stake in C-Bass, one of the reigning buyers, securitizers, and servicers of delinquent loans.
GMAC's investment, which would allow it to quickly expand its presence in the delinquent loan sector, follows a related initiative by Donaldson, Lufkin & Jenrette. Earlier this year it hired away several executives from GMAC to set up a subsidiary in Princeton, N.J. The DLJ unit plans to buy and securitize nonconforming mortgages and to include a special shop for servicing nonperforming loans.
The potential size of this business line is huge. Mr. Dammen estimated that out of $4 trillion in outstanding mortgages in the United States today, 3%, or $120 billion, are delinquent. He said that the figure could double to $240 billion in the next 12 to 18 months.
Since the liquidity crisis of October 1998, most of the major subprime mortgage lenders have filed for bankruptcy. Given that these failed lenders have issued $125 billion of mortgage- and asset-backed securities over the past three years, Mr. Dammen said, it would not be a surprise if 10% to 20% of the loans underlying those securities go bad.
Banking regulators published a proposed rule in the Federal Register on Sept. 27 that would require banks to hold $1 of capital for each $1 of residual interest in pools of high-risk securitized loans, and would limit banks' ability to use residual interests - the riskiest pieces of securitization deals - to satisfy more than 25% of their regulatory capital requirements.
The measures would encourage banks to unload these assets, adding to the loans available for operations like C-Bass.
It all depends, he said, on whether the failed subprime lenders and banks will sell. Mr. Dammen's company is betting they will, and is hurrying to make sure it gets a piece of the pie.
The key is to move quickly. Working with other firms, Mr. Dammen said, will enable GMAC to build a stronger market presence faster than it could have by simply building up its own business.
Mr. Dammen said that GMAC is newer to servicing delinquent loans and has a smaller outfit than C-Bass's special servicing subsidiary, Litton Loan Servicing LP. GMAC has been in this business, he said, for three to four years, whereas Litton has been in it for over a decade. He added that C-Bass's management also has more experience in the niche market of buying delinquent loans and getting them to reperform.
Learning from Litton and the other outside servicer, Mr. Dammen said, will also help GMAC improve its bidding on portfolios of distressed assets. He plans to compare the three companies' performance on certain loans and on different parts of loan pools, to see which types of loans each company works with best. When GMAC starts to get a feel for this, he said, it will know why certain portfolios do well and others don't, and will thus have a better idea of how to price its bids.
Another motive for investing in C-Bass was to increase GMAC's capacity to service bad loans. GMAC's shop, Mr. Dammen said, is already busy dealing with the delinquencies in the company's huge portfolio, so it will need help from Litton and others to take advantage of the windfall of nonperformers that it expects to come from troubled subprime lenders and banks. He said this is why GMAC plans to send some loans to a third special servicer.
By increasing its presence in this market, Mr. Dammen said, in the event of a recession or an increase in defaults, GMAC would be in a much better position to defend its portfolio from losses and could take advantage of other companies' desire to offload their delinquent loans.
One of the things he hopes GMAC will learn from C-Bass, Mr. Dammen said, is how to develop better loss mitigation technology.
"There are [major] barriers to entry" into the nonperforming sector, said Bruce Williams, chief executive at C-Bass. "It takes time. You have to develop the technology, the analytics, all of the default servicing platforms."
Bidding jointly on loan portfolios is another potential area of collaboration between GMAC and C-Bass. "Pools of collateral are becoming more mixed," Mr. Williams said. "In the future we could have a very good bid for the subperforming [part of a pool] and they could do it for the performing [part]."
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