GSE NPL Sales Programs: Five Questions to Ask before Investing in Non-Performing Loans
Not produced for or on behalf of Fannie Mae or Freddie Mac.
Investing in non-performing loans through the GSE NPL sales programs is an attractive option to investors looking for new opportunities to support residential communities. Fannie Mae and Freddie Mac (the GSEs) have been selling non-performing loans (NPLs) since 2014 and 2015, respectively, to reduce their holdings of less liquid non-performing assets and gain more favorable execution compared to holding the loans. Likewise, investors can profit from NPLs by maximizing the number of loans they can get to re-perform. All these sales involve a servicing transfer to private investors who usually have greater flexibility to resolve the loan with modifications to keep the borrower at the top of the waterfall of resolution tactics, as required by the GSEs.
The uncertainty of NPLs is different from other types of whole loan investments. Unlike investing in performing-loans, where you bet on whether a loan will default or prepay too quickly to recoup an investment premium, investing in non-performing loans is a bet on the future performance or disposition of an already delinquent mortgage. To manage the high degree of uncertainty inherent in this asset, potential investors should consider the following five questions before investing in non-performing loans:
- What are the characteristics of the NPL pools the Fannie Mae and Freddie Mac have sold?
- How are NPLs priced?
- How should I structure funding?
- Do I have the necessary operational readiness?
- What outcomes should I expect post sale?
What are the Characteristics of the NPL Pools Fannie Mae and Freddie Mac have Sold?
Exhibit 1: NPL Pool Types by GSE (as of 12/31/2016)
Fannie Mae and Freddie Mac have similar NPL sales programs. Both GSEs provide a larger, geographically diversified pool offering and a smaller, geographically concentrated pool offering (usually in states where foreclosures must be pursued through the judicial process). The smaller pool offerings provide more opportunities for smaller investors including non-profits and minority-and women-owned businesses to participate in the NPL sales programs. Fannie Mae and Freddie Mac named these programs as presented in Exhibit 1. The NPL sales in UPB from 2014 to 2016 can be found in Exhibit 2, below.
Exhibit 2: NPL Sales in UPB ($B) at Settlement
The characteristics to consider include:
- Geography: Most Extended Timeline Pool Offerings (EXPOs) and Community Impact Pools (CIPs) sold by Fannie Mae and Freddie Mac have been Florida, New York, or New Jersey pools so far, while NATs and SPOs are usually geographically-diversified pools. Investors should consider unique risks such as local regulations and laws (e.g. different foreclosure timelines in judicial states), volatility of the housing market and local economy, and operational readiness to service the loans.
- Average Delinquency in Years: Fannie Mae and Freddie Mac sell NPLs when the borrower is typically behind their payments for at least one year. The average delinquency for pools sold through December 2016 ranged from 1.4 years to 6.2 years, with Fannie Mae pools more delinquent than Freddie Mac pools at settlement. Given the low delinquency status of the loans, investors should expect that many of the loans were previously modified or are currently in the process of modification and/or foreclosure or foreclosure alternatives.
- Average Loan-to-Value (LTV): Fannie Mae and Freddie Mac have traditionally pooled NPLs by LTV for larger offerings and by geographic location for smaller offerings. For lower LTV loans, there is typically an inverse relationship between price relative to the stated UPB and LTV. However, for higher LTV loans (usually an LTV ratio above 110 percent), investors often bid as a percentage of the value of the underlying property. Investors could potentially make a higher profit on the loan if they can offer better-term modifications to help the borrower bring the loan back to current and/or from arrearages or other recoverable debts.
- % Previously Modified: A significant number of loans in NPL pools have been previously modified. Knowing this percentage, NPL investors can gain insight into how many loans in a pool are likely candidates for successful loss mitigation activities; prior modification indicates that the borrower has a higher likelihood to be engaged. Although private investors have greater flexibility than Fannie Mae and Freddie Mac to modify these loans, delinquent loans that have already undergone one or more modifications frequently present the new servicer with a more limited set of options.
- % In Foreclosure Proceedings: A significant portion of NPLs sold by Fannie Mae and Freddie Mac is in foreclosure proceedings, generally above 60% at settlement. Investors should take into consideration varying foreclosure timeframes across different states, particularly those with a long timeline in judicial states.
- % Verified Borrower Occupancy: According to FHFA’s further enhancements to NPL Sale Requirements, NPL buyers and servicers may not abandon the lien and “walk away” from the property if it’s vacant. The Enterprise Non-Performing Loan Sales Report indicates that NPLs where the property was vacant had a much higher rate of foreclosure, while NPLs where the home was occupied by the borrower had a higher rate of foreclosure avoidance outcomes.
How are the NPLs Priced?
Fannie Mae and Freddie Mac ask investors/bidders to bid at the loan-level and determine the winning bidder based on the aggregate bid price on the pool. On some occasions, the GSEs sell multiple pools together on an all-or-none basis. Therefore, investors/bidders typically have their models price each loan based on the loan-level data provided by Fannie Mae and Freddie Mac. Likewise, the GSEs utilize mathematical models to determine if the pool sale price meets their internal reserve levels and makes economic sense.
With the necessary capital and expertise, hedge funds, private equity funds, and other investors can seek higher returns from their NPL investments. NPL buyers and their servicers will try their best to keep the borrower in the home and subsequently sell the re-performing loans at a higher price after a period of consistent performance history. NPL investors seeking to pursue a foreclosure strategy are usually more skilled at foreclosure and property management and more willing to buy loans that are vacant and/or have a low likelihood of resolution. However, they are required to follow FHFA’s NPL sales requirements and other requirements specified by the GSEs.
The introduction of Fannie Mae and Freddie Mac’s NPL sales programs has brought transparency into the NPL market, allowing investors to better evaluate and price the NPLs. Investors use their pricing models (e.g. cash flow models) to determine their bid price depending on the investor’s strategy. Additionally, they use variables such as unpaid principal balance (UPB), delinquent balance, LTV, delinquency in years, product type (interest rate, term, current P&I, etc.), current modification type, foreclosure and bankruptcy status, and geographical location.
Freddie Mac and Fannie Mae publish the “cover” bid price (i.e., the highest non-winning bid) on their traded NPL pools. We plotted the Cover Bid Prices against the weighted average LTVs based on BPO (Broker Price Opinion) at trade as an example to show the relationship between LTV and price. Exhibits 3 and 4 reveal an inverse (and intuitive) relationship between cover bid price (% of UPB) and LTV. When pricing very low LTV loans, investors take into consideration recovery of arrearages through either a capitalization modification or in liquidation. When pricing high LTV loans, investors are more likely to bid as a percentage of the value of the property (see Exhibits 5 and 6). The average cover bid price for pools with different LTV ranges is presented in Exhibit 7.
Exhibit 3: Cover Bid Price (% of UPB) – SPO/NAT Pools*
Exhibit 5: Cover Bid Price (% of BPO) – SPO/NAT Pools*
Exhibit 4: Cover Bid Price (% of UPB) – EXPO/CIP Pools*
Exhibit 6: Cover Bid Price (% of BPO) – EXPO/CIP Pools*
*The pricing analysis was based on the pools where Fannie Mae and Freddie Mac released cover bid prices as of 12/31/2016.
Exhibit 7: The Average Cover Bid Price for Pools with Different LTV Ranges
How Should I Structure the Funding Required to Invest in NPLs?
Investors should consider the pool size before bidding to ensure that they can fund the deposit due at trade and proceeds due at settlement. To date, UPB at settlement is up to $600M for SPO/ NAT pools and less than $25M for EXPO/CIP pools. One to two business days after trade date, a non-refundable deposit (usually 10% of the aggregate price of the NPLs at trade) is required from the winning bidder for each pool. The purchase proceeds, or the net of any deposit, are required from the purchaser on the closing date.
To be eligible to bid on any pools, prospective bidders are required to provide proof of liquid funds for the deposit to cover the offering types/pools they are interested in along with other required qualification documents. After qualification, Fannie Mae and Freddie Mac allow investors to leverage their trade by using funds from a financing partner. Prospective investors should consider whether they have enough funding, either independently or via financing partners, for the purchase proceeds.
Do I Have the Necessary Operational Readiness to Invest in NPLs?
SPOs and NATs have similar timelines, two to three months from offering to settlement. Timelines for EXPOs and CIPs are typically longer — three to four months from offering to settlement — because some smaller investors need more time to evaluate the pool for bid and raise funds. After the deal is settled, an additional one to two months is typically required to transfer servicing. The purchaser is also required to provide post-sale reporting to the seller for a certain period.
- Due Diligence: After trade, the physical custodial files and copies of the mortgage and credit files will be available for the purchaser to review. The purchaser can review the files or have a 3rd party perform due diligence on the pool(s) it is purchasing. Prospective investors should consider whether they have the capability to handle due diligence in-house.
- Servicing Transfer: NPL bidders need to ensure that they have the appropriate servicing lined up. FHFA has very specific servicing requirements for NPLs sold by Fannie Mae and Freddie Mac. For example, the new servicer must be a HAMP SPA or HAMP Successor Servicer and must be approved by the GSEs in the Bidder Qualification Process. The new servicer will also need to work with the interim servicer to complete the servicing transfer after the deal is settled.
- Post Sale Reporting: Prospective investors should consider whether they have the reporting mechanism and infrastructure to capture the required data points and provide on-going reporting to Fannie Mae and Freddie Mac. The GSEs require NPL purchasers to provide loan-level reporting on a monthly basis in a pre-determined template for about three to four years.
What Outcomes Should Investors Expect Post-Sale of NPLs?
Prospective investors might be curious about actual loan outcomes from recent NPL sales. The latest report, released on June 1, 2017 provides NPL sales data and preliminary loan outcomes as of December 31, 2016.
NPL outcomes are typically measured in terms of “resolution,” or the percentage of loans that go through either foreclosure or a foreclosure avoidance process, such as loan modification.
As of December 2016, 40.7% of the 45,446 loans that were settled by June 2016 had been resolved, a 10.1% increase from the resolved outcomes as of June 2016. More than half (23.7% of the 40.7%) of the resolutions involved foreclosure. Foreclosure and non-foreclosure resolution rates were higher than six months ago.
The percentage of NPLs where the servicer had established contact with the borrower, co-borrower, or trusted advisor (“Right Party Contact”) increased from from 63% as of June 2016 to 67% as of December 2016 due to the fact that the new servicers have been servicing those loans for a longer period on average. The rate of non-foreclosure outcomes for borrower-occupied homes increased from 17% (June 2016) to 19% (December 2016). In addition, the rate remained higher than those for vacant or non-borrower-occupied homes. Also, as expected, the rate of foreclosure outcomes for vacant properties increased from 29% to 39%. Exhibit 8 shows the borrower outcomes by Verified Occupancy provided by FHFA.
Exhibit 8: Borrower Outcomes by Verified Occupancy
*Loan Outcomes by Verified Occupancy in the Enterprise Non-Performing Loan Sales Report – December 2016
The FHFA data represents a valuable tool for investors who may be considering Fannie Mae and Freddie Mac’s NPL sales programs. Funding and operational requirements are equally important considerations. We expect that continual monitoring of these loans’ performance over time will give qualified investors the necessary insights to determine whether investing in non-performing loans is an appropriate fit for their portfolios.
Not produced for or on behalf of Freddie Mac or Fannie Mae.