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Thursday, October 7, 2010

The Private Mortgage Lending Industry - A CPA's Perspective


High quality loan opportunities now available for mortgage pool lenders
The health of real estate lending has been a closely-watched concern in 2008 as the residential subprime mortgage market collapsed. But it’s no longer only brokers, builders and potential borrowers paying attention — it has become a hot topic for investors looking for a safer place than the stock market. 

What those investors will find is a private equity corner of the lending market that has tremendous opportunity, but has been hampered by the economic slowdown and lack of investor confidence.

Essentially, a year of intense media coverage on the collapsing subprime mortgage market has kept many investors away from all forms of real estate.

A problem with that general observation, however, is that it overlooked an investment opportunity: the private mortgage pool market, where private equity is pooled and lent.

Having been in public accounting for more than 12 years dealing primarily with financial services clients in the mortgage lending industry, I continue to be amazed at the magnitude of mortgage pool lending that occurs in the private sector (i.e. using private investor equity rather then conventional lending resources).

Although the subprime failures have had a clear negative impact on real estate values, one positive impact on the mortgage pool industry from such failures is the abundance of high quality loan opportunities presented to each and every mortgage pool manager out there. As the conventional lending world continues to ratchet down its underwriting standards, making it increasingly difficult for borrowers to get a conventional loan, many, if not most, of the well-qualified borrowers are being turned away.

So where have these well-qualified borrowers been turning?

They are turning to the mortgage pool industry in droves. The mortgage pool industry is one predicated primarily on the underlying collateral of a loan with loan-to-value (LTV) ratios that typically do not exceed 70 percent. Private equity is lent at interest rates above prime — today ranging from approximately 10 percent to 18 percent — in exchange for far fewer regulatory hurdles. The LTV limits are distinctly different than the subprime 100 percent LTV lending that took place for many years which, coupled with declining property values, became the formula for the current subprime market failures.

Many of our clients are telling us that they are being presented with some of the best loan opportunities they’ve seen in a decade: lower LTV ratios and the high-quality borrowers that would have typically borrowed through conventional lending channels.

In fact, our mortgage pool clients are telling us that they are seeing 50 percent to 100 percent increases in loan demand over the last couple of months.

Though that’s a significant spike caused by the current lending environment, the mortgage pool industry is accustomed to seeing growth as investors and borrowers have been flocking there at increasing rates for several years. At our firm, we have seen our mortgage pool practice grow at an average of over 100 percent annually for the past three years. In fact, the mortgage pool industry has seen hundreds of newly formed mortgage pools enter the private equity lending arena over that same time frame.

But the current problem has been that the mortgage pool managers can’t capitalize on the increased loan demand. Certainly they’ve been hurt by nonperforming loans just as the rest of the mortgage industry. But the real limitation has been a lack of investor confidence in real estate that has slowed investor contributions to their mortgage pools. The subprime market failures and drumbeat of negative press on the economy has private equity investors nervous.

This nervousness exists despite returns from private mortgage pools that are, in general, still good. Funds with a concentration in commercial loans are still yielding double-digit returns.

So, it seems as though the mortgage pool industry is in a state of flux. Great loan opportunities are being presented to mortgage pool managers daily, but their ability to fund these loans is stymied by investors sitting on the sidelines with their hands in their pockets waiting for the media to tell them that real estate is a wise investment again.

While I am certainly not an investment advisor, nor am I giving any investment advice in this article, I still believe real estate to be one of the soundest long-term investment options available. If there are high-quality loans to be funded that will improve the characteristics of a mortgage pool’s portfolio (i.e. increased diversity, lowered overall LTV ratio, etc.) and increase investor yields, I would continue to consider the mortgage pool industry a viable investment option.

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