Smaller, thinly capitalized investors in nonperforming mortgages could face liquidity concerns in coming months as private-equity investors begin to re-examine their commitment to the business while bolting for higher returns elsewhere.
No one is predicting an exodus of private-equity money from the sector quite yet, but industry veterans say the business could soon bifurcate with larger nonperforming-loan firms (with proven track records) holding steady, while smaller players find it harder to get backing.
"This is all about 'the trade,' " said a nonperforming-loan executive in the Midwest, requesting anonymity.
The problem, he said, isn't the returns in the business are poor — it's a matter of yield. "You can get an [internal rate of return] of 13% on this business still, but some of these funds are saying that's not good enough anymore — they can make 20% by trading currency."
In other words, the risk and reward on other investments, be it commodities or stocks, are starting to look better.
To date, the highest-profile exit from the nonperforming-loan space came about a year ago when Marathon Asset Management in New York, a hedge fund, pulled the plug on its fund and liquidated its residential holdings as well as a servicing affiliate.
In recent interviews, investors and managers alike continued to complain about a lack of available product and the spread between the "bid" and the "ask" price of distressed loans. The gripe is consistent: Banks have plenty of nonperforming loans to sell but they won't let go of them at a price that investors in these loans like. (One loan trader estimated that of all the nonperforming-loan deals offered over the past two years, just 7% ever closed. "Seven out of 100," he said. "It's the bid/ask.")
Last month, Kondaur Capital of Orange, Calif., slashed almost 40% of its work force (155 full-time employees), citing a lack of available product to buy. But that hasn't stopped its president, Jon Daurio, from trying.
Last week Kondaur hired an executive whose sole job will be to beat the bushes at community lenders, persuading them to sell their NPLs.
Just before announcing the hiring of the executive, Mark Ferrara, Kondaur found out that it was the winning bidder on a 1,000-loan NPL pool offered by the Department of Housing and Urban Development.
The new loans bring Kondaur's nonperforming-loan portfolio up to 4,000 units, but because the firm liquidates roughly 10% of its holdings each month it must continue to feed the machine, which is why it hired Ferrara. (Once it buys a loan it moves to cure the note either through a deed in lieu or a foreclosure.)
In other words, it appears that Kondaur, instead of relying solely on auctions, is being proactive by hiring someone to knock on doors. But will it work? Some nonperforming-loan investors say they've tried the knock-on-the-door approach and it hasn't succeeded.
One mortgage executive, who manages a firm that services roughly $90 million of distressed loans, said he knows of competitors that are scrambling. "My 'wheel house' is buying one to 15 loans and I've approached credit unions and community banks. They don't want to part with them," he said. "I've tried. They think this stuff is worth [80% of the broker price opinion] and I will tell you that it's not. I'll offer 60, but they continue to turn their noses up."
This executive, too, did not want his name published, a common request of many in the sector who talk to the media.
