Jeffrey Bernstein

Is the Legacy Loan Program Doomed to Fail?

The question of unintended impacts is undoubtedly a good one regarding all these new programs. But to gain a little insight into what is to come with whole loan sales, just look at the federal reserve data on bank loans. Residential real estate loan delinquencies have blown through the highs of the early 90s and are on a ballistic trajectory. These are loans where the owner has stopped paying interest and principal. (Charge-off rates are also following suit and much more rapidly than in the 1990 period, probably due to less equity in properties and the economic slowdown, keeping borrowers from recovering and banks being quicker to charge off the loans) Where should delinquent loans be valued? If they were traditional 80% LTV loans, in the absence of plunging real estate prices somewhere in the 90 cents + on the dollar range would be a reasonable start (statistically, some of these borrowers will start paying again and eventually pay off their loans and penalties, while those resolved through foreclosure have high frictional costs of dealing with a foreclosure sale). However, with real estate prices down 10 to 40% nationally and a large overhang of supply, one must be much more sanguine about "severity" of losses. My guess is the whole loans that have gone delinquent should be valued at somewhere in the mid 70 cents per dollar or less, for an investor to take them through the foreclosure process and get their money back plus a return. Now maybe there are a bunch of "legacy loans" that aren't delinquent yet, but banks are worried about, that they would like to get off their books. How do you value those? My guess is with the trajectory of delinquency as sharp as it is buyers will look at individual "worrisome" loans as delinquent loans - what other rational approach is there. You could buy a large portfolio of these still performing "worrisome loans" and factor in a big margin for future delinquencies above current levels to diversify your risk. But the bottom line is there is huge pain to come which the banks can't afford to take and in most cases the debt needs to be expunged through foreclosure so a buyer can buy the asset from the bank or debt holder at a haircut that truly makes sense, because delinquencies are soaring, and delinquent loans will not become current again in large numbers. We are not talking about corporate debt, bought for a discount where the borrower recovers eventually. We are talking about delinquent loans that need to be liquidated, or loans that look questionable in a world of soaring delinquencies, that have some high percentage chance of being liquidated.