Note Values: A Tale of Three Different Worlds

When it comes to your loan’s value, your loan can fall into three quite different tiers. The different tiers / worlds are completely distinct and command vastly different values. Inside of each of the three different tiers there are grades based on the type of loan and several other factors. Please keep in mind, all loans are extremely unique & this discussion is extremely simplified. This entire discussion revolves around the grading of the loan or pricing to the risk. There are numerous other scenarios that can affect the loan’s grade besides just collateral type. There are a high number of complexities that can not be covered in this article which can affect the value of your note. Additionally, this is my opinion of the market & all companies / note buyers have different criteria. The three different note tiers are as follows:

» Tier 1: High Quality
» Tier 2: High Risk
» Non-Performing Notes

Tier 1 and Tier 2 are generally separated by the quality / credit risk of the borrowers. A borrower with a decent consumer credit score (620+) will generally fall into the tier 1 category. Tier 1 has the highest value and by far the greatest number of willing buyers; thus, more liquidity and competition in the market. These borrowers are characterized as a borrower who could go to a traditional bank and take out a loan. Regardless, it will still be a requirement that the loan be performing with current property taxes and property insurance policy.

The note industry works primarily off the Time Value of Money. As of the date of this article, these tier 1 loans are typically purchased between a 10-12% yield, which has increased significantly due to the drastic increase in FED funds rate we have all experienced. Please refer to my other articles about the market and how the yield of notes purchased changes with market fluctuations. Let’s say you have a 30 year note with a 5% interest rate and the note buyer is willing to purchase your loan at an 8% yield. The discount you will see in your offer / quote will be the difference between your 5% interest rate charge to the borrower and the 10% yield requirement, spread out over the 30 years of payments remaining (less acquisition costs).

As stated above, the main different between tier 1 and tier 2 loans are generally separated by the quality / credit risk of the borrowers. Tier 2 loans are characterized by a borrower with a consumer credit score between 600-450 and they generally would not be able to obtain a loan from a traditional bank. These loans are harder to sell and will require a large discount to be sold. It is still expected that the property taxes and property insurance are paid and current. The credit score of the borrower is by far the best indicator of risk the financial industry has available. These loans have an exceedingly high propensity to be a problem loan, go through bankruptcy, become in default, or go through foreclosure. Wall Street would classify these loans as “beyond junk bonds”. For all these reasons, there is a limited number of companies that will purchase these loans; these loans are illiquid and a higher discount off the principal balance is typically offered with the purchase these loans. Some companies will not even send a quote on this tier of loan & definitely will not purchase them

Non-Performing loans are characterized as a loan that generally has one or more of the following issues: lack of property insurance, unpaid property taxes, past due monthly payments, bankruptcy filings, pending disputes, other defaulted terms of the note or Deed of Trust, etc. These loans are characterized as loans that are in default of the terms of their note and/or Deed of Trust & most likely will require legal expenses, extra work, have considerably more risk, and /or foreclosure proceedings. The value of these loans can sometimes be higher than tier 1, depending on the collateral value and loan-to-value, but generally company a lower price than tier 2 performing loans. There is a large number of note buyers that will not knowingly purchase these types of loans. These loans are generally purchased based on their liquidation value. A liquidation calculation looks similar to the following:

Expected Collateral Sales Price

– Repairs
– Sales Commissions
– Holdings Costs
– Unpaid Property Taxes
– Expected Legal Expenses
– Risk
– Profits
_____________________________

= Note Purchase Price

Knowing what type of loan you have or are trying to sell will help you understand why your loan is priced in which manner. Hopefully, your Note Buyer took the time to explain some of these nuances & did not simply mail a quote letter without an explanation. There is good reasoning for the pricing.