A new report by Semper argues that the U.S. economy is transitioning from a post-crisis, recovering market back into a normalized market, and that NPL/RPL investments “should disproportionally benefit from the increases in credit availability and home price increases that typically occur during these transitions due to the embedded structural leverage to these factors.”
According to Semper, the housing crisis and its immediate aftermath turned portfolios of clean, current-pay loans into “mixed bags of underwater, non-performing assets.” But this environment in the NPL/RPL market in turn allowed for the mortgage holders who preferred performing assets to transfer impaired mortgages to investors who saw opportunities through active loan servicing. Consequently, post-crisis changes in banking capital requirements compelled many NPL and RPL holders to reduce holdings of their assets on their balance sheets. This, Semper argues, created excess supply in the market, and that led to varied investment approaches‒‒private equity, hedge funds, and REITs, for example‒‒being set up to absorb that supply.
“Today, we estimate an NPL inventory of [roughly] $105 billion, compared to estimates of $35 billion prior to the financial crisis,” Semper reported. “However, not only is the supply of NPLs still well above pre-crisis levels, NPLs are still well over double historical levels, and the market continues to draw new supply from a steady stream of ongoing loan defaults within the outstanding universe of pre-crisis mortgages, as well as post-crisis origination.”
Semper argues that despite a recovering economy on its way back to normal, the need to effectively work out the NPL borrower base has not changed. Further, the company reported, these borrowers are being liquidated in a much more stable and functional credit environment than what we saw in the period immediately following the financial crisis.
“As certain players have exited the trade, the supply and risk reward profile remains,” the report stated, “but it is now combined with our positive outlook on housing technical and fundamentals.”
Semper recommends several approaches: NPL securitization senior tranches featuring 40 to 50 percent credit enhancement, coupon step-ups that limit the extension of securitizations (and, thereby, encouraging issuers to exercise optional redemptions); RPL shifting interest securitizations that center on heavily seasoned underlying loans that boast strong credit profiles; and NPL whole loans that allow opportunities to invest directly into an active asset management strategy based on the underlying credit, and allow investors to either highlight or reduce exposure to certain sectors or loan characteristics such as legal jurisdiction or property type.
“We remain focused on investments and liquidity within the NPL and RPL sectors and remain constructive on the fundamental outlook of the assets and within the investment strategies above,” Semper concluded.