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This week Bruce is joined by Jon R. Duario. Jon is the chairman and chief exective officer of Kondaur Capital. He founded Park Place Capital in 2001, and sold it to Ameriquest Mortgage Company in 2002. After the sale, the name of the business changed to Sprint Funding Corp, and Jon remained as president through May 2006. He received his Juris doctorate and Masters from UFC, and his BA Cum Laude from Harvard. He is also a fifth degree black belt in Tae Kwon Do.
This week Bruce is joined once again by Jon Daurio. Mr. Daurio is currently the chairman and chief executive officer of Kondaur Capital. Previously, Mr. Daurio co-founded Parkplace Capital in 2001, sold that business to Ameriquest Mortgage Company in ’02. After the sale the name of the business was changed to Sprint Funding Corp. John remained with Sprint as president, general counsel through May of 06. John founded Encore Capital Corp., a national wholesale residential mortgage banker. Mr. Daurio received his juris doctorate and masters from USC and his bachelor of arts degree cum laude from Harvard, and somehow in his spare time managed to get a fifth degree black belt in Tae Kwon Do.
Note pools most frequently involve a competitive bid situation, but not always. When a large pool of loans, or any pool of loans for that matter, is being sold, the seller typically will sell those loans. Most analogous to what I think people would understand to be a sealed bid, although it’s not literally in a sealed envelope or anything like that, so it is a competitive bid situation. Many of our sellers that we’ve dealt with repeatedly though will sell or deal with us on a negotiated trade basis, meaning that they’ll deal directly with us, and I believe they do that because we have proven ourselves over the last 3 and a half years that we’ve been in business and buying these loans to be if not the most competitive bidder meaning we’re paying the highest prices for these loans, at least the most experienced and, I’ll use the term easiest, purchaser to deal with because the purchase of these loans is not an easy procedure, and there’s tons of laws and issues that have to be addressed when a loan is purchased and servicing is transferred.
Its hard to imagine the infrastructure you have to have to do diligence on for a pool of loans, especially if it’s all over the country. That’s one of the reasons Daurio’s company has almost 500 employees and growing.
The way the market works, which is the majority, on a competitive basis, a pool of loans is given with information about the loans, the address of the house, the credit history of the borrower, the terms of the existing loan, the payment history, especially since I focus on non-performing loans, when the last payment was made, where those payments were made and you get what’s called an indicative bid. We at Kondaur as well as others give an indicative bid stating, “If all of the information that you’ve provided to us is true, this is what our price would be. However, we need to conduct a due diligence review of the loans in order to A. verify that the data that you’ve given us is true, and B. determine what other types of compensating factors or issues that could change what we offer for loans. I will note that Kondaur Capital Corporation is unique and has a reputation as being the nation’s only true loan level bidder, meaning when we receive a pool of loans; let’s say 1,000 loans, we give 1,000 individual loan prices and allow the seller to cherry pick us. Bruce was surprised to hear this.
Many of Daurio’s competitors are surprised when Daurio explains to them which loans he doesn’t like out of a pool of 1,000. For example, I might say, “Okay, well I like your prices on these 820 loans, but I don’t like it on this 180 loans.” Many of our competitors in that situation will say, “Well wait a second, we’ve gotta re-price because we assumed we were going to purchase all the loans.” And that’s in essence the difference. It’s that we do a meticulous, an extensive review of each individual loan to the point that each individual price stands on its own. So in answer to your question, ‘How long does that take?’ Typically that takes us between two and three weeks to complete.
This is not for the purpose of getting the indicative bid. The indicative bid is something that we do on a macro basis or a modeling basis that would give a price. And then the final price takes us about two or three weeks.
The value of a loan I would say is what a ready, willing and able buyer would pay for that loan, and because I am a ready, willing and able buyer, my purchase price is an accurate depiction of what the value of that loan is. And in turning the value of that loan, we spend a tremendous amount of efforts analyzing both what the expected sale price would be of the home securing the loan assuming that we’re going to take title to the house as part of the resolution effort which we do approximately 75% of the time. The (indistinguishable) majority by paying for a deed in lieu of foreclosure as opposed to foreclosing on the loan, as well as an analysis of what is the current credit situation of the borrower, which we determine with very little information available to us because during that bidding process we’re not allowed to contact the borrower. We have to rely on existing servicing and collection notes and the origination file that might or might not be available.
For every 100 loans purchases, Kondaur eventually owns the house as an REO about 75% of the time. For the other 25% of loan purchases, Kondaur is selling the loan on a one-by-one basis or refinancing it. With the available FHA programs, Kondaur could successfully do a refinance of the loan about 4% of the time. About 1% of the time the borrower’s actually able to come up with funds to give me a short payoff where Kondaur will forgive a fairly significant amount of the principle balance but they’ll be able to pay me. Or Kondaur will modify the note either by principle forgiveness and/or payment reduction, but in that situation Kondaur won’t hold it; it’ll still sell the note or it’ll sell it as is.
Kondaur sells 100% of the REOs that it takes title on, even after we’ve taken property back. As Jon said in the past segment, when Kondaur takes title to a house as REO it is very, very quick if there are people still in the house to go through any of the cash for keys process. Or, if the occupant won’t cooperate, an eviction process, and then Kondaur rehabilitates the property to put it in turn-key condition, meaning that whoever buys the house doesn’t have to put any money into the house in order to live in it, and then sell it. Typically, Kondaur has a REO off the books within about 3 months.
There are some opportunities for investors willing to come in and pay at a lesser price and close these things in a week. This prevents Daurio from taking the 3 month journey. But again, we don’t take cash because we have a need for liquidity. I’m very, very fortunate in this sense that my company is very well capitalized. We have access to well over a billion dollars of capital. But the reason why we do it is I am very pessimistic on a national basis and especially in the Inland Empire as to home prices in 2011 and 2012. So if there is an expected, which I think in the Inland Empire could be as high as another 1% per month decrease in the value of the homes. If I get cash today, it’s better than trying to get under contract in 3 months. This is a side note: we, with rare exception, will ever accept a purchase offer where the close of escrow is beyond 30 days.
FHA has about 555,000 people 90 days late or more, and they only have 50,000 current REOs. Daurio is interested in getting pools of loans that are able to be purchased from the Department of Housing and Urban Development. He is currently dealing with members of HUD. He is trying to figure out how we might be able to buy and/or service their loans.
Another thing that makes Kondaur Capital somewhat unique in this market, especially relative to other people that are buying these loans, is I require only two representations and warranties on behalf of the seller: that they own the loan, and that they can sell it. Meaning that if they breech either of those representations or warranties; they didn’t own the loan or they didn’t have the ability to sell it, I can mandate under contract that they have to buy it back. Things like title, what leans are on the property, I take upon myself the responsibility for determining that, and the way we determine it is rarely by a full-blown title insurance policy, but there’s a product that many of the title companies make available called an ownership and encumbrance, or ONE report, and that’s what we rely on for trying to determine what leans exist against the property or what the situation is with who really owns the property and how title is held.
We never buy a loan that’s in the MERS system. One of the things that we require before we close on the purchase of any loans is that the loans are out of MERS before we purchase them. From the day I started the company and built it we wanted it out of MERS. I won’t say I anticipated these kinds of issues, but I always want to try to minimize the number of parties that are involved and the resolution of the loan. One of the reasons why we do very few short sales is because typically in a short sale the borrower’s going to vacate the house by selling it, and we’d rather just pay them for a deed in lieu of foreclosure and then sell the house ourselves.
Daurio has noticed some attitude changes of the occupants in the 3 years that he has been doing this. This is because of the media making borrowers more aware that owners of loans, like myself, would be willing to pay them for a deed in lieu of foreclosure despite the fact that they haven’t made payments for months or even years. We’ve seen some people that are more amiable to take that because they didn’t even know it was available. Then we have some borrowers that because of the publicity of issues on litigation with respect to issues like modifications or MERS or the robo-signer issues or things like that they’re holding out. I guess there’s actually a third thing, and the third thing is that people are just making economic decisions that unlike what we offer at Kondaur Capital Corporation to a borrower to vacate, the borrowers are making economic decisions saying, “Okay, you’re willing to give me X dollars, but I could stay in my house rent-free for X number of months,” and the two don’t equate. So therefore it’s economically better for them to remain in their house rent-free than it is to accept what so many of my competitors offer which is simply a nominal amount of money.
There are many failed loan modifications within these pools. Potentially half of the loans I buy today are failed modifications. Bruce is very surprised by this. Bruce doesn’t understand why a lender would choose the pool method of selling as opposed to making it one at a time. He would think they would net more by doing this. Daurio thinks it’s more ignorance or purposeful sticking your head in the sand to avoid the issue. Let’s recall that there is a separation of the owner of the loan and the servicer of the loan. Many servicers of these loans are the same servicers that were granted the right to service these loans when these were performing loans and therefore the amount of money that the servicers are being paid to service the loans is woefully inadequate for the servicer to properly staff both in terms of quantity and quality of people. Quite frankly these servicers aren’t staffed to be able to service these loans on a one-by-one basis; and the owner of the loans, even if they get smart enough to realize that this is an issue, is unwilling to pay the servicers to adequately staff. This is not that bad of a decision because so many of the relationships are adversarial in the sense that a servicer typically makes money on servicing fees and therefore liquidating the loan is not in their best interest. But it may be for the owner of the loan. That’s why at Kondaur, we’re an owner servicer. We do third-party service for some, but those are the entities that understand and we actually make our self obligated to take the route that is the best for the owner of the loan and not necessarily for us. Daurio tries to align those interests in the contracts he has with them.
This round of foreclosures and not receiving payments is probably creating a lot more overhead for the servicers than they were anticipating. At Kondaur Capital Corporation, when we service with third party service, in our servicing agreements we really retain a tremendous amount of flexibility and authority to do what we think is best. In fact, I have not taken on third party servicing assignments where the owner of the loan wants to inject their opinion. In other words, they want to put a limit on how much I could offer for a cash for keys or for a deed in lieu of foreclosure based on things like a percentage of what the loan is worth or a percentage of what the house is worth or a percentage of the unpaid principle balance, all things which I think are irrelevant in determining how much should be offered to a borrower for cash for keys. What should be offered to a borrower for cash for keys should be the subject of two analyses. One, if the borrower were to make an economic decision and continue to live rent-free, what is that value relative to what is being offered? And then secondly, what is the benefit to getting the house quickly, especially when you are like I am where you think housing prices are still going to depreciate fairly significantly in the upcoming months and years.
Bruce just did some research on not just the pricing of California in terms of what homes are selling for, but the cost per month. Cal Poly Pomona does a report and has for several decades, and twice a year they reappraise the same address in many different cities in California. I went back to 1990 level pricing and compared it to 2010, and I’ll just pick Lancaster/Palmdale. The actual price is -11% for that 20 year period, dollar for dollar, not inflation adjusted. Interest rates were 10.2% in 1990, and interest rates now are say 4 and a half. So you have a 55% discount on the cost of a loan and you have income that’s increased. So it’s interesting that the market is so unwilling to buy a product that’s virtually on sale at an all-time level monthly.
Daurio agrees, but there are other situations in which, for an owner of a loan such as himself, getting ownership of that house can be faster and better. It’s not just because he expects housing prices to continue to deteriorate, but also because rent-free borrowers in the house are not expending money on maintenance, and so there is an increased amount of what we call deferred maintenance, which is a great cost. Thirdly, when we take title to a house by paying a borrower for a deed in lieu of foreclosure, the borrowers are not vindictive as we have heard borrowers have been in other foreclosures where they rip out the piping or cabinetry or plumbing or things like that. Most of Kondaur’s borrowers, nobody happy about the fact that they’ve lost their home, but they feel like they’re definitely treated better and better off than with their previous servicer.
Bruce feels that is a good point, because somebody can do an awful lot of damage in a bad mood in one day, no doubt about that. Daurio considers this sort of property damage to be criminal. Bruce has found it very hard for anyone to acknowledge that this might be true. We buy at the trustees sales, and we have sometimes people very blatantly doing things that were detrimental to the property. You can call the police; you can even go to the extent of a lawsuit and it would be very tough to justify the activity just because it doesn’t seem like you have too many people on your side.
Daurio believes there will be some different occurrences in 2011 from 2010. He see more loans going to default. Also, he see more loss severities, because he believes housing prices will depreciate more in 2011 than 2010.
Kondaur Capital Corporation will begin purchasing commercial loans. Daurio started a subsidiary company called Kondaur Commercial; and it is going to both third-party service and purchase initially small balance commercial loans. By small balance he means 5 million or less.
Kondaur Capital has purchased quite a number of land loans. It’s just not as large a market as one to four family or small balance commercial. Bruce thinks this would probably entail holding it at this point. Daurio disagrees saying, “No actually, again, it’s all of a function of so many things in real estate: you make money on the buy. We buy land loans when we think we have an exit strategy that is profitable.”
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