Due Diligence and Credit Report For Investing In Notes

Due Diligence and Credit Report For Investing In Notes

Livecast #


In this episode we cover how to read credit reports as well as routine due diligence we perform before buying a portfolio of non performing notes.

Ron Happe: Good morning everybody, welcome to the live cast today, excuse me. Today we're going to start another series of educational live casts, these are going to be on due diligence and we're going to start with, primarily, reading a credit report today. I will start out again by indicating our disclaimer, this is for informational and educational purposes only, we're not trying to sell you any securities, we're not trying to sell you notes, we're not trying to do anything but provide you with some education today and we're just going to get started here. 

I've got an introduction to make and then I'm gonna turn it over to Brent [Stafford 00:01:04], Brent is our Asset Manager and Brent does a lot of things for us. To give you a little background, Brent has a 15 year history of being a mortgage broker, owns his own mortgage broking company. He does a lot of things for us, he's involved in talking to firsts a lot, helping homeowners do modifications, helping homeowners speak with their firsts to do a lot of work, to help them out so that our seconds that we buy are more valuable. Another thing that he does is work with the first to see if we can buy their first after we own the second. He's very well versed, he does a lot of our due diligence in the realm of credit reporting, in looking at credit reports. 

One thing I will say is that when you get into this business, especially if you're buying seconds, you need to be able to check credit and you need to be able to check it frequently, because if you have a delinquent second, you need to be aware of what's going on with that first all the time. In our procedures we check the first, we check the credit report to see the status of the first every month if that first is delinquent. If it's not delinquent, we check the credit report every three months, because we want to be sure that the first is not going in a position to foreclose, we want to be the first to foreclose. 

I'm going to turn the presentation over to Brent, he'll take over and explain the credit report to you. Brent, say hello.

Brent S.: Good morning, everybody.

Ron Happe: We'll get started.

Brent S.: Hello, everyone. We're going to get the information up on the screen here. I'm going to over some information about credit reports with you guys, the first thing we wanted to do is get some information to you on some different codes that you're going to see on credit reports to get you familiar with what you're looking at. We included a chart here that's going to give you a good breakdown of all the different codes. This is in the ECOA section, which we'll show later in one of the other screenshots.

This is just telling you exactly what the type of accounts are, what they're designated as, we can go through and read it, but this is something that you guys will have, you can go back and refer back to. I'm just going to give you, like I said, some information on what type of accounts these are.

Ron Happe: Can I input something here, Brent? I see at the bottom of this one it says Equifax, can you just brief us on the Credit Reporting agencies, who they are and that they may see some other name?

Brent S.: Sure. Equifax is one of the major bureaus, you also see TransUnion and Experian. We pulled some information for you, this was something that Equifax had available on their site to share with everybody to give them an explanation of what they're seeing. This is stuff that you can find out there on the internet.

Ron Happe: Okay, great. All right, here we go.

Brent S.: When you're looking at a credit report, this is generally a first page of the bureau, what you going to see up at the top is usually your own information, your name, address, that kind of thing, this is going to be followed by the applicant's information or the borrower's information. In this case we obviously had to black out everything, bear with us on that, bellow that you're going to have the applicant's credit score, if you're pulling [inaudible 00:04:57] model. That's going to give you a breakdown of what the actual number is, what that bureau's range of scores are and what the factors are, when you see these things bellow and down there, those are the factors or the reason for the score that you see. What the actual formula is and how they get there, that's a big secret that nobody has the answer to. We just know that these are the factors that are calculated in that score of 625 that you're seeing there.

Ron Happe: That range then is 320 to 844 is that basically what I'm seeing up there that an Experian report would say that the score would be somewhere between 320 and an 844, is that correct?

Brent S.: Correct, They are all going to be roughly the same. 

Ron Happe: All right. Okay. Before we go any further, this one here you said was what? Six?

Brent S.: 625.

Ron Happe: All right, 625. Can you give us an idea of what 625 is? When you're underwriting mortgages, can you give us an idea of what is a 625 versus an 844, how do you rank those?

Brent S.: In the mortgage world, when you're looking at underwriting a loan, a 625 score is going to be kind of an entry level score, really, it's a lower to middle range score, excuse me, the FHA stuff that you're going to find or the Fannie and Freddie stuff, the scores can get bellow 600, but generally a lot of the loaners have gone to scores [inaudible 00:06:37] the 640s. 625 may be a score that could limit some of your ability to borrow.

Ron Happe: If we were primarily hoping that, at some point, we could have this homeowner refinance, would a 625 credit score, enable them to refinance their second, provided their first was current, of course, or refinance to get the first and the second combined if there was equity in the property? Would 625 allow him to do that? If not, where do you think that they need to be just so that the people that are listening know that that is an option or it isn't an option when they're pricing this tape?

Brent S.: A 625 can get you there. Especially with some of the programs they released to assist some of the homeowners with some relief, 625 can definitely get you where you need to be. Probably not on a standalone second, but probably in a refinance situation where they can go in there and do a complete transaction, including the first and second.

Ron Happe: Great. Sorry to interrupt, but I think that's kind of important when we're doing a due diligence for, maybe, pricing the tape. We certainly want to know if refinance is a possibility.

Brent S.: When we go down to this next section, this is a breakdown of what you're looking at within an account on a credit report. You'll see the red boxes that we've highlighted, on the right is the ECOA box, which is the reason why we gave you that breakdown earlier. What that indicates to you is what type of account is this and how is the borrower associated to it.

In this case you'll see there a J and hyphenated by a B, what that means is this was a joint account and they are the borrower or primary borrower. This particular credit report here is an Experian credit report, XP is the source, they all have their unique code. Then you have the creditor's information. Our credit reports here are broken down pretty well in that, they lay it out for you pretty easily and they give you a breakdown of what you're actually seeing in each box. I highlighted the next one, where it says account type MTG, because that's another abbreviation that they're going to use, MTG for mortgage, you'll also some on there that'll be an REV for revolving, you might see [inaudible 00:09:18] at the very bottom where it says AUTO, these are just some different abbreviations that you're going to see to tell you what type of account that is.

Ron Happe: If we were looking to see what the first was doing, can you give us an idea by looking at that first line there? What are you saying that you would be looking at if you were concerned whether the first was current ... I see there that the original balance, the current balance, can you just tell us what you see?

Brent S.: Sure. You're looking at the original balance on there and also gives you a couple of the things that are important that you want to see, which is the date that it was opened and the date that it was reported. The reported date is something you're going to want to look at a lot, because oftentimes some of the creditors, especially in the mortgage situation, are not reporting on a monthly basis. You'll want to make sure that you're taking look at that date reported so that you know you're getting fresh information.

In this case you'll see that it has their payment information there and how far past due right bellow that, we know that there's a zero past due on this particular mortgage. This is a pretty fresh report, this was freshly pulled, we know that it's current. The boxes that you'll see highlighted on the right are actually ... The reason I want to point those out is because that how you're going to know what you're looking at. You're seeing a box there that's got 30, 60 and 90 day ranges, you'll see that there are zeros indicated, there's nothing indicated in any of those boxes, which means they have not fallen behind on the credit report.

When you see, in that box next to it, the item is listed as an M1, or mortgage one, what you're seeing there is a current mortgage loan that has no past due or delinquent payments.

Ron Happe: All right. By the way, for you that are listening and watching this, this is a real note that we own, correct? We own a second on this property, the first is current. According to the credit report, the first is current. Where do we go from here then?

Brent S.: From there, generally, we're going to try ... I would be looking to see if we can find where that our second report [inaudible 00:12:00]. Because, oftentimes, we're going to want to see how far back did that report ... in here for this, let me get to the next slide, if you go to the next page, all right, that's different one that I have here. There we go. 

This is just another example, this is another page within that credit report that's going to give you another credit types. You'll see there's another mortgage up top and I'm going down the line, in the account types, to look at, I just want to point out some different examples, but there's another mortgage, which is the Bank of America loan up top, this have several other INST, REV, those are in installment loan and a revolving loan, just a couple of the other credit types that you're going to see. Again, an auto loan at the bottom.

Our note isn't appearing on here, I would go again onto the next page, I do believe it's the next one, yes. Up top here, GMAC, this is a loan, which is the delinquent mortgage that we hold a second for. This is being reported a little bit differently, we want to point that out, that's what you'll see over to the right of this one is you'll see that is indicated as an M9, the M9 is indicating that this is a charge-off or a, in this case, they sold it, they charged it off, sold it, listed as a 9.

What you're also going to see is the date it was last active right below that. The last time that it was late, then you're going to see, in the box to the right of that, or to the left of that, excuse me, is the date. You'll see they started reporting on this one 90 days late, it goes from 8 of 09, 9 of 09 and so on. When you see these two things together, what you're looking at, the date that was last active, which is what they define as last active, would be the last charge on the account, or the last payment date, essentially, was in 9 of 09. You can look at it and it corresponds to that, they were still 90+ days delinquent. In this case it doesn't report before that, we don't know how many months consecutively prior to the 9 of 09 charge-off date.

That's what we're looking at here, is an actual date of last activity in 9 of 09, appears to be the actual date of charge-off on this one and you can see that it was lastly 11/09, which is the date that they actually wrote that loan off, that would be their last point.

Ron Happe: Okay, what that means to us is that we can determine if we use nine September of 2009 as the last payment date, whether that's accurate or not, whether they made a payment, whether their last payment was in July of 2009 or August of 2009, we're going to use September of 2009 to determine our arrearages correct? Let's say that we bought this in September of 2014, we have five years of delinquency there and the payment, we would just take 60 months times of payment to come up with an arrearage is that correct Brent?

Brent S.: Correct.

Ron Happe: Okay. Here's a case where we have a huge amount of arrearages on a first that is current. In our estimation, this is a very nice note to buy, because we have so many options that we can work out with the homeowner, because obviously every time they write a check for their first, they're telling us "I want to stay in my house." Now, it's up to us to make that possible. We can do that utilizing the arrearages making a deal on this huge amount of arrearages that they have as well as setting up a payment schedule that they can handle. All right? Where do we go from here?

Brent S.: From there, this is really the breakdown, as far as what you're going to see and what you're going to look for on a credit report as it relates to your second. The other thing that we did include would be the next page, which is some ... This is the account separated, this is the one that we were just now looking at, probably can see this one a little bit better. One other thing that I forgot to mention on this one, when you look at the reported date, when it was reported, part of the reason why we can rely on that information is because this was reported nearly two years after it was actually charged-off. We can pretty much rely on those dates to be fairly accurate.

Ron Happe: One thing that I also would like for you to see is that this is a home equity line of credit, a HELOC, one of things that we look at for the future of what's happening in the next three to five years in this business is [inaudible 00:17:27] going to be in the inventory is that there's approximately $500 billion dollars worth of home equity lines of credit that are resetting between 2015 and 2016 where the peoples have been probably paying interest only up until that date, if they're being paying at all. All of a sudden, their payment could go up, probably will go up, at least 50%, because now it's going to be a fully amortized loan, probably over 20 or 25 years.

If a home is upside down, how many of these home equity borrowers are going to pay for an upside down loan? There's going to be a lot of these available to purchase.

Brent S.: The last sheet that I had included in here, I think would be on the next page, I believe, is going to be just another breakdown for everybody. You can get some information on the abbreviations that you're seeing on the credit report. This is a breakdown that was available online and gives you some more information on, not just the ECOA or whose account it is, which is the stuff that we looked at earlier, where there was joint, individual, but also gives you a small breakdown on the lower-left, at the timelines, at the payments. When you see the M9 or the R1 or that abbreviation up there that we looked at on the last page, this is a breakdown of those timelines. 

A one is going to be paid as agreed, two is going to be 30 days plus and so on. You'll see that information there on that box in the lower-left, also some other abbreviations that are credit specific, but probably stuff you won't see too much, mostly, what's going to be relevant for you is what's in those boxes there.

Ron Happe: Okay. One of the advantages that we have, that you don't have, it that this is something people like Brent become experts at when looking at a credit report, they can look at it pretty fast. There's a couple of things that glare at me when we're looking at a credit report. We really don't care much about the [inaudible 00:20:05] or really the credit report, what we're looking at here is, if we're buying seconds, just what is the first doing.

There'll be times when [inaudible 00:20:17] that says "not reporting", when I see a credit report where the first is not reporting, what challenge does that present to you?

Brent S.: That brings a lot of challenge to you because you don't really know what's happening with that homeowner, one of the things that you're going to have to do at that point is you're going to have to go find that loan. We use a number of means to go up there and look for that information, because a lot of times when these loans have been sold, the new mortgage holding is not reporting, that's actually a pretty common thing for us to find.

Ron Happe: When i talk to people about this business and buying seconds, I often talk about the way that we can get hurt, the number one way for us to get hurt on a second is not paying attention to the first. If we don't pay attention to the first, the first can foreclose us out. One thing you have to keep in mind is that that's the worst thing that can happen to us. The credit reporting, the reading of a credit report and looking at it on a monthly basis is extremely important to our business, you have to do this, because if the first gets in front of you on a foreclosure, you can get wiped out, your lien can get wiped out, you still have an unsecured loan, [inaudible 00:21:45] you can do with that too, but we need to know what that first is doing.

In addition to that, if we have loans that are where the first is, non-performing first, then we have an opportunity to go to that first and try to buy that, then we can do a wrap on that with the first and the second and get the homeowner on a payment plan, a work out schedule, I think, right now, we have one lender that we have six loans out that we're trying to buy, six firsts. That's another thing that Brent does for us is negotiate with the first to buy those loans.

We we're in a much stronger place if we know what the first is doing and we're in a much stronger place than the homeowner when we can negotiate with the first on their behalf. Usually they are sticking their head in the sand, don't want to talk to anybody, they don't know what to say, usually the bank is not in a position to really negotiate with them, it's either pay your arrearages and get current or we foreclose, very important that we watch this.

Brent S.: I actually have a couple right now that are in that situation, the first is coming into fault with them, we were just on the cusp of a workout agreement, the customers have withdrawn a little bit because they're unsure of what to do with the first, we have to step in and help them out and walk through that.

Ron Happe: Right. We have to keep in mind one of the big says "the first doesn't want to foreclose", they don't want to own that house, there's a whole bunch of things in the last several years that have happened with the first doing a foreclosure. You all remember how the MERS scandal, the foreclosure scandal, there's been so much bad press about first foreclosing that they really don't want to foreclose. If we can get to talking with them, then we have a real opportunity to help the homeowner on the first also, provided they want to stay in the house. If they don't, we have alternatives for there too.

Brent, can you tell us just if ... We're going to cover this pretty extensively next week is bankruptcy, can you give us an idea if we were looking at the credit report for somebody and they had declare a bankruptcy, where would you find that?

Brent S.: If they had declared a bankruptcy and we don't have an example of that on this particular report, but there's an actually-

Ron Happe: We put one on there next week to show where it is, but I just want people that would have an idea that yes you can find it on the credit report and where would it be.

Brent S.: Right. It's actually fairly easy to see it, it's going to be, there's a separate section, actually, for public record items and stuff. It would be actually ... Do we have this page on there on ... account's split page?

Ron Happe: Yeah. I think so. We'll find it here.

Brent S.: Give us just one second and we'll get this on here. Right here on this page, if you look at the very bottom that's a section called public records, and this particular borrower has none, but if there was a bankruptcy, most of the time it's going to be back here in your public record section and it's going to be listed, it will be listed with the court that they filled it in and they'll have their case number, the dates and that kind of thing.

Ron Happe: Okay, great. I think next week we'll cover bankruptcy, we'll cover the PACER, which is where you can find out all kinds of information about, it's public information, you can find out a lot of things about bankruptcy there, about what they owe, who they owe, what's going on, get the name of the trustee and that sort of thing. We'll cover that pretty extensively next week, because bankruptcy is another thing when we're doing our due diligence. We want to know if there's a bankruptcy, of course. 

Usually, when we buy a pool of notes, there'll be warranties and representations that the seller makes. If they are in bankruptcy, then that's something that should be disclosed to us. We're not saying that we won't buy if they are in bankruptcy, but it certainly influences how much we'll pay for a note. We will buy, if they're in bankruptcy, as a matter fact, we're looking at a tape right now that is nothing but bankruptcies. I've had some questions come to about the supreme court looking at the not-aware bankruptcy ... I will cover this today just because it's so current is that the supreme court ... B of A has appealed some lien stripping from bankruptcy, which has been happening in eleven-

Brent S.: Eastern District.

Ron Happe: Eastern district, of the United States, that's Georgia, Alabama, I think, maybe Florida.

Brent S.: Florida.

Ron Happe: Florida is in that too. The B of A has challenged that and the supreme court is going to hear it. We're not concerned about it because if the court decides that the strip can be made, then nothing is changed, everything is the same as it is today. We know that the likelihood of a bankruptcy working out for the five year period or three year period, that the trustee sets up payments very, very slim, we'll cover that next week. If they overturn the ruling of the eastern district, then the lien remains even in a bankruptcy, a decision would be reversed and we're in a stronger position than we are right now, it doesn't really worry us.

If you have questions on bankruptcy, get them in to us so we can include them in next week presentation, if you have questions on the credit reports that we went over today, anything that you need to hear from us, any questions that needed to be answered, please get them in, we'd be very happy to answered them for you. Again, I thank Brent for being here, he's very knowledgeable in this area and better for him to tell you his firsthand experience than for me.

Brent S.: Thank you, Ron.

Ron Happe: Thanks for being here, everybody, see you next week. Thank you.

Brent S.: Thank you.

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