As the real estate market continues to strengthen, investors are clamoring to get their hands on securities backed by pools of nonperforming residential mortgages.
Investors flock to residential NPLs
The search for higher yield is drawing the interest of not only hedge funds and private equity firms, which have a history of purchasing NPLs as whole loans, but also more vanilla mutual funds who need to invest in securities and now can purchase bonds backed by pools of the NPLs, according to The New York Times. While these financial institutions are providing the demand side of the equation, The Housing and Housing and Urban Development Department has been a major source of supply.
Since 2010, HUD has sold more than 100,000 troubled home loans that were FHA-backed and carried a combined unpaid principal of $17.6 billion, the media outlet reported. The government agency held more than a dozen auctions to sell these loan portfolios, and plans to have more sales.
Troubled loan sales climb steadily
An example of institutional investors' appetite for NPLs is the auction that HUD held in June, in which 27 industry participants submitted bids, according to the news source. This figure was roughly double the amount that made an offer to purchase during a similar auction one year before.
Thus far in 2014, investors have participated in 28 deals backed by $7 billion worth of NPLs, according to data provided by structured finance cashflow models provider Intex Solutions and reported on by The New York Times.
MBS offer strong yields
The New York Times provided information at a time when bonds backed by NPLs offered yields of roughly 4 percent, compared to 2.42 percent for 10-year Treasury notes. Investors searching for yield in a tight market are increasingly being attracted to these bonds.
The yields on many fixed-income instruments have remained low in the current interest-rate environment. The Federal Reserve held its benchmark borrowing costs near zero for several years and with Treasury rates at historic lows and traditional ABS spreads very tight, the NPL bonds look increasingly attractive
While many experts have weighed in on when they believe the central bank will hike the benchmark rate - and what timeline it will use to bring them to more ordinary levels - the Fed has not declared any definitive plans. While interest rates remain historically low, investors could keep flocking to bonds backed by troubled mortgages.
The market for residential mortgage-backed securities is still smaller than it was during the last real estate boom, but some believe that activity will continue to heat up, according to The New York Times. Earlier in 2014, trade publication Asset Backed Alert predicted that market participants would orchestrate bond deals worth between $4 and $5 billion during the last six months of the year.
These lofty forecasts are supported by analyst estimates that the U.S. has roughly $660 billion worth of nonperforming mortgages, and institutional investors' continued desire for yield will push the demand for the loans even higher than it is now, the media outlet reported.
These major NPL buyers and issuers of NPL securities are drawn to HUD auctions in particular because of the large sized pools and regularity of the offerings.
Financial institutions interested in loan sales might benefit from working with a loan broker such as Garnet Capital Advisors, which has substantial experience in this space.