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Inside The World Of Non-Performing Notes

October 23, 2024

chrisseveney

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Creating Wealth Simplified | Non-Performing Notes

 

Chris Seveney discusses how he navigates the world of non-performing notes and everything that goes on in the life of a note investor. He breaks down the three key components of asset management and how you can deal with each one the right way.

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Inside The World Of Non-Performing Notes

For this episode, I want to talk about navigating the world of non-performing notes and what we do daily with our portfolio so people understand what goes on. What’s a day in the life of a note investor running a fund that’s buying, selling, and managing these mortgage loans we’re acquiring? Before we get into that, I do want to talk a little bit about, just for people who haven’t read in the past, define mortgage note, what it is, why we beat by a non-performing, and a little bit more about a regulation A+ offering where investors can invest with as little as $5,000. That money goes into the company, which the company then takes those funds to buy a portfolio or single assets.

We mix it up with performing and non-performing loans. We mix it up because we want that portfolio diversification for us, which we believe is an attempt to try and mitigate some of that risk. If you have all non-performing loans, it’s like having all high-risk something that your variations could fluctuate where you always want that mix. I want to start with that and first dive into non-performing loans and what is a non-performing loan, which somebody is not paying on the mortgage.

All the assets we buy are backed by real estate. We don’t get into credit card debt or student loan debt. We stay away from all of that information. We focus on mortgage loans. It’s something that’s secure to buy a property. If the borrower ends up not performing, we can go ahead and start the process and potentially exit through the property versus through the borrower, which is our preferred method. If you want to learn more about our different exit strategies, feel free to go watch some of our prior webinars. We talk a lot about those exit strategies that we have.

On a daily basis, managing a portfolio of loans is not easy. I’m not even going to talk about our investor relations side of things. That team works in regards to making sure our 700-plus investors’ questions are answered or they’re getting their distributions on time. We’re answering questions for people who are interested in potentially investing with us. That’s a whole separate segment of the business.

I want to focus just on that asset management side. There are three key components of the asset management. There’s one, our acquisitions, which is acquiring assets that I’ll talk about. Second is the actual asset management of after you acquire the loan. Third is the exit strategies and disposition of the loans. 

Creating Wealth Simplified | Non-Performing Notes

Non-Performing Notes: There are three key components in asset management. First is acquisition, second is the actual asset management, and third is the exit strategies and disposition of the loans.

 

Acquisition

Let’s talk about the acquisition side of things. Every quarter for 2024, first three quarters, to give an idea, we have seen approximately $5 billion in loans. Think about that for a second. We’re through three-quarters of the year. We’ve seen probably about $15 billion in loans. On average, we’re buying $1 million or $2 million a month in loans, plus or minus. Think about that in the sense of $1 million to $5 billion. For us, we see plenty of opportunity. The challenges, how do you go about selecting the right deals?

That is something that, as somebody who invests and if you’re looking to invest, the question you should ask is, how do you source your deals? Not only how you source the deals but how do you choose the right deal? This is very important as a fund to make sure it’s a balanced portfolio or choosing the right deals. For us, we do a process, which is called cherry picking. We will not just look at a whole tape and then say, “We are going to bid X amount of dollars without looking at every single asset.”

That is one of the differentiators we hold against some of our larger competition. They don’t have the manpower, the time, or the staff to go through every single asset. For example, there’s a loan pool that has over 2,000 assets that is bidding. We can’t put 2,000 assets. That’s $750 million. We went through and sourced select areas that we want to and then we target specific assets that we want to target as part of that. For us, it’s being extremely focused is what we want to look at.

We also see other pools of assets. Now, we don’t try and force the issue on these loans. “Chris, what does that mean, force the issue?” To me, I read that is taking additional risk. For example, we saw some loans. We made some offers and they came back and countered. If the property were to go down the foreclosure path, it would be a good deal, but if the borrower who was only four months behind turned around and got caught up and made those payments, it would be a bad deal. You might ask, “Chris, how is it better in some instances of foreclosed and take the property back?”

Here’s the reason why. The loan was modified to a 2% interest rate or it was written at a 3% interest rate. In certain states, you can foreclose in 90 to 120 days. If you’re buying it at a 20% discount or 30% discount, it makes sense. Let’s take that loan as if it was only four months behind and they turned around and made those four months’ payments or file bankruptcy and you’re only buying it at a $0.70 on the dollar. It doesn’t make sense because your return on that asset, because it’s got a little bit of a discount, but you’re buying alone at 2% or 3% essentially, it’s going to crush your long-term plans.

The borrower is never going to refinance. It may sell, but you’re also not going to be able to sell that loan. Think about what happened with Silicon Valley Bank. Now, they had all these bonds and everything at 2% and 3%. People wanted to get all their money out. They had to go sell these bonds. Who wants to buy a bond at 2.5% when the bond market is at 4.5%? They had to significantly discount it. It hurts their numbers. A typical acquisition after we go through and cherry pick is, as a team, we will go through an initial round of selecting ones we want to target. We’ll put numbers to them.

It’s all part of due diligence, where we look at as much about the person, the property, and predicament. We’ve got episodes on how we do all of that. I want to stay high level. People who know me are probably laughing. I never stay high level. Through the assets, we put numbers to them. As a team, we have an acquisitions investment committee team that we meet once a week. We review the numbers and go through and ask questions with each other. Put a final score to that asset and determine are we going to bid this or are we not going to bid it.

That is the process that we have as part of that first phase. If an asset gets a bid accepted, then we go through a whole other process of what’s called the go, no go, which is an NC Excel spreadsheet. We put all the information down and where this comes in handy for me as CEO of the company. Our team members put this together. When we have our second round of investment committee meetings, I can look at the spreadsheet. I don’t have to go through all the notes and go through everything.

We’ve already had the title review by attorneys. We got BPOs. We’ve got everything we need. It’s just the checklist of, “Here’s everything we know.” We score that loan based on a 0 to 100 and if it doesn’t meet a specific score profile based on our target return, we say yes or no, and we make a final decision. A lot of interaction within the team, eyes looking at the asset, and questions that get answered. What happens if this or that?

The context is very communicative and working together as a team to go through because sometimes, somebody else picks something up. We keep great records of everything we do in every situation and scenario. We have this process down pretty well. We’re always constantly having acquisitions going on. We meet every week to go through now all the acquisitions that were having.

Asset Management

Now, let’s shift over to the asset management side. We’ve acquired the asset. How do you manage these assets? Larisa, who is a team member, now handles all the day-to-day. What does that mean? What’s a day in the life of Larisa? I used to do this and manage large portfolio while working W-2. I know this is not an easy assignment or easy task because Larisa is constantly dealing with servicers or the people collect the money. Answering questions, borrowers who are behind, and want to make a partial payment, eo we accept it? Do we not? Loans that are in foreclosure, bankruptcy, or some form of loss mitigation.

Having the communication of let’s get a forbearance or draft a forbearance. Make sure it’s reviewed or foreclosure, chasing attorneys and making sure they’re staying on top of the paperwork. While investing in notes is slow like watching the grass grow, now it’s like 30-day increments of things typically happening. People pay their mortgage or like a demand letter is 30 days. You want to make sure you stay on top of these people, whether it’s a service or attorney or whoever it is, because 30 or 40 days will pass and you think they’re doing something. They’re not. They’re not setting a reminder. They’re just wondering, “We haven’t heard from the lender, so all must be good.”

It’s always important in asset management, you are the manager and you are in control. A perfect example I’ll share, there was a post I saw online where somebody asked the question of, “What is the service they’re doing in now areas that were struck by the hurricane in North Carolina?” We’re doing this in October 2024.

I chimed in. I’m like, “What do you expect them to do? You are the lead. You’re the manager. You’re paying them a specific amount per month to call the borrower and collect the payment. That’s what they do. If there’s no power or anything, what do you want them to do? If you want to pay to have somebody stopped by the property, they’ll arrange that for you.” They do what you’re told. Think of it being like AI. You ask AI a question, and it’s going to respond, but it’s not going to magically just tell you out of the blue like, “You should do this,” without you prompting it.

You have to prompt the servicer to perform a specific task if you want it done. The same thing with the attorneys and title companies. As part of this asset management, it’s not you just sit on your hands and wait. You get to be very proactive working with all the vendors. There are many more vendors that your service or your attorney. If you take properties back, there are REO companies, which we’ll talk about dispositions.

There are title companies because you might be ordering title reports. There are BPOs where you’re ordering price opinions on properties. There are door-knockers where people knock on the door. There are the bankruptcy trustees and your bankruptcy attorneys. There’s a lot of individual players. Some loans can suck up a lot more of your time in regards to a lot of back and forth to attorneys. There’s also the paperwork side of making sure all your paperwork is in order.

There’s a collateral custodian recording all the docs. There is a lot going on. Think of this person as like the project manager on a construction site, if you’ve ever been a part of any renovation. They’re the ones managing all the subcontractors which is what an assessment manager does on a loan while it’s non-performing. What this person also plays that role of is thinking of them as that project manager. They’re all so playing the role of assisting on the acquisition side. They’re helping you buy the assets as well.

Disposition

Lastly, there’s that disposition side, which a lot of fund managers, from what I’ve seen, this is the area where they don’t put the most attention to. I find this to be extremely important to understand. As a company that manages a fund, investing and performing in non-performing loans, there’s a specific churn of assets coming in and assets coming out the door that you need to do.

If you want to maximize your revenues and your profits, you need to know when it’s time to give up on a loan and also know when it’s time to sell a loan. Let’s take loans that are non-performing that you’re stuck in litigation. We had one in New York that we sold because we know it was just going to continue to get stuck. We sold it. We made money on it. Did we make what we wanted to? No, but the longer we held it, it was going to burn a bigger hole in our pocket.

The other is after you get a borrow or reforming and they start paying again, they’re 6 to 12 months payments, uou want to churn that loan. You want to sell it to an investor as a reforming loan. Hopefully, you’re confident that they will keep paying that loan, then use that money, then reinvest and maximize area profits on that one to get another one and rinse and repeat.

I wanted to share that because that’s something that people always focus on the acquisitions because that’s the sexiest part of note investing. It’s, “I’m buying this loan. I got this loan.” The easy part is buying. Managing and getting rid of it is the hard part. That’s honestly where you make your money. I know everyone says you make your money on the buy. In notes, you’re going to pay me versus somebody else. It’s probably going to be pretty close. Let’s just screw up that number and like a preset. You’re going to go to the store and buy a gallon of milk.

People always focus on the acquisitions because that is the sexiest part of loan investing. But buying, managing, and getting rid of it is the hard part. Share on X

You can go to three grocery stores, but a gallon of milk is cost is the cost. What you do with that gallon of milk to maximize its use is basically where you add the value. That’s where asset management and disposition in note investing come into play. That’s where we have a great advantage based off of our team and our people. I wanted to mention that because, again, people always focus too much on that acquisition.

What do you have to do in the disposition side of things? There’s a lot and sometimes considered painful, especially if you have an REO. We use a third-party company to help us liquidate it. It’s not often that we do any type of renovation on a property, but we do it on occasion. That person again now acts as a project manager managing that disposition and making sure that, as an REO, they have an agent lined up. The grass is still getting cut and the property is still within its phases. If there’s a price reduction, they’re working on that.

If you’re selling a loan, they are responsible for collecting the bids, reviewing the bids, and analyzing the bids. Providing all the due diligence documents to the buyer. Putting together the contract. Putting all this stuff together and then making sure after it’s sold, the money comes in the door and servicing transfer goes well. As well as getting all the documents that the buyer is going to need from your company in order to record that loan.

In foreclosure, which is probably the most stressful, which is working with the attorneys and making sure they have all the proper documents and it’s going to sale. There’s no hiccups. Making sure we’ve got the right numbers we want to bid on. They put together a nice spreadsheet understanding what do we want to bid on this asset. If it’s a $100,000 payoff, do you bid $100,000 or do you bid $80,000? People will say, “Why would you bid $80,000?” The answer is, if I take it back at $100,000, then I have to pay a transfer tax, I’ll have to get an agent to list it. I’m not going to pay property taxes and insurance.

I’m going to spend $10,000 easily in the blink of an eye. It’s probably not going to sell for $100,000. Whereas if it sells for $80,000, I’ll have to worry about any of that. $80,000 may end up netting you more than $100,000 does and this is that game that you’ve got to play and balance out of to try to maximize your value without over-inflating your number that cause more work for you and also provide you less income.

Episode Wrap-up

I know I rambled off a lot about a day in the life, but these are all the things that are constantly going through our heads every single day. For example, right before this episode, I looked and got an email that we were negotiating with a seller. There are some title issues on the loans. Our attorneys and their attorneys are trying to go back to get this resolved. It’s like that ping-pong back and forth.

We’re trying to say, “Let’s just get on a phone call. Let’s go back to the 20th century, where people use these things called phones. Not just electronic devices that send messages but something you can speak with.” We probably would have had this resolved and then we will probably close on the asset. Another thing we’re looking at is that we have two loans under agreement in Florida. Now, as I’m doing this, there’s a hurricane hitting Florida. I’m not sure which area it’s going to hit but now it’s additional due diligence that this person or our team is doing to make sure that’s all taken care of.

The best way to explain a day in life as I wrapped this episode up is every note the investor goes into the day, but I’m not sure what that day is going to be. You can’t have a list of 5 or 10 tasks you want to be or want to have. One little thing from an attorney or an email or something, just like a snap of a finger, completely throw you in a tailspin and you have to drop what you’re doing and tackle this other issue. That’s why I love this business. That’s what my real estate career has been. I was in the real estate side for many years. That’s what it was. You go to work hoping you get certain things done, or you know you have certain meetings, but in between those meetings, you have no idea.

I hope this sheds some light on a day in the life of a mortgage note investor when you’re working in operating on a fund. As always, please leave us a review on your favorite station, on iTunes, Spotify, or Amazon. If you want more information about us and our offerings, make sure to visit us at 7EInvestments.com. Thank you all. Take care.

 

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