Much has changed over the past 18-plus months in not only the seller finance industry but the mortgage acquisition market as a whole. Back in the “good old days” an investor’s pricing philosophy was pretty straightforward. It was really very basic. Three key factors drove pricing: credit, equity (LTV), and seasoning.
Investors would evaluate these three key factors both independently and together on each deal. Strength in one or more of the three factors could outweigh significant weakness in another factor. For example, a deal with weak credit (590 FICO score) loan has 36 months seasoning and a 75% LTV, the strength of the seasoning and equity helped offset the credit risk involved. Therefore pricing would not get hit as hard as the credit would indicate. Or on a loan where the credit is extremely strong (725 FICO score) which was a relatively new loan (only 2 payments made) and only 10% cash down would still bring a strong price offer. Why? Pricing models predicted that borrowers with credit in this range default at a very low percentage.
Today’s market can be summarized by one word: “Disconnect”. Disconnect is defined as an unbridgeable disparity, as from a failure of understanding. Currently we are faced with such a disconnect between the “bid” price and the “ask” price that very little product is in fact trading at all.
The pricing models have evolved ten-fold over the past year and a half. Sure in the past there were other factors that affected pricing, such as the property type, the occupancy status and the interest rate. But now the factors are extensive.
It is now imperative that pricing models do a much better job of “predicting” the level of risk prior to acquiring an asset. In todays market environment it is more important than ever to identify and evaluate risks and then select and manage methods to adapt to such risks. Risk management is the process of analyzing exposure to risk and determining how to best handle such exposure.
So what factors impact the risk of potential loan trades? The obvious factor is credit. While the credit score of the borrower is a definite indicator of the risk associated with the loan, current models go much further than just analyzing risk based on the credit score. The credit of the borrower is weighed along with the loan-to-value as well as the combined loan-to-value and the seasoning on the loan to help forecast the “frequency of foreclosure.” In other words: statistical analysis is done to determine how often a loan with a 605 FICO score and an 80% LTV, a 95% CLTV with only 5 payments made tends to default and go into foreclosure. This frequency of foreclosure ratio directly impacts the price of a loan.
The property location as well as the housing trends in that market also impacts the risk in several ways. House Price Index (HPI) data is used to examine the relationship between the stated loan-to-value and the current market supported loan-to-value drilled down to the zip code. The term “declining market” has become a household word for almost two-thirds of our country. These declining market trends add to the risks, and subsequent reduction in pricing, involved in acquiring loans in these locations.
What is it going to take to “correct” the market? Well first of all if I had that answer I would be a very popular and well compensated man. Popular opinion believes the first step must be the stabilization of the housing prices. The government is currently trying to finalize the financial-system bailout plan to address falling home prices which is key in ending the financial crisis. The concept of a public/private bank structure (similar to the old RTC) is also an option being discussed to help set floor values on certain assets in order to get deals trading again. Perhaps this will help resolve the disconnect facing the market today.
The Buyline 