This has been a frustrating four years since the mortgage market blew up in our faces. After two newly instituted compulsory exams, a ton of new regulations (Federal and State), and four hundred imploded lenders later, we still don’t have a positively charged mortgage market that we can speak of. Those who have equity in their properties, provable income on their tax returns, and at least 6 months of payments in the bank are the only ones who are currently able to get financing. The self-employed and the commission earners with weak tax returns, along with underwater borrowers don’t really have any options available in this market at this time. (Just to be clear, the underwater borrower who doesn’t have a loan owned by Fannie Mae or Freddie Mac, originated prior to June 1, 2009 has no options). We’ve had HAMP, HARP, DU Refi Plus, Open Access, and countless other programs providing a plethora of alphabet soup for the fortunate pre-June 09’ Fannie or Freddie borrowers, but for the Alt-A, subprime, stated income, no-doc, no income, stated asset borrower who still makes all of their payments, there is no relief in sight. They deserve relief too, right? Of course they do. Here are some ideas as to what can potentially be done.
First of all, there are over 472 investment entities around the world with at least $10 billion in investable capital. That’s nearly $5 trillion waiting to be deployed into investments of all sorts, and all $5TT is chasing a scant array of deals in the marketplace. You have hedge funds, mutual funds, private equity funds, insurance companies, and private individuals looking for investments. There have been a few which have expressed a bonafide interest in making investments in the origination of real estate mortgages. Accordingly, they should wholeheartedly participate in our anemic market. At the present time (late May 2012) 10-year Treasury bonds are paying a paltry 1.5%. A 30-year, A-paper mortgage can be locked in 3.375%. With the average Alt-A, no-doc, no asset, stated income, stated asset loan from the mid 2000s hovering at an interest rate in between 6 and 7.5%, it seems easy for an investment firm to underwrite transactions or structure mortgage pools that would yield investors 4.50% – 6.00%. This already occurs at the hard money level. Tens of thousands of private individuals and firms make loans everyday charging 5-7 points, earning 9.99%-14.99% in interest income, while collecting thousands of dollars in fees on short to medium term loans for borrowers who may have the cash and the income to support the debt service, but can’t prove it. Thus, we can clearly see that the demand is there for a product that fills in the middle.
Real estate is the most visible, understandable, and historical asset that individuals or entities can invest in. Bought “right” as an investment class, it offers stable cash flows that are predictable and consistent. It’s not sexy like Facebook, but there won’t be the post-IPO heartburn that many investors have had during the first two weeks following the first day of trading of the social media megamachine. As such, many investment houses should consider an origination, securitization, distribution, and servicing platform that is geared and catered to the non-Fannie/Freddie marketplace that is busting at the seams with unserved borrowers. The infrastructure can be set up fairly effectively and efficiently. Those with mortgage investment banking (IB) experience can start from scratch with the IT and their rolodexes, or can partner up with large, small, or mid-sized IB-firms that have the capability to underwrite, market, and distribute the paper to the masses while recycle capital to make new loans. The one concern is obviously the risk, and how do we address its mitigation.
Many loan originators have retired their sales hat and instead picked up the consulting hat. With their former days of making loans behind them, they have now chosen to “workout” and restructure non-performing loans; many of which they put on the books! These individuals are true risk management material. They know what works and what doesn’t. To them, if a stated product is going to work, it will need certain debt service covenants and other provisions to reduce its risk of default. In my banker days, the “credit admin” folks and the chief credit officer were all former “linespeople” who booked loans that occasionally went bad. They learned from their mistakes and as shareholders of the bank, they had a vested interest in making sure that bad loans weren’t placed on the books in the future. Many of these people went on to form the bank’s capital markets group that originated, securitized, distributed and sold off billions of dollars of loans each year, which makes the bank a tidy profit. When all of those factors are considered, the private incentives are all plausible and doable.
Finally, one should consider public-private partnerships. As witnessed throughout the Great Recession, the federal government has a propensity to engage in various forms of “partnership” with the private sector when the returns look favorable or it just needs to get a messy situation off of its books (e.g. JP Morgan Chase’s acquisitions of Washington Mutual and Bear Stearns in 2008). In the Chase example, the government was trying to contain a pure catastrophe with both institutions. After both banks encountered meltdowns of global propensity and were subsequently taken over by the regulators, Chase swooped in and bought both wounded entities for cents on the dollar. The kicker was that the Federal government provided a backstop to Chase against potential losses. From that instance alone one can clearly see that when the motivation is there, the government will guarantee private industry against losses in order to avoid an economic tsunami.
In the end, I do see private industry moving from the sidelines to get into the game of providing real estate capital. There is $4.72 trillion dying to put its dollars to good use. Even though the Dow is off and Facebook has lost 25% of its IPO value, tenants still need a place to stay and consistent monthly cash flow is still king. There are a lot of out of work or underutilized finance professionals with the origination, securitization, and distribution experience that can recycle and refresh the mortgage market with more capital to book new loans. Most importantly, there are millions of ready, willing, and able-bodied borrowers dying to get scarce financing. Redwood Trust is already in the game originating and securitizing non-Fannie/Freddie loans. So, how many more will follow suit and how long will we have to wait? I am not sure how long, but I hope that it is soon, as there is a need that needs to be filled and now.
Preston Howard is a mortgage broker and Principal of Rose City Realty, Inc. in Pasadena, CA. Specializing in various facets of real estate finance, he can be reached at firstname.lastname@example.org.