Another month has come and gone. In an ever-changing market, it helps to reflect on what has happened, so we are better equipped to move forward. What this means for today’s episode is another 7e update for the month of April. Chris Seveney goes solo to give a market analysis of what we saw in the past month within the mortgage note fund as well as in the financial world. What are the things happening in our current market that impact our business? What is going on in the banking industry? Chris covers these things and more. So tune in to keep yourself up to date on the market.
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7e April Update With CEO & Founder Chris Seveney
In this episode, I’m going to nerd out again and do a little bit of a market analysis and market update for what we were seeing. Talk about the month of April 2023, what we saw within our mortgage note fund and what we see out in the financial world as being a note investor and having a note fund. We are typically on the front line to see what banks and institutions are doing. I wanted to give you a market update and talk about how that impacts our business. Please stay until the end because this is a question we get asked a lot. How do current markets impact our current business? We’ll talk a little bit about the Feds raising interest rates another quarter point. Let’s dive in.
First, let’s talk about the month of April 2023, which was a very interesting month for us. It was our best month ever in regard to acquisitions. We closed or are in the process of closing on a little over $1.5 million in loans in the month of April 2023. The product and the information that we saw that was on the market for April 2023 were very interesting for what we were seeing. We saw more products in April 2023 than we had seen in the entire quarter one of 2023. The beginning of the year 2023 was similar to the last quarter of 2022 but the first month, we saw more products than we saw the prior quarter. We are seeing a lot more assets come on the market.
The next thing is once you start seeing more assets, let’s talk about pricing for those assets. Pricing is starting to creep down. When you look at why it’s creeping down, it’s because investors are looking for a little higher return on those assets. In 2022, when interest rates were significantly lower, people weren’t discounting as much to achieve specific rates that were above what the Feds and what they could get, the risk-free rate of return, as people may say. Times have changed and times are changing.
I’ll run some numbers down for those who are in-depth in the space but also, to let people know how we track and what we track. For example, in the month of April 2023, from 1 seller alone, we saw over $200 million in products. A lot of the products they put out did not trade because the bids were maybe what the sellers expected. As we’re going through some of these corrections, there’s a little bit of a disconnect between the seller’s expectations and the buyer’s expectations. We’ll talk a little bit about that as well.
The different types of loans that we see, for example, there was a non-performing loan pool that was a little over about $5 million and it didn’t trade. The seller’s expectations were wanting somewhere above 80% on those loans and it didn’t trade. It’s because of that and pricing is coming consistently coming down on those assets, even on the ones in equity.
A large number of loans we’ve seen were what’s called bridge financing, which is short-term financing. A lot of times, it’s for investors or people who are looking to churn cash pretty fast. That had about $14 million in loans that came across our plate. The average interest rate or the weighted average coupon is a term that’s used, which is the average rate across them was about 11%. That sold at a slight discount that would yield about a 12% return approximately for those types of investors. That’s interesting because people did pay close to par, which is close to what the value is on paper.
What’s interesting about that is in 2022, that would’ve traded for 105% or a higher percentage. Investors were happy with an 8% to 9% return or even lower that was buying a lot of this type of paper. They would bid around that number. In 2023, interest rates are rising and the cost of capital is getting more expensive. People are looking trying to nudge up a little bit there. A big chunk was non-QM loans and scratch and dent loans. Let me explain first what a scratch and dent loan is. This is interesting because we’ll talk about it a little more along with the banks.
For people who want to understand the mortgage space, here’s a high level of a lot of institutions, whether banks or lenders. They will originate a loan. They’ll collect fees based on points. It’s a fee that they’ll collect. A lot of times, they’ll securitize the loan and sell it to Fannie Mae or Freddie Mac, which is a government-sponsored entity that will buy those loans. A lot of these non-bank lenders are originating loans to then turn around and sell and they’re like middlemen. They’re creating the loan but pushing it aside.
Scratch and dent loans are those that have a defect. They could not be sold to Fannie or Freddy. We’re seeing a lot of loans that originated in 2022 at 3%, 4% or 5%. To give you an idea, the weighted average coupon of over $70 million of loans was 4.5%. You can’t touch that rate in 2023. These institutions that have these couldn’t sell them to the government. All of a sudden, it’s like, “I got to sell these and get them off our books.”
In 2022, this loan of 4.5% loan probably would’ve sold for about $0.95 on a dollar. In 2023, they are averaging in the mid-‘70s to give people an idea. That’s a big 20% discount from where they were. For us, that’s still higher than something we’d want to pay on those types of loans but what that’s showing is some softening in the market on pricing because finally, people are adjusting to 2023’s interest rates. I wanted to share that with people a little bit and why it’s important to understand. We track a lot of this data because we want to know what is trending. It’s very important for people to understand.
Here’s one last thing I’ll mention. We’re three days into May 2023 and we’ve already seen over $100 million of assets come across our plate for sale. I’m seeing a lot of that scratch and dent-style loans. Also, I’m starting to see a mix of other types of loans as well. For those who know us, our primary focus is on the non-performing space and we take a look at all these assets. Just because we may not be buying certain assets, we follow the markets closely so we understand everything that’s going on in the market.
I’m going to pivot a little bit where I felt like I was diving deep into the weeds and sharing some of that data with people. Let’s peel it back and talk about the big picture of what’s going on. The first thing I want to talk about is what’s going on in the banking industry. We had First Republic, another bank go under. This is the fourth bank that has gone under in the past. Let’s put little things in perspective. In 2008, people were around investing in real estate. Those were pretty rough times. There were 25 banks that went under in 2008. The banks that went under which are much smaller accounted for about $350 billion in assets. The 4 banks that have gone under count for $550 billion in assets.
From a numbers perspective, the number of banks is significantly lower but the amount of money that has been out the door is significantly higher. I will state that there’s a lot more money in the financial system in 2023 than there was years ago so you have to play that into account. I want to make a point that $550 billion is a lot of money. What happens when these banks go under? You hear JPMorgan Chase or somebody comes in and buys them. As part of this process, the FDIC steps in as well, that’s who ensures the first $250,000 in your bank account. They’ll come in and also assist in liquidating the assets of the bank.
For example, FDIC has reached out to BlackRock who they did years ago, liquidate and sell off these assets. A lot of these assets are originated. They’re loans typically that originated at very low rates. Similar to some of the numbers I was sharing with you, if you ask the experts, which by no means am I an expert in any of these topics, they expect probably about a 30% haircut across these assets, which is significant. When you start looking at dollars, this is where people need to start paying a little more attention to certain things. 30% haircut, maybe a little less, say 25% on $550 billion of assets that are going to come out. It’s about $125 billion of losses, which are going to be covered by the FDIC. The FDIC is covering a lot of these losses.
The FDIC on their balance sheet has roughly $125 billion, which they’ve been saving up for the last several years where they’ve been saving all this money. That then begs a question. The FDIC has to take all of its reserves to pay these first four banks. They’re FDIC season solvent. As an individual who thinks they understand a little bit about finance, I have money and bank accounts.
A question that pops into my head is, “How is the FDIC going to ensure my money in the bank if they don’t have any money?” Typically, they get it from fees from banks but if all of a sudden, they have to start charging fees to these banks, it’s going to be exorbitant, I would have to imagine. Where do you think the banks are going to get those fees? They’re not going to take it out of their profits. We know that. Come back and charge a consumer.
The other area, which is probably going to happen is the government’s going to step in. If the government steps in, where are they going to get the money? They get it from taxpayers. Either way, a taxpayer is probably going to lose. It’s something to pay attention to because it is going to have a significant impact down the line on how banks and bank failures are going to be treated if more banks continue to go under. That begs the question, “Do we think more banks will go under?” I am not an economist on a micro level but typically when things start to sour, there’s a first wave. Things get a little sturdier and then a second wave typically follows.
With interest rates also rising again in the current interest rate environment, I do think there’ll be another wave of bank failures. Simply because a lot of these banks, which may have been mismanaged, I’m not going to get into how they’re managed because I’m not involved in their day-to-day. If they have a lot of assets on their books that originated at 3% and 4% and the market in 2023 is saying it’s 6% or 7% and they need cash, they’re going to have to liquidate something and it’s going to have to be those assets which will have to sell at a discount, which will take from their profits.
This was a good educational experience for us because we have to submit an audited financial study to SEC which we do every year. When we go through our audits, the first question they ask us is, “Are your loans held to maturity or are they held for sale?” We model our loans as held for sale. The difference between held to maturity, which is what banks typically do and held for sale is how you value that asset. Think of a hold to maturity, which is you have a loan and it’s worth that value for its life.
Let’s go to real estate, for example. You buy a $250,000 house. On the books, it’s worth $250,000 in 2023. In 2028, whether or not, that house has gone up in price. That’s what banks are doing. As rates have increased, that $100,000 loan at 3%, even though if they had to go sell that thing and say they sold it for $90,000, on their books and balance sheet, it’s still showing as $100,000 because they anticipate they’ll have to hold a maturity.
Held for sale, which is what we do, every year, we have to value that loan. We will come up with a new value for that loan dependent upon market conditions and market pricing. If it’s gone from performing to non-performing, the value may go down. If it’s gone from non-performing to performing, the value may go up. It’s an actual snapshot of if you know what hit the fan and everything had to sell, we have a very good idea of what it’s worth compared to these institutions that hold things to maturity. The price is based on face value. If it was an 8% loan or a 3% loan, it’s based on what it was at that time, which would’ve two different values if they were to hit the marketplace.
I want to mention that a little bit because this is why we’re starting to see some of these institutions get in trouble. I’ve mentioned in the last episode as well why we’ll see more distressed debt on the market. It’s because if they have performing bonds or loans at low interest and they have non-performing loans, they’re going to want to liquidate those non-performing loans. They have to move those over to the balance sheet anyways to liquidate them versus putting them, selling something else and holding that debt, which is not their primary focus. Banks are not in the business to hold real estate assets.
The other macro thing we are starting to see is loans that are in lines of credit. It’s if you buy a house for $200,000 and it was worth $250,000. Over time, it appreciates, which most real estate has appreciated in 2018. In 2023, the house is worth $400,000. Instead of getting a whole new first loan that’s at a low-interest rate, they can go to a bank and say, “I want a line of credit,” which is a loan they can borrow against that equity in their house, typically up to 80%.
What’s happened during COVID as what we’re seeing is a lot of loans or these lines of credit were taken out and used to pay credit card debt during that time because credit card rates started to go up. Instead of paying 18%, 16% or 20% credit card, people were taking a line of credit at 5% to pay off in over 10 years and pay down that credit card debt to lower their payments. It seems a good idea because you’re borrowing money at 5% to pay off that credit card so you can lower and start saving more money.
What do you think happened? In a lot of instances, we are seeing the distress side. They’ve gone and got that line of credit but racked up more credit card debt. The Federal rate has increased, which doesn’t technically correlate with interest rates that are on ten-year treasuries but we’re not going to go down that path. When the interest rate is on credit cards, typically it’s more correlated.
People have gone out and spent that credit card money again. The rates on the credit cards have gone up. A lot of these lines of credit also have variable rates to them. Those are also increasing. They’re going back to the banks because they still have some extra equity to try and pull some of that money out. What are the banks saying? “No, we’re good. We’re done.” It’s because banks everywhere are tightening their belts. Lending is getting much more difficult to get in 2023 than it was in 2022 or 2021.Banks everywhere are tightening their belts. Lending is getting much more difficult to get today than it was a year or two ago. Click To Tweet
Think about that for a second. Getting a loan in 2023 is going to be more challenging than it was in 2021 because the Fed is pulling money out of the system. The banks are also tightening their belt. Another way to look at it is many of us have played the game Monopoly. You all start with a certain amount of money in Monopoly. If all of a sudden, everybody got double the amount of money to start with, which is essentially what we did by printing all this money the last several years, you buy a lot more and pay a lot more for that item because you could. All of a sudden, they’re pulling that money back out. It’s like, “I got to be more careful with this money because it’s not free-flowing.” That’s another aspect that we are seeing.
Let’s talk about how this impact 7e because it’s important to note. We do get asked a lot, “The banks are in trouble. Bank stocks are crashing. We sell shares. Does that mean our stock is going to go down? How does that impact our stock?” First, we tell everyone, “We’re not a bank. We don’t have deposits. We’re not originating loans at 3% or 4%.”
I was speaking to somebody trying to explain it in layman’s terms. The best way someone put it is, “You’re like a company that buys furniture. When you’re driving by and you see it going out of business, meaning they got to liquidate and sell it at a discount, you can then buy it, turn around and make money off of that, whether you create something new or resell it.”
I thought it was a pretty good analogy of buying stuff that’s going out of business at a going-out-of-business sale, then for us to repurpose it and acquiring it. For us on distress loans, work with the borrower to get them on some type of modification or program if we can, then turn around and sell that back on the secondary market to other investors.
I wanted to explain that to people because I thought that was important to discuss. There’s a lot of information flowing out there about what’s going on. Some of it is accurate. Some of it is not accurate. I want to let people know that for us what’s going on in that banking industry and them with these loans and so forth is something that will give us more opportunity in the future.
I hope all of this made sense to everybody. I do want to thank you. This is a wrap for another episode of the show. Thank you for joining us on this journey to unlock the full potential of your financial future. We hope these insights have opened your eyes to some new possibilities, helping you to take a closer look at your dream of generating passive income. Also, gaining control over your money and hopefully being able to secure a comfortable retirement.
As somebody who also has a 401(k) and self-directed IRA, I’m always looking for investments as well that have low risk and provide me that passive income. Always remember, the path to financial freedom isn’t a straight line but with the right guidance and mindset, you can make it a reality. Make sure to like us on your favorite platform, whether it’s Spotify or wherever you tune in to us. Thank you all. Have a good day.
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