Reasons Why Small Funds Will Be Better for Borrowers (Post-Pandemic)
I like having small note funds. By small, we currently have about $4 million in assets under management, or about 18 non performing and re-performing notes. We plan to get to $25 M but that’s still considered small in our world.
We are small, nimble, quick to respond, and can think outside of the box, unlike the big guys ($500 M+) who are too big to pay enough attention to the assets that they need to and who are frustratingly bureaucratic to borrowers and anyone else they do business with.
Here’s why I’m so excited about our size and the upcoming opportunities we’ll see in the post pandemic era….
First, What are the Big Banks and Funds Like
Let’s start off by looking at what the big banks and funds are like.
These are some but not all of the descriptions of how big banks and funds operate:
Poor Customer Service
Make Mistakes Frequently
Take Took Much Time to Do Things
Have Too Many Assets
Slow Decision Making
Don’t Need to Make Big Profit on each Asset
Have you ever had experiences like these when dealing with your own Big Bank?
Problems Stem from their Structure
All of these issues stem from the way Big Banks are structured. I touched upon this when I wrote this article on why Judicial Foreclosures take so long.
Big Banks have the ability to raise HUGE amounts of capital. They are great at setting up processes for large amounts of accounts and making sure that their systems work under certain conditions. When it comes to non performing loans, their systems aren’t equipped to handle them in an efficient manner.
Systems Handle Performing Loans Well
Their systems can handle 100,000 performing loans in which the borrowers make their payments every month. Customer service call reps can handle routine issues from borrowers and most general inquiries have answers already mapped out for them.
Not Non Performing Though
Things turn tricky when the borrower has a situation that requires more attention, when their problem isn’t scripted or easily resolved. This is what regularly happened post 2008 and Big Banks got overwhelmed, made mistakes, and generally made a mess of things.
Anti Foreclosure Laws
It also led to lower public trust in how they ran their business and foreclosed, especially when they made egregious mistakes. This resulted in a myriad of laws to put in additional protections and safeguards to prevent Big Banks from wrongfully foreclosing. As a result of Big Banks’ shortcomings, in some states there are laws that require mandatory mediation, single point of contact for the borrower, and no dual tracking.
To us, it’s extremely frustrating that so many steps have been added to the foreclosure processes in some states because we operate completely differently but I understand why politicians pushed these additional restrictions.
They’ve worked but only because they’ve added extra bureaucratic layers that can help catch mistakes. The other result is that these delays apply to all lenders, regardless of how well they do business, which slows down the foreclosure process for everyone which delays the economic healing that occurs when necessary foreclosures happen.
The fundamental part of the structure that leads to these inefficiencies is compensation. Bank employees are hourly or salaried employees whose compensation is not tied to any particular asset. Their primary motivation is to keep their job and continue getting their regular paychecks. To keep their jobs, they do what their bosses tell them to.
Their bosses have their own goals and performance metrics laid out for them by their bosses. They are typically concerned with the portfolio as a whole or other higher level metrics and not concerned with any particular non performing loan.
What’s a distressed borrower to do when no one really cares about their particular situation? Unless the borrower’s situation fits inside the box of that particular Big Bank and what it has already decided it can do, he or she is out of luck.
Another result of incentive misalignment is that the foreclosure process is slowed significantly. Foreclosures consist of a series of sequential steps that can take months or years. Any delay in a particular step will stop the whole process until it’s resolved.
When the incentive of the employee is to do the bare minimum on a task, all they have to do is check on the progress of the task assigned to another. When that other person (possibly another employee at an attorney firm with the same misaligned incentives) says that the task hasn’t been accomplished yet and to check in next month, they have both successfully done what’s reasonably required of them and can move on to the next task.
How about Smaller Funds Like Ours?
For a small fund like ours, that level of effort is unacceptable. The bulk of our compensation is directly tied to the performance of each asset so we have a completely different sense of urgency. We track every step in the foreclosure process and follow up consistently until each task is completed and do the same for each remaining step in the process until the foreclosure or other loss mitigation effort is completed.
Speed of Execution
We become the squeaky wheel that gets the grease. Most of the time, it’s actually easy for us to get tasks done more quickly because most outside employees appreciate the speed at which we work. They can get their task accomplished and off their plate quickly instead of having tasks that linger because their opposite counter part at a Big Bank is dragging their feet or can’t get a decision from a higher up.
With all of the economic distress related to the coronavirus lockdowns, we believe that we’ll see an increasing number of defaults over the next 6 months to 3 years.
The biggest tool that lenders have used thus far have been forbearances. (I predicted this in my blog post of coronavirus predictions.) As state economies open, those that needed forbearance help will hopefully recover, catch up on their mortgages, and avoid default.
There will be those borrowers out there, however, that won’t be able to. For so many different reasons, there will be those that just can’t catch up and will find themselves in default.
Performing Mortgage Loan Funds in Trouble
We believe that the next big sources of non performing notes will be mortgage loan investment funds that buy performing loans and use leverage to amplify their returns.
They’ll have less income that will make it harder to make their debt payments and will be forced to sell.
When this happens we expect to see more COVID related defaults as opposed to the regular delinquencies and the borrowers that have barely managed to hang on since the 2008 Financial Crisis. It will probably take 2-4 years for all of this to unfold and for these non performing loans to come to the secondary loan market. We’re used to seeing and buying loans with borrowers that are severely delinquent and are trying to stay in properties for us long as they are able to while paying the least amount that they have to.
Sympathetic to Plight
To me, the situation will be a lot different when we’re dealing with borrowers who were paying for years on a mortgage and then all of a sudden had problems because of the coronavirus lockdowns. The shutdowns were out of their control and has and will cause economic havoc for some time.
When these loans come our way, we’ll be in a position to help. We are real human beings that will help our borrowers to get caught up and stay in their homes. We can think outside of the box. Our borrowers have never been just numbers to us.
We can handle each situation individually and give it the attention it needs. We don’t have the rigidity or the uncaring bureaucratic structure of the big banks.
That’s what excites me: Being in the perfect position to help people and our economy recover from mortgage related problems due to the coronavirus lockdowns.
Andy Mirza is the Chief Operating Officer for Coastline Capital Fund Management, LLC, a company that creates and manages funds that buy, sell, and liquidate residential non-performing notes (defaulted mortgages).