Why would a new performing note sell for 87.5% UPB?

Question

I've been reading a lot about notes but am still very new. I'm not sure if this is the going rate, but suspect it isn't. Why would some sell a brand new note for 87.5% UPB? It is like they just made the note and are taking a loss on it.

General Note Information

Lien Position1st Mortgage/Deed of Trust

Note Status Performing

Note Type                             Conventional

# of Payments Last 12 Months0                                                                                                 Paid To 01/01/2017                                                                             Loan Maturity 01/01/2046                                                                             Property Type Single Family Res                                                                             Original Balance $64,125.00                                                                             Principal Balance $64,125.00                                                                             Est. Market Value $81,590.00                                                                             Payment Amount $735.67                                                                             Note Rate 9.750%Sold Rate 9.750%Seller Comments:                                                                                               Newly  originated note with full RMLO package from Texas Pride Lending  included. Documents prepared by MLH Legal in Dallas, TX. This is a well  written and well qualified note. Borrower's debt to income ration is  UNDER 30%.  Solid borrower, relocated from Ft Worth to the Tyler area at  the request of his employer. Property is on a half acre located in the  very desirable Whitehouse Schools District.

Paid To 01/01/2017

Loan Maturity 01/01/2046

Property Type Single Family Res

Original Balance $64,125.00

Principal Balance $64,125.00

Est. Market Value $81,590.00

Payment Amount $735.67

Note Rate 9.750%

Sold Rate 9.750%

Seller Comments:                                                                                               Newly  originated note with full RMLO package from Texas Pride Lending  included. Documents prepared by MLH Legal in Dallas, TX. This is a well  written and well qualified note. Borrower's debt to income ration is  UNDER 30%.  Solid borrower, relocated from Ft Worth to the Tyler area at  the request of his employer. Property is on a half acre located in the  very desirable Whitehouse Schools District.

Scott Carson · Answer

Its' pretty simple....a lot of brand new note buyers are looking for a 15% yield on their money...that's why the discount as it equates to them at a 15.733% ROI.

Scott Hawley · Answer

Thanks for all the information everyone. I'm just starting my note research journey and love the sharing.

James C. · Answer

Rich,

Non conforming property issue in this instance deals with the underwriting of the loan. Properties must meet certain criteria in order for the note to be sold on the secondary market. When I looked at the property it appears to be a MH on land, and older than 1974. I could be wrong on that.

There are mortgage brokers that hold the loans they close, and package them for sale to the secondary market. In order to hold the mortgages, they need to have a line for credit to pay everyone off at the closing. This line of credit is known as a "Warehouse line of Credit". Most lines have a small portion of the line available for non-conforming loans. Non-conforming loans are loans that can't be sold on the secondary market for one reason or another, mostly because they don't meet some underwriting guideline. There is a potential for this section of the line to generate some good profits, but it needs to be managed closely. Going over the limit for the non-conforming portion of the line is a good way to get yourself in hot water with your lender.

Given Scott Carson's statement above, I am obliged to suggest that it's probably the reason why it's discounted. It's a dead simple explanation, whereas mine, while possible, are more complex.

Thanks,

Jim

James C. · Answer

Scott,

Some things come to mind:

No seasoning.

Borrower has blemishes on the credit report/low credit score. (yes, <30% back end is good, but could be a credit report issue)

Lender is over non conforming covenants on line, and this is a non conforming loan for one reason or another (because his bank says it is and won't take it on the line). If this is the case, this loan could be the runt of the litter, and the lender wants to keep his bigger non-conforming loans on the line so that he can sell them for 104% when they are seasoned.

Underwriting made a mistake in documentation and secondary market rejected it (BIG ding to the underwriting department).

Property is non-conforming in some way.

Loan balance too low for secondary buyer.

Secondary buyer flaked at the last minute (unlikely, but possible).

Minor title issue that secondary market/buyer doesn't like.

The note could have been structured with that sale price in mind, and written to sell it quickly.

If you can... ask why... it never hurts, if they answer, and it's nothing to do with the note quality, then you have it (assuming you can verify). If it does affect the note quality... then it's good to know and you can price accordingly.

Best advice, due your due diligence, double check it, and if it still looks good buy it!

Good Luck!

Jim

Kevin Moen · Answer

@Scott Hawley I second many of these posts. To also more simply answer your initial question, notes trade at a discount as a reflection of risk. I don't know many seasoned investors who would buy a note with 0 payments for 87% of UPB. There would need to be some strong redeeming factors like very high equity for that to be an investment we would make.

Also your thoughts on the seller taking a loss are likely incorrect. I sell notes at a discount all the time. Just because the UPB is $100k (for example) does not mean I have $100k of cash in the deal. The power of finance is creating money out of thin air. This is banking, and why sellers can often afford the discount.

Don Konipol · Answer

@Scott Hawley, you don't mention this note was the result of a purchase or a refinance.  If a purchase, or a refi of a recent purchase, the the amount of down payment and source of down payment may be an issue.  A $64,125 note with the borrower having invested 30% down o his own money is worth more (less risk) than the same note amount in which the borrower put 5% down borrowed on credit cards.

Jay Hinrichs · Answer

@James C.  any way you cut it old HM on land is risky...

Rich Hupper · Answer

hi, what is a non conforming property issue? Does this have to  do with zoning?

Also what is a "non conforming covenants on line"

Thanks

James C. · Answer

Scott,

Found the note you mentioned.   Non conforming property issue.

If you want to discuss further PM me. I'm in Tokyo time zone, just FYI.

Good luck,

Jim

Why would a new performing note sell for 87.5% UPB?

Most Popular Reply