Due Diligence When Investing in Notes

Due Diligence When Investing in Notes

Livecast #


In this livecast Ron Happe and Saprina Allen discuss due diligence to be performed before you purchase notes for your portfolio.

Ron Happe: Good morning, everybody. It's Tuesday again and welcome to our livecast. It's a great day in Northern California. It's actually raining. We don't know what that is after this year, but it's raining pretty hard today. It's always a good day when Saprina is in the office. We have Saprina Allen with us today. Saprina is our Executive Vice President in Asset Management and she's going to be involved pretty heavily in today's livecast.

For those of you that know her, I'm sure you're excited to see her. For those of you that don't, Saprina has over 20 years experience. She hates to admit that, but she has over 20 years experience in the asset management departments both in large institutional lenders as well as working for private investors. She's a nationally recognized trainer and we are fortunate that she joined our firm actually starting in March. March 1st.

She's going to be assisting me a lot on these livecasts because she's extremely knowledgeable and well respected in the industry, so welcome, Saprina. Glad to have you in the office this week. I know that you've had a severe winter. You probably would rather have it nice and sunny, but we're happy that it's raining. Before we get started, let me just do the disclaimer again.

We are not trying to sell you anything today. We're not trying to sell any securities. This is for educational instruction only. We don't want to violate any securities rules. Also, Saprina and I are neither attorneys nor accountants and we're not giving legal or accounting advice. Some of the things that we say, you might want to run by your attorney or a CPA. We're here to help you be successful in the loan and, or excuse me, in the note business.

We are primarily a defaulted first and second mortgage buyer. We work them out and then we either keep them for cashflow, resell them, and we do that also for other private investors. That's why we're here. We're here to help you be successful in this business. Today, we received a question from a note investor. Arthur [Budding 00:03:12]. His question had to do with due diligence.

It was a little broader than we can cover in just a 30 minute period, but we wanted to go through the due diligence that we would do if we received a tape or even if we received a one-off loan that we were going to bid on to buy. Now primarily, we are second loan investors. That's what we're going to be primarily focused on today. I'm going to run this by Saprina on a topic by topic program so that she can address what she does when she is looking at a tape in order to price it and make an offer on that portfolio.

Saprina, let's say that yesterday we received a tape of notes that the seller expected us to bid on and you were going to do your due diligence on that tape so that you can come up with a number you feel comfortable paying. Can you, first of all, just start off by saying, okay, what are you going to look for first?

Saprina Allen: One of the things that I'm going to do is I'm going to look to see what information is provided on the data tape. Just not throwing any investor under the bus or any seller, but sometimes it's lacking information. When I look at the tape, I want to make sure that I have a full property address, I have a borrower's first name and last name, I have the physical property address.

Sometimes you have to make sure that the address that they're ... if they provide you two addresses, meaning one could be the borrower's primary residence and what the address is for collateral. I want to make sure that it's the collateral address that they're attempting to sell. I also want to know if there's a bankruptcy status on the tape, if credit is available, if there's an occupancy status, and also if ... I think that's it.

Ron Happe: Okay. When you look at that tape, do you ever see tapes that don't have that information available? If it doesn't, what do you do? Let's say that you get a tape that does not have a full address or you really can't do any research on that property or it doesn't have a status it's either occupied or unoccupied. You don't know. What do you do about finding that out?

Saprina Allen: I will reach out to the seller to see if they have more information on that tape. If the full address is not available, it's really, really hard to do a lot of due diligence on that tape in order to make a very sound investment. If the seller's not willing to give that information, you just need to make a decision that this isn't the tape for you and move on. If you start engaging with the seller and they can provide that information, that's great.

Sometimes what you will find is that they'll give you very vague information. It'll tell you it's behind a performing first or if it's equity coverage, but they won't give you all the information. What they're looking for is wanting you to actually execute a confidentiality agreement before they actually release all that information to you. That's sometimes why you don't get all the information initially.

Ron Happe: If they say "Provide a confidentiality non-circumvent agreement", would we be willing to do that in order to get that information?

Saprina Allen: Absolutely.

Ron Happe: Okay. All right. Let's say that they cooperated with us. They gave us the full address, we can now assess that property knowing exactly which one it is. Is there anything else on the tape? Anything else that you would be concerned with that you would want to find out before you would arrive at a price?

Saprina Allen: Absolutely. Even in seconds, you need to make sure that the taxes are current or somewhat current because some of those properties can go to tax sale. They go to tax sale and there's no recourse. You could actually buy a second mortgage that's been wiped in a tax sale. If you don't know that information up front going in, that could actually be really, really risky.

Ron Happe: Okay. All right, so we need to know whether the taxes are current or whether delinquent. How do we find that out?

Saprina Allen: There's a couple ways that you can do that. You can go to a county website. In order to find out what county the property's located in is if you Google the property address and say "What county is 123 Main Street in Sacramento, Ohio located in?", it generally will give you what county it is. Sometimes smaller communities don't have their tax information online, but they will provide you a phone number.

Once they provide you that phone number, you can call in. You can give the [inaudible 00:08:32] code number or you can give the physical address and they will let you know if property taxes are current or delinquent. One key thing that you need to do when you actually call into the tax assessor's office. The question is, "Has any taxes been sold?" Sometimes the counties will actually sell tax certificates. Sometimes they're redeemable, sometimes they're not. That's really important that you make sure you verify that information.

Ron Happe: Okay. I've heard of a website called NETR Online. netronline.com. Is that something that is a website that's usable for finding out about taxes?

Saprina Allen: Yes it is.

Ron Happe: Okay. Maybe that's a place you go first and some counties are not going to be on it. If it's not on it, then you would just have to Google and maybe place a phone call to the county, but definitely you think that we need to be checking on delinquent taxes. Okay. What else would you look for on that tape? I know that most of the tapes that we get, they can have a whole lot of fields on an Excel spreadsheet. What would be another, let's say, critical field that you think has to be on that tape?

Saprina Allen: Value. Even though the seller will provide you with a value, verify, verify, verify. Verify that the value that they're giving you is correct. Sometimes they're low when they don't know the market and sometimes they're high. You need to make sure that you are verifying what that value is. How do you do that? You can reach out to a local real estate agent in that area where you're doing the evaluation, you can do a BPO, you can use some online tools.

Ron Happe: What exactly is a BPO?

Saprina Allen: It's the broker's price opinion. It's basically giving you area comps. I would suggest that any comps that's provided to you not be further than a mile away from the property that you're evaluating. Make sure that if an agent gives you a BPO, you make sure that their values are coming within a mile radius of the structure.

Ron Happe: Okay. Any time limit backwards? Let's say as far as ... and I think you probably want to look at solds only.

Saprina Allen: Yes.

Ron Happe: How far back do you think would be allowed to give you an accurate assessment of what the comparables were?

Saprina Allen: I like to look because the areas in the market is just changing so drastically. I like to look at sales within the last 90 days. If there's not comps available within the last 90 days, go back six months. Anything greater than that, you're really, really not going to get that sound value you're looking for. The markets change so great in a year that if you don't have 90 days to six months, you need to do some more digging on that value.

Ron Happe: Great. Okay. Another category that would be important for the investor who's buying this tape or a one-off note, what's another thing they ought to be looking for?

Saprina Allen: They actually need to be checking bankruptcy to see if there's an active bankruptcy, meaning a chapter 7 or a 13. I will talk about bankruptcy a little bit later after I get through some of the other due diligence processes that you should do when you're evaluating a tape. It's really important to know that if a borrower is in an active 7 or a 13.

Ron Happe: Okay. What else? Do we care when they've made payments or if they're making payments or when their last one was or whatever? Is that usually on the tape that we could look at, investigate?

Saprina Allen: Sometimes the seller will provide you with a pay to date and a last paid date. That is very, very important. Even though a paid to date might be January of 2012 but the last paid date might have been December of 2014 and now it's 2015, that is really a key indicator that you may have a borrower that's willing to put some skin back in the game after having some type of a hardship.

You have to remember that even though the loans are nonperforming, if there's emotional equity in the properties, if the properties are occupied, there are ways to actually find those golden nuggets in a data tape if that information's provided. Life happens to people. People hit hardships. Just because they hit a hard time doesn't make them bad people.

Ron Happe: You mentioned emotional equity and that's a term we hear kicked around a lot. Can you maybe explain what you consider emotional equity? What that really definition is to people that are investing in the note?

Saprina Allen: Emotional equity is worth more than actual real equity in a property. When you look at your BPO or you have somebody do a drive by and they're taking pictures of a property and you see that the lawn is manicured, you see that they have maybe Easter decorations in the yard since we just passed Easter, those are the things that let you know that somebody is still attached to their home.

They're still calling it home. There's not a bunch of trash in the yard. They're doing everything that they can to have pride and ownership to keep that status in their neighborhood regardless of what type of neighborhood it is. That emotional equity is so valuable to you. They're not willing to just walk away. They're willing to fight for their property, but they just hit hard times.

Ron Happe: Okay. What else should we be looking for, then? Is credit important?

Saprina Allen: If a seller can provide you a credit report, it is so important to take a look at that credit and evaluate that. What are you looking for on that credit report? You're looking to see if they have any IRS tax liens. You're looking to see if they have any judgments. You're looking to see if they just bought a new car. You're looking to see if they have any other mortgages that's performing.

It also will tell you sometimes their job history, how long they've been on the job, what type of work that they do. You can look to see if there's any recent inquiries. Sometimes a homeowner is acquiring to get a new mortgage. You may see that somebody's actually looking for an apartment. You can tell that all from the credit report. The credit report is very, very informative on what's going on with your borrower. Sometimes it's a lot of medical debt.

That medical debt lets you know that something happened. Somebody got sick in the family and you see all of those collections on the credit report. It just helps you wrap your mind around what type of conversation you can have with the borrower if you have to engage. Please do not make contact with the borrower before you've funded a deal. Getting all of this information, you're just making notes on your spreadsheet or however you're doing your due diligence. It is a very, very good piece of information to have.

Ron Happe: Yeah. A comment that I could make there is that you cannot or should not, you will not contact a borrower until you have complied with all the procedures and legal requirements that you need to comply with. A RESPA letter needs to go out from the prior servicer and 15 days later, a hello letter from your servicer. You cannot contact the homeowner until that's been done. You can buy a note and find yourself with nothing if you violate these laws.

Be sure you're up to date on what the legal requirements and procedures are. I would suggest that you nail down a procedure that you use and you use it over and over and over again. That doesn't have anything to do with due diligence, so I'll move on here. I just don't want anybody getting themselves into trouble. Credit reports. How easy would it be for somebody that's just buying, let's say, four or five notes that has not done it before? How easy is it for them to get a credit report if the seller doesn't provide one?

Saprina Allen: It's not very easy to get a credit report. You have to go through a vendor to actually get that credit report and you have to actually set up an account. There's things that happen for you to be able to pull credit. There's someone that comes out almost like an inspector or an auditor to take a look at your office space, look to make sure that you have shred boxes, making sure that you have file cabinets that lock, and also making sure that you're not in almost like a studio apartment.

If you're operating out of your home, does anybody have access to that area of the home where you're going to be pulling credit reports? If you don't own your home, more than likely you're not even going to be able to be approved to pull credit unless you have an office space that you're utilizing on an everyday basis where you're set up for an office.

Ron Happe: One thing that we've found is that even though we can pull credit, we cannot sell. We cannot pull it for anybody else. If you went to get a car loan, the car loan people would have a contract with somebody who pulls a credit for them. We are not allowed to do that. The use that we have for our credit reports has to be for ourselves. We can't pull it for a third-party, let's say.

Be careful with credit. The Consumer Finance Protection Board is very, very strict on credit, so don't make any mistakes in that area. What we've been talking about here, Saprina, has been primarily ... well, not really. A lot of it was directed because we are involved in seconds. Is there anything that you would do differently if the note was a first, a delinquent first versus if it's a delinquent second?

Saprina Allen: It's nothing really different. I would make sure of two things. I would make sure that that value was solid. You can buy $100,000 note. If the value of the property is only $10,000, depending on how you're buying that, you need to make sure that you're paying based off of value and not off of UPB.

The other thing that you have to factor in is your foreclosure expenses and cost depending on how delinquent the property is. The other thing is to make sure the property's still standing. Sometimes you can buy a note and there's nothing but raw land because somebody has razed the property due to violations to that property. Make sure that the property is still standing before you actually fund that loan.

Ron Happe: Yeah. Just a little side note to that, you may find it funny. I don't find it that funny, but a couple weeks ago, we had purchased a second and we found out, we celebrated that we found out that actually our loan was a first. We were so excited that we were now in first position until we found out that the house had burned down. On a first, you want to be sure of what you're buying there. We were not that excited after that. We now own a lot that we got to clean up.

In Los Angeles at our boot camp, there were a lot of questions on ... First of all, I think credit would be ... I think you'll agree with me, Saprina, that credit would be a really good topic for us to cover on a livecast all by itself. Just go over how you run credit, how you read a credit report. It can provide you with a lot of information if you know what you're looking for. Saprina can help us out on that.

I think the questions that were raised the most had to do with bankruptcy. I know there are a lot of people confused, a lot of people emotionally distressed about bankruptcies. I know there was one person there who had several of his loans in bankruptcy and was looking for help. Maybe you could cover a little bit more about bankruptcy and what to look for, how to find out information about it and so on.

Saprina Allen: A couple of things that why you look for bankruptcy or the status of a loan being in bankruptcy when you're doing your due diligence. If you actually buy that loan, you have to file a proof of claim. If it's too late to file a proof of claim on chapter 13, there's not a lot you can do. You need to make sure that your seller has done everything that they need to do.

Ron Happe: Can you maybe differentiate between a chapter 7 and a 13 so that people know when you say chapter 13 what it exactly is?

Saprina Allen: A chapter 7 basically discharged the borrower from all of their debt. It doesn't extinguish your lien, it doesn't void the lien except in the 11th District, which is Florida, Georgia, Alabama, and now there's a new case in Maryland which is not in the 11th District. Those states right now are allowing lien stripping, which I'll cover in a few moments, in a chapter 7.

In a chapter 13, it's a reorganization of debt. Generally, they're reorganizing their secured debt first and then they're also addressing their unsecured debt, which would be something like credit cards, medical debt. You would be treated as an unsecured creditor depending on how the chapter 13 plan is proposed. One of the things in reference to a chapter 13 and the reorganization of debt on what you need to look for when you're doing a bankruptcy check in PACER is that you need to make sure that you don't see words such as 'cramdown', 'lien strip', 'eliminate lien'.

Those are keywords that you will find in a chapter 13 addressing the junior lien, which the space that we're in, or the second lien position or the third lien position. When you see that, you need to make sure you're paying attention to why are they doing that. A lot of times they'll say that the property is underwater. Sometimes it's just based off of the tax assessed value, which is not always appropriate in doing a lien strip.

As a second lien holder, we could actually request a forensic appraisal or challenge that value with the borrower. The other thing is that if it is not the borrower's primary residence, they cannot lien strip you in a chapter 13. Those are things that a lot of people don't know and they're not aware of. The other thing with bankruptcy is that there's no bad note, it's just bad pricing. You need to pay attention to what you would actually pay for that note when the borrower's in a bankruptcy.

Ron Happe: I think from our point of view as being note investors, in our company, we don't let bankruptcy scare us. As a matter of fact, sometimes bankruptcy is the best thing that can happen. It can delay our collection, but it could wipe out a lot of the unsecured debt that a borrower has enabling them to make the payments to us. In addition, I think one of the things that we find about bankruptcy is you also now have somebody you can talk to.

If a homeowner declares bankruptcy, you have to stop all your communication with that person while they're in bankruptcy. You can't send them letters, you can't call them on the phone. You can talk to their attorney and you can talk to the trustee. In a lot of cases, the deal that we would be willing to make with the borrower is far better than the deal the trustee is going to put them in.

A big factor that we look at is that 90% or over 90% of all chapter 13s are not competed. That means the trustee has put together a payment plan and that payment plan is so severe that the borrower, the person in bankruptcy can't make the payments or is just unwilling to. That bankruptcy is dismissed. Difference between discharged that Saprina was talking about discharge means they actually completed it where dismissed means it's thrown out. Now we're back in the same position that we were before.

Bankruptcy is something to be aware of because you don't want to make any mistakes. It is not something to be afraid of. In fact, we would take a look at a tape that was nothing but bankruptcies if we could buy them at the right price. Like Saprina said, there's no such thing as a bad note, there's just bad pricing. If we can get it for the right price, we would take care of that. Saprina, is there anything else that you would like to bring up today to the people that are on?

Saprina Allen: I just want you all to know that I talked about life has happened with borrowers. One of the best ways to become successful in this industry is to treat every homeowner with dignity and respect. If you can do that, you will be so successful in this. If you're willing to offer them a helping hand or give them the olive branch that the traditional financial institutions is not able to offer to them, you will have a win-win. Sometimes it's not going to be on the first call, it's not going to be on the second call. If you actually continue to just show the homeowner that you care and you have the ability to help, you will be so successful in this industry.

Ron Happe: Great. Thank you guys very, very much and I was certainly glad that Saprina was here with us today. I want to just alert you and let you know that we are having a boot camp in Orlando, Orlando, Florida, May 15th through 17th. That's a Friday, Saturday, Sunday. These are intense educational-only boot camps. We're not trying to sell anything there. We will not try to get you to sign up for a $25,000 coaching program, we won't try to sell you a course that we have on CD or whatever.

This is strictly three full days. I mean we'll go until you are exhausted and we're exhausted covering everything that we think needs to be covered in order to be a successful loan business. We're going to show you exactly how we do business. You'll see all the tools that we use. The first day we'll go over some financial information about how to enhance notes, how to use a calculator to make money.

Saprina and Ingrid will be on the second day to show how to work out and service your notes. Tyler, a licensed attorney, will spend a day with you going over how to raise money, how to do a private placement memorandum, how to do a capital raise without violating the Securities Exchange Commission. He's there to answer any questions about the legislation and the legal atmosphere.

He'll discuss Dodd-Frank. He'll discuss the Consumer Finance Protection Bureau or Board and all the things that you need to do to comply with all of that in the debt collecting and the servicing end. Really it is an intensive three days of learning. If you go to notemogul.com, www.notemogul.com, you can find out all about it, see the venue. It's going to be at a very, very nice hotel close to the Orlando Airport. We look forward to seeing you there.

The month after that, we will be in San Francisco. We're going to have these on a regular basis throughout the remainder of this year and the first part of next year. Next week, we'll probably get Saprina. We're getting real high tech around here. We'll probably have Saprina on a Skype or a camera of her own and while she's in Ohio and we're here, but very fortunate to have her here today. Thanks, Saprina. It was kind of late notice to get her on board, but she did a great job and we appreciate her being here. Thank you guys ever much and we'll see you next time. Bye.

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