BiggerPockets

Securities Lending - What There is to Know

Thursday, September 23

In the world of loans, lenders expect that the borrower provide some type of 'collateral' in case the borrower is not able to pay back the loan in the future.

Collateral is something valuable, with absolute value that the lender can posses from the borrower if the loan can not be paid. There are many types of collateral, ranging from houses, real property, cars, collectibles, or financial securities.

Financial securities are instruments that people use to invest money, such as bonds, stocks, mutual funds, and t-bills. These financial securities are worth a certain value, and may gain or lose value over time. Many financial institutions recognize these instruments and understand their value. Certain banks will even allow a person to use their financial securities as collateral for a loan.

Many banks will also loan these securities out to investment banks or brokers in exchange for collateral such as cash or mortgages. There is big money to be made in securities finance lending. It is estimated that over $2 trillion in these loans exist globally.

One type of securities financing is known as a 'stock loan'. A stock loan is used by an investor who owns free trading stocks and would like to convert their stock equity into cash without selling the shares. These types of loans use stocks or bonds as collateral. The borrower places their stock up as collateral to receive a certain loan compared to value of the shares current worth. There are a few types of stock loans that exist.

The shareholder may place the stocks as collateral for a non-recourse stock loan or they can get a margin loan.

The first option, the non-recourse stock loan will give the borrower the ability to borrow money against the value of the shares that would be placed up as collateral. These loans are similar to home equity loans for stocks. The borrower is able to borrow against the current value of the securities offered as collateral.

Since the shares of the stock are such solid collateral, the borrower is usually granted a below prime interest rate for the term of the loan. At the end of the loan's term, the borrower may choose to either pay back the loan and receive the stock back with any appreciation, or forfeit the shares instead. A borrower may decide that if the stock has lost significant value to just hand back the stock with no further recourse. These loans are very useful to a stock owner who needs cash for any purpose but does not want to sell their shares.

Another option is a margin loan. This type of loan allows the borrower to buy more shares of stock with money borrowed against the value of the stock placed up for collateral. Most lenders will offer a high LTV on these margin loans as they are used to buy other securities that will be held under control of the brokerage.

If the value of all the securities begins to drop below the LTV, the borrower will be required to sell all of their shares before the lender's money is lost or put an immediate cash infusion to make up the margin requirement of the loan. When this happens it is called a margin call.

Depending on what the borrowers want to accomplish and their risk level will determine the right scenario for them. However, both options should be examined carefully in today's market.

The Causes Behind The Current Economic Climate: A Layman's Guide...

Thursday, July 22

It seems now that everyone is aware that the world's economy is in a troubled state at the moment. And we're aware that much of this is due to the housing market.

Or at least, part of it is. There are a number of other factors, so let's take a moment to look at some of those...

1) After the .com boom, interest rates became attractively low, which lead people to buy more property rather than rent. This lead to property values increasing, and when people saw their houses double or triple in value in a few years, many decided to sell and purchase another place with a larger value, hoping to double or triple that as well.

2) Investors began to trade in mortgage-based assets. When someone takes out a mortgage, it becomes an asset to the bank, since they have income and profit generated by the mortgage. They can bundle mortgages together, and resell them as a financial product to the big movers and shakers in financial markets. The banks and investment companies also take out insurance policies on their investments to ensure they are covered in the case of loss.

3) The US (and other countries) loosened the limits on lending, allowing people to get mortgages that previously would not have been able to. In addition, mortgages became available in the US that allowed them to have a fixed-rate mortgage for a few years, which then changed to a variable one (adjustable rate mortgage, or ARM).

4) The housing bubble burst because the average house became to expensive for the average person to buy (never a good thing), and interest rates rose.

5) All those ARMs got to the end of the fixed rate periods, monthly repayments rose, and people began to default. In particular, as many people were in negative equity (the value of their house was less than their outstanding mortgage), some just stopped paying their mortgage. This meant they lost their home, and suffered the credit rating hit.

6) With defaulting, the value of the mortgage-based assets began to decline, and eventually became unsellable. Insurance companies paid out to cover the losses. Which is why investment banks and insurance companies (Lehman Bros and AIG) were some of the first big casualties of the current crisis.

7) Finally, with financial companies not able to trust each other to be stable, they began to withdraw inter-bank lending, and so many financial institutions that did not have a good retail front (ie, customers walking in the door with their salary) began to suffer - their investments were devaluing, they couldn't borrow more, and so on.

And so it went and here were are...

Banks toppling and being taken over every day. Insurance companies, investment companies, and other financial institutions struggling. Larger governments bailing out the central banks. Smaller governments applying to the International Monetary Fund for help. Recession being spoken about in real terms.

All from a few, simple mistakes.

Real Estate Investors ARE Responsible Property Owners...

Wednesday, July 21

Are landlords responsible citizens?

Some would say that they are not responsible. Some government officials have blamed housing investors for contributing to the recent property booms and the over inflated values in some areas.

While there are many reasons why property values rise and in the end it comes down to supply and demand, it can be argued that real estate investors act as a release valve to moderate the excesses of volatile property markets.

Generally speaking investors want to make their profit when they "buy" - not when they "sell", and because they need to pay attention to the bottom line, their purchases need to be profitable. It is rare for genuine real estate investors to get carried away with price when purchasing a new property.

Of all purchasers they almost certainly will have worked through the figures very carefully... obviously, more carefully than Congress!

By helping to maintain the national stock of rental property the investor will keep many would be home buyers out of the market simply because they are satisfied and well accommodated in a rental home... sounds like responsible landlords, to me.

In contrast, government itself can add to the cost of building a new home with a large array of infrastructure and compliance costs that have increased hugely over the last few years and have impacted on the final price of a new house.

Real estate investors are also criticized for not putting their investment dollars into the nation's stock markets and helping business to grow. The answer to that can be seen in the volatility experienced in the stock markets over the last few months. In contrast housing investment is a safer investment. Returns still tend to be good even in a depressed market if you have good tenants.

The rents bring in income and the fact that values drop has no barring on anything unless you are compelled to sell and of course you do not willingly sell in a depressed market.

Some would even argue that you never sell investment property. After all, why would you sell something that is making a profit. If you want to buy something else owner financing can be organized readily enough under most circumstances.

The fact that property investors own a huge portion of a nation's stock of rental homes, should make them valued citizens of in this country.

After all, who is going to accommodate the homeless if investors dropped out of the market. Government would doubtless pick up the slack, and, of course, the cost would be huge and there would be no economic advantage gained.

If there is a lack of investment in real business then that is a problem for business to sort out. Safer stock market offerings would do well and shakier enterprises may founder but in the end investors will look after their own interests.

Real estate investment has for years proven to be safe and lucrative for the long term investor.

Was Your Mortgage Loan Written in Compliance?

Tuesday, July 20

Greed... It can be a very powerful force. Easy money. Fast profits. Cut a corner here, omit that. Even huge corporations are run by humans. And humans have emotions. They face temptations. Some succumb. Others prevail.

Who was in charge when your mortgage loan was written?

Statistics show that up to 85% of all loans written between the years of 2002 and 2006 contain errors. Is yours one of them? If so, it could be costing you a lot of money.

A lot of loan modification companies sprung up almost overnight. Once again, not all of them are scrupulous. A lot of people paid for services and no services were provided. Sometimes large fees were paid up front for promised results that could not be delivered. Legislation has since been enacted to help protect the homeowner in this arena.

What does a loan modification do?

If a loan is found to have significant errors when it was written (e.g. the agent writing the loan was not licensed in the state, or his credentials had elapsed, etc), the loan can be changed to more favorable terms. Perhaps the interest rate will be permanently lowered. (Usually there is a three month trial period to make sure the homeowner can pay the new payment amount before it becomes permanent.) The actual length of the loan could be shortened. If severe mistakes were made, the loan itself could be abolished. (Rare, but it has happened.)

Okay. So what is the best way to find out if your loan had mistakes made when it was written? The safest way is to have a forensic loan audit done. This would preferably be done by an independent agency.

Do you think your bank would have your best interests at heart? Or theirs?

With a forensic loan audit, attorneys look at your paperwork and determine if the loan was written in compliance with federal and state lending laws.

The cost? As one of the TV commercials says, "Free is better". Some companies may charge up to $1,000 for a financial loan audit. Even then, it can be a bargain over time if the audit finds errors and a loan modification results.

Just know that there are some reputable companies who will provide a FREE forensic loan audit. Arm yourself with knowledge, know in black and white if your bank made some mistakes and then make an informed decision if a loan modification is right for you and your family.

The Lower the Investment-to-Value Ratio, the Safer the Note

Monday, July 19

The post below is reprinted by permssion by Rick Gordon, Director - Transactions, Florida Asset Financing Corp....

An investor in mortgage notes in the secondary market has one objective... that is, to earn a targeted return on investment.

Although in purchasing such notes we evaluate the seasoning, the down payment, the payor's credit scores and other elements, ultimately the most important factor is the value of the property relative to the amount owed.  

Just because a borrower has paid promptly for a period of time or has good credit or put up a sizable down payment does not assure that he or she won't run into future cash flow problems and an inability to make required payments.

As mutual fund operators always caution, "past performance may not be indicative of future results."

However, if an investor holds paper with a low balance owing relative to the value of the property, the investor has a very high probability of "coming out whole" and realizing its targeted return either through receipt of the promised periodic payments, or, if for any reason the payments are not made, through realization of an equivalent amount through foreclosure on the property.

The lower the investment to value ratio, the safer the note.

Seller Financing & The Future Value of Money...

Friday, July 16

The Future Value of Money (FVM) is a concept of which many people are unaware. Simply put, the FVM means today's dollars are worth more shall future dollars.

This is one of the reasons why notes with longer terms are discounted more than short-term notes. The reasoning behind the FVM is twofold.

The first reason is inflation. Inflation will drive the value of the dollar down over time. The same two dollars that will buy a loaf of bread today will not buy a loaf of bread ten years from now. Likewise, how many loaves of bread would two dollars have purchased twenty years ago?

The second reason is a sort of almost opportunity cost. Money currently tied up in an investment is unavailable for another investment. This is also affected by the length of time of the commitment. The example below will explain this further.

Let's look at a few examples using interest compounded monthly. We will calculate the value of $ 1 000 in ten years if we invest it at 5%:

• Investment: $1,000.00
• Interest: 5.00%
• Time: 10 years
• Final Value: $1,647.01

Now your $1,000.00 is unavailable to you for ten years while it is earning 5% interest. If someone was to offer you an investment opportunity at 12% interest, you no longer have that $1,000.00 to invest (hopefully you have other money available).

Let's continue with the above scenario, but this time you know that you can make a 12% "yield'' on your money elsewhere. Therefore, when you are offered the one-time future payment of $ 1,674.01, you know that to make it worth your while you need to make more than 12% on your money. For this investment, you want to make 15% also on your money.

• Future Payment: $1 647.01
• Interest: 15%
• Time: 10 Years
• Value in Today's Dollars: $370.93

Investors target a desired "yield" when making an offer on notes, because they know that they can make that same yield (at relatively the same level of risk) elsewhere.

This yield is based on many different factors, but in general is based on the unperceived "risk" of the investment.

Now let's look at a fully-amortizing note and discount a few individual monthly payments to see how the FVM increases the discount the farther into the future we go. For this example, we'll say that we want to make 12% on our money:

• Face Value: $150,000.00
• Interest: 6%
• Term: 30 years
• Yield: 12%
• Monthly Payment: $899.33
• At Payment #60: $495.04 Value in Today's Dollars
• At Payment #120: $272.49 Value in Today's Dollars
• At Payment #240: $ 82.56 Value in Today's Dollars
• At Payment #360: $ 25.02 Value in Today's Dollars

This is why the discount is steeper on the long-term notes; the last few years of payments are so far into the future, the FVM reduces their value dramatically.

Using a different scenario, let's take a payment stream of $500 per month and compare the amounts offered for 15 years and for 30 years of payments at the same 8% yield:

• 15 Year Term: Future Value: $52,320.30
• 30 Tear Term: Future Value: $68,141.75

The difference between a 15-year and 30-year term only yields an additional $15,821.45.

You can see that doubling the amount of payments adds only about 30% to the value of the cash flow stream. This is because those particular payments do not begin for another 15 years, and the Future Value of Money discounts them much more than the first 15 years of monthly payments.

To discuss the Future Value of your seller financed note, call us toll free at 1-800-349-6119.