What you won't see on fantasy TV shows: a cratered real estate industry, few jobs, foreclosed homes, and empty office space

By Christopher Palmeri

The sun still sets magnificently on the cliffs of Laguna Beach. The Angels are slugging away on another could-be-the-champs baseball season. Over in Disneyland (DIS)—the self-proclaimed Happiest Place on Earth—a new attraction debuts in June. The Innovations Dream House will show off high-tech gadgetry from Microsoft (MSFT) and Hewlett-Packard (HPQ) while allowing guests to interact with the fictional Elias family as it prepares to attend a soccer tournament in China.

If they weren't make-believe, the Eliases would probably be postponing that trip and worrying about their jobs. They might even be fighting foreclosure on their Dream House. That's life in Orange County these days as the subprime disaster comes home to roost.

A 1,000-square-mile swath of well-heeled suburbia just south of Los Angeles, the "O.C." was the main headquarters for dozens of mortgage companies that have now gone bust, among them Ameriquest, once the nation's largest subprime lender, and New Century, once among the top 10. As a result the region is one of the hardest hit by the collapse of the housing market. Big builders such as Lennar (LEN) are putting new construction on hold. The Orange County Register calculates that 43 local mortgage outfits laid off some 7,200 workers last year.

Orange County still looks like a sunny, can-do place, with an $8 billion-a-year tourism industry and shopping malls the size of small cities. It is home to 3 million people, whose $58,000 median annual household income is $10,000 higher than that of the U.S. as a whole. There are shiny new office towers and subdivisions filled with Spanish-style homes. But like native son Richard Nixon (born in Yorba Linda, wintered in San Clemente), the O.C. has a dark persona that seems to rear its head every so often. In 1994 the county became the largest municipality in the country to declare bankruptcy, done in by bad investments in dicey securities. Now it's the subprime mortgage fiasco.

BOOM TOWN GONE BUST
"The culture here is very real estate- and finance-focused," says Michael Capaldi, a principal at Newport Beach-based developer Renaissance Pacific Properties. "When real estate is good, it feels like a boom town."

Even now, big cities such as Irvine and Anaheim are a far cry from more beleaguered locales such Cleveland and Detroit. While the county's rate of 3,300 foreclosure filings in March is three times what it was a year ago, on a percentage basis Orange County is doing better than neighboring regions. In nearby Riverside and San Bernardino counties, 8% and 6% of homes are in the foreclosure process, vs. just 2.4% in Orange County, according to research by market tracker Default Research. Moreover, the median sales price of a home, while down 14% to just under $600,000, is holding up better than the statewide fall of 26%.

But there are other signs that the county's economy is worsening. Retail sales and vehicle-registration fees are running 10% below what they were in the prior fiscal year. Frank Kim, Orange County's budget director, says he's anticipating much lower revenue next year from property taxes as homeowners ask to get their dwellings reassessed at lower market values. As a result he's keeping the county's projected budget flat at $6 billion, after years of 5% to 6% increases.

The county is also doing better jobs-wise than the rest of the state and the nation. Its unemployment rate, 4.3%, is nearly two percentage points under California's average and one point below the U.S.'s. But Orange County is heavily dependent on homebuilding industries, and about 6,200 jobs in construction and finance were lost through the third quarter of 2007, wiping out employment gains in government and business services, says Esmael Adibi, director of the Anderson Center for Economic Research at Chapman University in Orange, Calif. Job creation in the county is expected to lag behind the rest of the U.S. for the rest of this year.

"Orange County is in recession," says Adibi. "It began with the mortgage industry, spilled over into construction, and now it's more broad-based."

LEADER OF THE SUBPRIME PACK
The roots of the mortgage meltdown lie with entrepreneur Roland Arnall, a real estate developer who founded Long Beach Savings in 1979. When the traditional real estate and banking businesses slumped in the 1990s, Long Beach Savings began offering home loans to borrowers with less than stellar credit. Long Beach Savings was ultimately sold to Washington Mutual (WM), becoming the basis of that company's subprime business. By then Arnall had also founded Ameriquest.

The formula was relatively simple: Lend money to folks whom traditional banks wouldn't touch, package those loans, and sell them on Wall Street. Take your profit and do it again.

Many of the alumni of Arnall's companies went on to found other mortgage outfits, mostly in Orange County. "It kind of fed on itself," recalls Jon Daurio, who worked for Arnall, co-founded Encore Capital (later sold to Bear Stearns) and who now runs a distressed-debt fund called Kondaur Capital. "As you had more people who were successful, it brought more people in to try it."

Today many of those businesses are gone. New Century went belly up. In March, H&R Block announced it was selling its Option One Mortgage unit, based in Irvine, to distressed-assets investor Wilbur Ross. Washington Mutual announced on Apr. 8 that it's shutting down much of its mortgage operation (BusinessWeek, 04/08/08). Ameriquest sold what was left of its business to Citigroup (C) last year after negotiating a $325 million settlement with attorneys general across the country over charges of predatory lending (BusinessWeek.com, 8/20/07). Arnall died of cancer in March at age 68.

TALE OF EMPTY OFFICES
The real estate businesses that are left are struggling. Homebuilder Standard Pacific (SPF), based in Irvine, recently replaced its chief executive and got 45 days of breathing room from its bankers as it negotiated new financing.

Florida-based builder Lennar recently suspended sales on two large projects, Central Park West in Irvine and A-Town in Anaheim, that were to involve some 4,000 homes. In March developer Urban West withdrew plans for 450 condominiums in Anaheim that had been opposed by neighboring Disneyland. Mark Boud, whose Irvine-based firm Real Estate Economics tracks residential construction in the county, estimates that the volume of new homes permitted for construction will fall to 4,700 this year from 8,000 in 2006.

The office market has also been slammed. Jeff Osborn, who leases commercial property at CB Richard Ellis (CBG), figures the amount of office space occupied by mortgage companies in the county has fallen from 8.5 million to less than 2 million. The office vacancy rate overall has more than doubled, to 14.7%. "It has obviously been a big hit to our market," Osborn says. Los Angeles-based real estate trust Maguire Properties (MPG) bought a portfolio of Orange County office buildings last year at the peak of the market and has since seen its stock fall 60%. The company put itself up for sale late last year but couldn't find any takers.

Filling those buildings will be tough, since new jobs are hard to come by. Bill Spitalnick, an appraiser who worked at both Ameriquest and Fremont, says he sent out résumés to every lender he could think of in Orange County and never even got a call back. He says most of the people he knew in the business aren't working (BusinessWeek.com, 3/26/08) and are, like him, living for the most part off their savings. He now spends much of his time writing letters to the editors of local publications. "It's going to get worse before it gets better," Spitalnick says. "It just started out small, and now it's affecting the whole world."

Scott Simon, who heads housing industry analysis at Newport Beach-based money management firm Pimco, recently sold his home with a view of the ocean in nearby Laguna Niguel. He was surprised that the property got several offers and went for close to his asking price, to a European buyer. "Good properties are still trading at pretty good prices," he says. "You come apart from the worst first."

LOOKING TO WASHINGTON
Still, Simon says he's renting for now. It's cheaper than owning, and he thinks lower prices lie ahead, particularly if government support for the housing market wanes. Housing, he says, is "the single most important thing in the economy right now."

Former home industry workers who have managed to find new jobs often have had to rethink their profession. The nonprofit Fair Housing Council of Orange County, which normally mediates disputes between tenants and landlords, recently hired a former real estate agent to negotiate with lenders to keep troubled borrowers in their homes.

In Anaheim, Mayor Curt Pringle had consultant Richard Florida speak to local officials on how to attract a new "creative class" of jobs to the city. He also hired J.D. Power & Associates (like BusinessWeek, a division of The McGraw-Hill Companies (MHP)) to evaluate the performance of municipal services to help the city attract new businesses and residents.

Lucy Dunn, chief executive of the Orange County Business Council, a sort of Chamber of Commerce, was in Washington this week to drum up funding for housing, infrastructure, and education initiatives in the county. Dunn says she is fighting stereotypes, fostered in part by television shows such as The O.C. and The Real Housewives of Orange County. In fact, the county is now more than 30% Hispanic, and some of the areas hardest hit by the housing downturn are in less wealthy Orange County cities located inland, like Santa Ana and Fullerton.

"There's a misperception that we're a bunch of white, rich beach lovers," she says. "The reality of our demographics and economy belies the myth."

Palmeri is a senior correspondent in BusinessWeek's Los Angeles bureau .

BusinessWeek - April 18, 2008

Do prep work to show the lender that cutting the value of the loan is the logical choice.

By Lew Sichelman, United Feature Syndicate
April 20, 2008

WASHINGTON -- As some troubled borrowers are simply handing the keys to their places over to their lenders and walking away, the vast majority desperately want to remain in their homes, even when they owe more than the homes are worth.

But in the face of interest-rate resets, how can they stay?

The stock answer is to call the lender -- before falling behind in payments.

First, though, the borrower has some important homework to do, said Jon Daurio, chairman of Santa Ana-based Kondaur Capital Corp.

Daurio's firm buys what are known as "scratch and dent" mortgages. These are nonperforming loans that others no longer want, "underwater" loans that Daurio's firm turns back into performing assets, allowing borrowers to keep their homes. Kondaur Capital purchases these loans from lenders at from 75% to 80% of their face value.

Do the math

For you to get the same deal -- to get your lender to write down the value of the loan by 20% to 25% -- the lender must be shown that taking such a cut is the only logical choice.

You want to show that if you fail, the loan's owner will be getting back a house that is worth less than it has invested in it.

Negotiating with the lender, however, is "an up-mountain battle," Daurio said. "It's not that it can't be done, but the probability is very, very low."

Still, it's not as if you don't have some leverage. The lender's choice is to write down the loan for a borrower who's already in the house and is ready, willing and able to make the payments, or foreclose, clean up the property to make it presentable and find a new buyer, all at a time when thousands of other sellers are trying to get rid of their own albatrosses.

To prepare yourself to negotiate, start by putting together a basic financial statement showing your assets and liabilities. On one side of the ledger, you'll list income and savings; on the other side, car loans, credit-card accounts, food and clothing allowances, child care and other monthly expenses.

"It doesn't have to be extensive or complex," Daurio said.

The idea here is to show that while you can afford to cover your mortgage now, you won't be able to do so when the payment goes up.

The next step is to show that your house isn't worth what it once was. Usually, value is determined by previous sales of similar properties. But in a declining market, this information is unreliable, so you have to find a way to show that like properties are not fetching the kinds of prices they were a few months ago. Provide the names and phone numbers of the agents with whom you spoke so the lender can check too.

Find a decision maker

Now it's time to make the call. Realize, though, that the person on the other end of the line is not likely to be employed by the company that originated your loan. Rather, he or she probably is working for a third-party servicer, a firm paid to administer mortgages.

Servicers are inadequately staffed to handle the current crush of defaults, Daurio said, and they are compensated on the amount of money they collect from borrowers. Consequently, he said, they are motivated to keep collections as high as possible.

With that in mind, you may be told to pay up or get out when you first call. But you're likely to be hearing that from someone who has no authority to restructure the loan.

You want to speak to the workout department, not collections, and with someone empowered to make concessions, Daurio said, "someone who understands this is a problem loan that is not going to get better with neglect."

Chances are your servicer is so overrun by the tidal wave of delinquencies that it will have little time for a borrower who's still making on-time payments, even if you warn that your situation is about to change. If you find that to be the case, then you have to figure out how to get the servicer's attention.

A word of warning, however: Some have suggested that, when all else fails, the best way for borrowers to be heard above the din is to stop making their payments. But it's a step that could seriously affect your credit rating, and all but preclude your obtaining financing from another lender.

Lew Sichelman can be reached at lsichelman@aol.com.

Los Angeles Times - April 20, 2008

LEW SICHELMAN | United Feature Syndicate
April 20, 2008

WASHINGTON—You've managed to pay your mortgage every month. But an interest-rate adjustment is bearing down on you like an out-of-control 18-wheeler. Worse, your house is no longer worth what you paid for it. Hey, it's not even worth what you owe.

While anecdotal evidence suggests that more borrowers are handing their keys to their lenders and walking away from such situations, the vast majority of owners want to remain in their homes, even when they are "upside down."

The question is, how can you stay in the face of overwhelming odds?

The stock answer is to call your lender—before your house payment becomes unmanageable and before you get behind. But first you've got some homework to do, says Jon Daurio, chairman of Kondaur Capital Corp.

Daurio's firm buys "scratch-and-dent" mortgages, non-performing loans that others no longer want. Daurio's firm turns them back into performing assets, allowing borrowers to keep their homes.

Based in Santa Ana, Calif., Kondaur Capital buys these loans from lenders at 75 to 80 percent of their face value, depending on the collateral. To get your lender to write down your loan by 20 to 25 percent, it must be shown that's his best choice.

In other words, you want to show that it would be better to have you still there making payments rather than the loan's owner getting a house that is worth less than he has invested in it.

Say that when you purchased your $125,000 house a couple of years ago, you took out a $100,000 mortgage. Since then, however, the house is worth just $90,000. But you still owe $99,000.

That wouldn't be so bad with a fixed-rate loan. You'd just keep making the same payment every month, and eventually—hopefully—the market would turn back around and your house will start rising in value, at least to what you paid. But you didn't take a fixed-rate loan; you took an adjustable mortgage in which the rate changes periodically and your payments reset accordingly. Or maybe you took a pay-option ARM in which you pay only the interest. And the moment of truth is approaching. So you give your lender a call and say, "Hey, can we work something out here?"

Negotiating with the lender is "an up-mountain battle," Daurio warns. "It's not that it can't be done, but the probability is very, very low."

Still, it's not as if you don't have some leverage. The lender's choice is to write down the loan for a borrower who's in the house and is ready to make the payments or foreclose, clean up the property and find a new buyer, when thousands of other sellers are trying to get rid of their albatrosses.

To prepare, put together a basic financial statement showing your assets and liabilities. On one side of the ledger, you'll list your income and savings; on the other side, your car loans, credit-card accounts, food and clothing allowances, child care and other monthly expenses.

"It doesn't have to be extensive or complex," Daurio says. The idea here is to show that while you can afford to cover your mortgage now, you won't be able to do so when the payment goes up. The message: Deal with me now before I default.

The next step is to show that your house isn't worth what it once was. Find out what properties comparable to yours sold for. Then speak with local agents to learn what similar houses now on the market are bringing in the way of offers.

Usually, value is determined by sales of similar properties. But in a declining market, this information is unreliable, so you have to find another way to show that like properties are not fetching the prices they were just a few months ago. Provide the names and phone numbers of the agents with whom you spoke so the lender can check.

Make the call. Realize, though, that the person on the other end of the line is probably is working for a firm paid to collect the payments.

Not only are servicers inadequately staffed to handle the crush of defaults, says Daurio, they also are compensated on the amount of money they collect. So, he says, it's in their interest to maximize collections.

Speak with someone in the workout department, not collections, and preferably, with someone in authority. "Someone," says Daurio, "who is empowered to make concessions."

Write to Lew Sichelman c/o Chicago Tribune, Real Estate, 435 N. Michigan Ave., 4th floor, Chicago IL 60611. Or e-mail him at realestate@tribune.com. Sorry, he cannot make personal replies. Answers will be supplied only through the newspaper.

Chicago Tribune - April 20, 2008

Kondaur Capital Corp., a purchaser of loans with regulatory, underwriting or performance issues, has formed a special team called Combat Loss Mitigators (CLMs) to meet current challenging conditions in the mortgage marketplace. CLMs have been deployed to turn around problem loans and portfolios.

With over 75 years of collective experience in all phases of mortgage banking among its top-tier executive leadership, Kondaur's most senior CLMs are well-positioned to create the sophisticated solutions that are vital to the survival of both borrowers and lenders in the current market, the company says.

"These unprecedented times have created a need for the combination of excellent default management skills - including, without limitation, loan origination and real estate owned liquidation expertise - and experience that defines these Combat Loss Mitigators," explains Jon Daurio, chairman and CEO of Kondaur.

MortgageOrb.com - May 19, 2008

By Ted Cornwell

Kondaur Capital Corp., a buyer of loans with regulatory, underwriting and performance issues, has formed a special team of "Combat Loss Mitigators" to meet current challenging conditions in the mortgage marketplace.

In the "red zone" caused by today's recession-like economy and fueled by depreciating real estate prices with little expectation of a near-term resolution, these CLMs, as the company calls them, have been deployed to turn around problem loans and portfolios that contain "scratch-and-dent" loans.

With over 75 years of collective experience in all phases of mortgage banking among its top-tier executive leadership, Kondaur's most senior CLMs are well positioned to create the sophisticated solutions that are vital to the survival of both borrowers and lenders in the current market, the company said. "These unprecedented times have created a need for the combination of excellent default management skills - including, without limitation, loan origination and real estate owned liquidation expertise - and experience that defines these Combat Loss Mitigators," explained Jon Daurio, chairman and chief executive officer of Kondaur. At present, he anticipates six million mortgage loans are headed for default.

Mr. Daurio notes that the CLM's complex role begins with the need to appreciate the scope and immediacy of the seller's liquidity needs. He also stresses that the CLMs bring communication experience to the table that helps them talk with troubled borrowers and face the difficult stay or sell decisions that must be made. "The analogy that I've come up with is I believe it is hand manufacturing vs. assembly line manufacturing. I believe most servicers approach this kind of asset management with an assembly line attitude," Mr. Daurio told NMN. He stresses that the CLMs are not doing combat with the borrower, but rather are willing to get in the trenches and work with borrowers who face difficult times. Following a servicing procedural manual isn't typically the best approach to working with them, he said.

Although the seller may simply want to unload the loan, Kondaur finds that working with the borrower to make adjustments - and ultimately creating a situation in which slightly lower payments can continue to be made - actually increases the loan's value, Mr. Daurio said. CLMs undertake detailed and time-intensive due diligence, producing a determination of "whether borrowers have the ability and desire to pay and stay or should sell and go," Mr. Daurio said.

Upon completion, single or multiple loans are then purchased and typically the only requirement or obligation of the seller is to provide the title to the loan.

NationalMortgageNews.com - May 30, 2008

The liquidity crisis has led to more buybacks, litigation and a return to full documentation

Jon R. Daurio, chairman and CEO, Kondaur Capital Corp.

As published in Scotsman Guide's Residential Edition, June 2008.

The housing market and mortgage industry have changed dramatically in the past year. Much of the fallout came from the increase in stated-income loans during the mortgage boom. Further, with stated-income loans, the rate of mortgage fraud increased, as borrowers often inflated their income to qualify for a greater loan amount.

As a result, the volume of mortgage delinquencies is at a historical high. Further, conventional wisdom dictates that one- to four-family residences will continue to depreciate at an unprecedented rate, and the economy will suffer a recession.

This unfortunately creates the perfect storm that likely will lead to more delinquencies and foreclosures, spurring quicker residential depreciation. It is a snowball effect with no end in sight.

Further, there has been much fallout from these events. Litigation has increased, with more mortgage lenders requiring originators to buy back defaulted-upon loans. Scratch-and-dent lending is on the rise, as brokers lacking liquidity to buy back loans turn to other sources. And more brokers now originate only fully verified loans, as many lenders no longer accept or fund stated-income loans.

Here's a look at how each of these affects the mortgage environment for today's brokers.

The impact of fraud

Many mortgage lenders are looking for reasons to find others to bear the losses that result from delinquencies. In master loan-purchase agreements (MLPAs) between lenders and originators, which were standard through 2007, originators make representations and warranties about the loans they originate. These state that the items in the loan files are accurate and true.

If there is a breach of any representation or warranty, a lender may require originators to repurchase -- or buy back -- the applicable loans at a price that would help it recoup its purchase price, all accrued and unpaid interest, and other incurred costs and expenses to preserve the asset.

Further, when a loan becomes delinquent, lenders will spend the time and money to review the mortgage file meticulously. It's often not difficult; mortgage fraud has been a pervasive breach of the representations and warranties in MLPAs, regardless of whether the originator knew of the fraud.

Mortgage fraud includes any material misrepresentation borrowers make on their mortgage loan application, including inflated lengths of employment, false job titles, false occupancy, inflated home values, omitted debts, false assets and inflated income.

Many stated-income loans can contain some income exaggeration. Therefore, allegations of material breaches of representations and warranties have grown exponentially, leading to actual and potential lawsuits. Defenses are almost nonexistent; however, some defense attorneys have alleged that the lenders themselves were at fault by creating guidelines that allowed for stated-income loans in the first place.

The scratch-and-dent boom

Regardless of these lawsuits' outcomes, repurchase obligations have led to a liquidity crisis in the mortgage industry. Brokers typically do not have enough cash to buy back the loans and cannot borrow enough cash. Thus, an industry of scratch-and-dent lenders has begun to flourish.

These lenders arrange to buy nonperforming loans at less than par -- or less than 100 percent of the loan's unpaid principal balance. The originator makes up the difference. These differences likely will amount to billions of dollars. With this much at stake, litigation likely will increase precipitously.

Scratch-and-dent lenders often find ways to liquidate the loans profitably, such as a loan refinance or resale or foreclosure of the home. To maximize revenue from such liquidations, lenders need a mitigator with default-management skills, including loan-origination and real estate owned liquidation expertise and experience. Many loan-servicers lack this personnel because a full refinance used to be the solution for these issues.

In addition, because so few loans were delinquent, loan-servicers often were willing to reduce their fees to historically low levels to service more loans. Thus, many servicers, still bound by these agreements, don't have enough capital to find, hire, train and manage default managers and loss-mitigators.

These issues have led to lawsuits for servicing-agreement violations, which almost universally contain language requiring that loans be serviced "in accordance with proper, prudent and customary practices in the mortgage-origination and servicing business."

Stricter underwriting

Increased fraud, defaults and buybacks also have led to stricter underwriting guidelines. In addition, lenders now spend a lot more time, effort and money ensuring that there will be no breaches of the representations and warranties in a loan-purchase agreement. Loan-origination costs have therefore skyrocketed.

At the least, lenders now require significantly more homeowner equity in purchase and refinance transactions, compared to earlier this decade.

Although the outcome of this change is unclear, it would not be surprising if protected classes of borrowers -- such as the elderly, women, blacks and Hispanics -- feel the effects. These groups may have lower home equity, lower income or worse credit histories. If so, litigation in these areas also could increase.

The reset effect

More than $500 billion of adjustable-rate-mortgage loans are estimated to reset this year, according to the Wall Street Journal. These resets likely will lead to significantly higher interest rates and payments for borrowers.

Fortunately, this payment shock is capped by ceilings on the amount by which an interest rate may increase at each adjustment date. Nevertheless, many borrowers cannot bear the increased payments, which likely will lead to more defaults, more foreclosures and greater residential depreciation.

To avoid the inevitable litigious mess from an increase in defaults, many mortgage brokers now only originate loans for which they can fully verify the data. Therefore, the number of stated-income loans likely will drop significantly. Further, they typically will only be funded when originators find other evidence of the income, in which case they will no longer be true stated-income loans.

ScotsmanGuide.com - June 2008

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Broker price opinions can help mortgage professionals determine property values

By Janice Ramocinski, executive vice president and chief operating officer, Kondaur Capital Corp.

Everybody seems to have a different theory about when real estate values will bottom out and stabilize, when default rates will stabilize and recede, and when home sales will increase.

A common consideration in these discussions is property value. Lenders, servicers and investors are grappling with the question: “What is this house worth?”

Brokers need a solid amount upon which to build their mortgage packages, for borrowers and lenders. Broker price opinions (BPOs) can offer them a new way to look at the value question and supplement other valuations they receive.

Although mortgage brokers typically don’t use BPOs, these opinions can be useful before ordering an appraisal. They can help mortgage brokers determine what is happening in a local market remote from their office.

Assessing the assessments

Determining property value is essential in real estate. Traditionally, the typical way to do so is to order an appraisal. But appraisals can be expensive and time-consuming. Then along came automated valuation models (AVMs), which are cheaper and quicker. In the middle, there was the BPO.

BPOs are usually prepared by real estate agents or real estate brokers. BPO-users, which typically are loan servicers, mortgage investors and distressed-debt buyers, may contact a real estate agent directly to get a BPO or may contract with a national BPO-provider.

These reports have some benefits. BPOs cost considerably less than appraisals and take a shorter time to get. And though they are costlier than AVMs, BPOs allow the preparer to see the property and to include recent photos in the report.

In this time of real estate uncertainty, loan servicers and investors are making many critical decisions based only on the BPO results they receive. But there can be troubling issues with doing so.

‘Local, local, local’

The first issue with an overemphasis on BPOs is market familiarity. The traditional real estate dictum is “location, location, location.” In the current environment, the phrase should be “local, local, local.”

It is common for a BPO-preparer to live and work miles away from the subject property. This person may not be the best “boots on the ground” — not like the local real estate agent or broker. Local real estate agents or brokers likely have current listings in the neighborhood and work with local buyers and sellers. A local agent may have looked at the house the last time it sold and likely knows about the neighborhood’s foreclosure and real estate owned (REO) activity.

BPO-users must develop their own data about the neighborhood and property through Internet research and by talking with local real estate agents and brokers.

For instance, if users are developing a foreclosure-sale bid, then they must look at the numbers and prices of local REO listings, recent REO sales, recent foreclosures and pre-foreclosure activity. They should then use the information they collect to determine an internal value and compare that with the BPO. In addition, BPO-users should have access to the BPO-preparer so they can ask questions and resolve discrepancies.

The real cost

If a BPO is less expensive than a full appraisal, then users must be aware of how that can factor into and affect the actual BPO. BPO-users also should be aware of a number of potential issues.

First, they should understand the preparer’s incentive — but the incentive to provide an in-depth and carefully reasoned BPO for $50 to $75 is uncertain at best.

Also, BPO-preparers may be motivated to supply a high value to convince the servicer or investor into ultimately listing the property with them or to prevent the servicer or investor from accepting a short sale through someone else. On the other hand, they may be motivated to supply a low value, get the listing, and sell the property quickly and cheaply to a client.

In addition, when hiring a BPO firm, users should vet the company and how it reviews BPOs. Most national BPO companies review the real estate agent or broker and/or the specific report.

The BPO-user should understand how the firm orders, reviews and reports on BPOs. What is defined as a “good” BPO, and is the benchmark for that rating relevant to the user? What process does the firm have for evaluating the user’s needs, and how does it use BPOs and their practical results?

Know what you want

Another issue for BPO-users to consider is matching the need and the order. They must clearly understand their use for a particular BPO and order it accordingly.

If the user is establishing an REO value, for instance, then the BPO should include REO comparables. Only by talking with the local real estate agent or broker, however, will the user understand if the local REO-listing prices are meant to sell the property or just to list it. When talking with local real estate agents or brokers with current listings of comparable properties, BPO-users should determine the quantity and quality of the offers being made.

Users who ignore actual local REO activity do so at their peril. If there is one foreclosure in a one-mile radius, then it may not matter. If the one- or two-mile radius is saturated with foreclosure and pre-foreclosure activity, however, then the actual REO selling prices will determine the user’s value — not the listing prices and certainly not the non- REO listings in the immediate area.

Effective BPO use is not simply about placing an order and using the results. Rather, it is essential to place an order knowing what you need and to challenge and compare the results with your own local information, using the actual BPO as one of many data points for your decisionmaking.

Scotsman Guide - September, 2008

Prices flat to down as Treasury plan unfolds

By Kate Berry

The imminent arrival of two big buyers for distressed mortgages — the Treasury Department and Goldman Sachs Group Inc. — is having little or no effect on prices.

If anything, prices for some types of "scratch and dent" loans have continued to fall, market participants said, because the cost of maintaining the assets keeps rising. State and local ordinances restricting foreclosures, and the continued drop in real estate prices in hard-hit states like Florida and California, have made it harder to profit from buying these loans, even at steep discounts.

The government's proposed Troubled Asset Relief Program, unveiled last weekend, would buy up to $700 billion of illiquid assets from financial institutions; the Treasury has said these could include both residential and commercial mortgage-backed securities and whole loans.

This week Goldman converted to a bank holding company, lined up a $5 billion infusion from Warren Buffett's Berkshire Hathaway Inc., and raised another $5 billion through an offering of common shares. A source at the Wall Street firm said Wednesday that it might consider, among many potential investments, buying assets like those on the books of the failed IndyMac Federal Bank. Goldman has the capacity to manage and work out such assets, having bought Litton Loan Services LP last year.

Still, this week "there's been no change in pricing, but I think that's because the plan is so nebulous," said Jon Daurio, the chairman and chief executive of Kondaur Capital Corp., a Santa Ana, Calif., buyer of scratch-and-dent mortgages.

"We're not convinced Treasury will buy whole loans instead of mortgage-backed securities, and we really don't know what effect it would have on the trading of mortgages — it could both increase and decrease discounts," Mr. Daurio said.

Discounts might rise, he said, because before they could sell to the Treasury program assets classified as held-for-investment, banks could have to reclassify them as held-for-sale.

As soon as it became known that such assets were now for sale, the additional supply on the market could depress prices, Mr. Daurio said.

Jim Callahan, the co-founder and executive director of Pentalpha Group, a Greenwich, Conn., advisory firm that specializes in pricing and workouts of distressed loans, said the market for such loans has gone "from no trading to a paltry amount of trading, so you can't say the market is back again."

Terry Couto, a partner in the Tampa office of Newbold Advisors LLC in Bethesda, Md., said the Treasury proposal has had "no impact on prices yet because there's really not a lot of people buying. Most are trying to sell and deleverage."

"The market thinks the whole Paulson $700 billion buyout will ultimately be smaller and the impact will be less effective and won't solve all the problems because we still have the underlying problem of consumers with mortgages they can't afford," Mr. Couto said.

The scratch-and-dent market covers a wide spectrum of mortgages, from performing loans with underwriting glitches to loans that have defaulted. Many investors have been burned because they bought assets from 2005 to 2007 and were unable to sell.

Pricing information is hard to come by and varies depending on the type of loan.

One scratch-and-dent buyer, who spoke on condition of anonymity, said bids for performing loans are trading between 55 and 65 cents on the dollar and that nonperforming first-lien assets are trading at from 35 to 40 cents.

Performing second liens are trading at 6 to 8 cents on the dollar, this buyer said.

"No one really has any idea what it would take for the government to buy these assets," the distressed asset buyer said. "What assets would they buy, and how would they determine the value? And how are they going to service it and dispose of it?"

Mr. Callahan said the government will run into problems valuing the assets.

"Virtually every loan prediction model out there didn't work because, if it worked, we wouldn't be in the situation we're in," he said.

It is also unclear whether the hedge funds and private-equity firms that have been buying these assets would be eligible to sell to the government through the program. At a Senate Banking Committee hearing this week, Treasury Secretary Henry Paulson would make no guarantees. "We want to deal with regulated financial institutions on a broad basis," he said, however.

Mr. Daurio estimated that, with nearly $12 trillion of loans outstanding — half of it in mortgage-backed securities and half in whole loans on bank balance sheets — the Treasury would have a "marginal" impact with just $700 billion of purchases.

"Whatever ultimately gets passed [by Congress] could be so watered-down that it really might not have a dramatic effect," he added.

American Banker - September 25, 2008

Distressed Asset Investors Hold Firm on Bids

A number of companies formed in the wake of the collapse of the subprime market are looking to turn a profit on distressed assets, but sales have been few and far between. Jon Daurio, chairman and CEO of Kondaur Capital, a scratch-and-dent purchaser/servicer, said there is no shortage of mortgages to bid on.

He said the number of scratch-and-dent mortgages in the market at the moment "infinitely dwarfs" the number available in the early 1990s. Daurio said the bid-ask on distressed assets is closer than it was a year ago, but he suggested that sellers are still asking for too much money.

"The bid is not going up; ask prices are coming down to realistic values," he said. Sales of distressed assets are currently driven by companies’ need for liquidity. "It appears that a lot of sellers have a need for cash," Daurio said.

Kondaur received more than $150 million in capital support from an undisclosed financial institution this week to expand its loan purchasing capacity. Daurio co-founded subprime lender Encore Credit Corp. and was a senior vice president at subprime lender Long Beach Mortgage Company.

He said some of Kondaur’s competitors are incapable of delivering on promised services. "We are hearing the horror tales of unsuspecting sellers dealing with these new entrants who demonstrate a surprising level of inexperience in scratch-and-dent transactions," he said. "They simply do not know how to conduct purchase and sale trades or provide basic customer service."

Daurio said some companies are making bids on assets and then extending the sale’s closure, waiting for dropping property values to strengthen their positions. He said a "final bid" often is often unreliable. When a pool bid is accepted, Daurio said the deal should close within four weeks, if not two weeks.

Servicing Issues

After acquiring a mortgage, Kondaur re-underwrites the borrower to consider a possible refinance, reduction in principal, cash-for-keys or a sale of the property. In a cash-for-keys scenario, Kondaur will pay a borrower’s deposit on an apartment and moving expenses. Kondaur is not a long-term buyer. Daurio said the company holds most of its mortgages for fewer than 180 days. Kondaur and Vantium Capital, another distressed asset purchaser and servicer, purchase whole loans.

Vantium also takes a personalized approach to loss mitigation and will not complete blanket loan modifications. Amy Brandt, CEO of Vantium, said the average employee at Vantium handles 180 assets, while the industry average is 800 assets per person. Vantium owns 40 percent of the assets it services, with the rest of the company’s portfolio owned by investors. "We have skin in the game," Brandt said.

Daurio said Kondaur originally planned on refinancing most troubled borrowers, but with a complete retraction of the non-agency MBS market, financing has been scarce. And he noted that most of the mortgages Kondaur acquires are not eligible to refinance into an FHA mortgage. Often the borrowers have not made a payment in a year. He said borrowers often inflated their incomes to qualify for mortgages.

"Borrowers bought homes they couldn’t afford due to stated income," Daurio said. Ocwen Financial, another special servicer, turned a profit again in the third quarter of 2008. Ocwen reported net income of $15.6 million for period, more than double the $6.0 million in profit it reported in the third quarter of 2007.

The company’s loan servicing segment drove profits in the third quarter of Ocwen shrank its portfolio. The company had $41.75 billion in subprime servicing period, down from $44.83 billion the previous quarter, according to Inside B& William Erbey, Ocwen’s chairman and CEO, noted that the company is considering spinning off Ocwen Solutions as a separate, publicly traded company. Ocwen provides technology products, outsourcing services and debt collection.

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Mods Won't Work for Many

By Ted Cornwell

While many advocates of streamlined loan modifications are scratching their heads over data showing a high "redefault" rate on modified loans, one industry insider isn't all that surprised.

Some executives, including Jon Daurio, CEO of Kondaur Capital, are skeptical about the prospects for mass loan modifications. Kondaur, a buyer and servicer of scratch-and-dent loans based in Santa Ana, Calif., pioneered "Combat Loss Mitigators," whereby a single collection specialist handles every stage of the resolution of each loan.

Mr. Daurio is more pessimistic than some about the prospects for a housing market recovery, predicting that nationally home prices will fall another 20% to 30% under pressure from rising unemployment and a weakening economy. He still believes the country faces two to three more years of falling home values before markets stabilize.

Already, he noted that in addition to high "redefault" rates on modified loans, many borrowers are defaulting on products such as pay-option loans before they adjust to become fully amortizing. In other words, they are defaulting before their monthly payment adjusts upward.

Rather than ditching the loan contracts and modifying the loans to make them more affordable, he believes refinancing borrowers who can afford to stay in their homes into more affordable loan products is the best solution. And with interest rates on conforming, 30-year fixed-rate home loans falling to levels not seen since before 1970 in late December, many borrowers may be able to reduce their debt burden just by refinancing.

He says actually modifying existing loans only makes sense for a "marginal number of borrowers," not the large volume of borrowers who obtained problematic loan products for homes they couldn't really afford in the first place. In most of those cases, it would be difficult to create a modified loan that the borrower can afford that will exceed the net present value of the recovery from foreclosure to the investor, he said.

"The fallacy of the effort to keep people in their homes is the assumption that people are in homes they should be in," Mr. Daurio said. "I believe that, by far, the vast majority of the horror stories you have been hearing involve people who are in homes that they never should have gotten in first place with loans they never should have gotten."

As for the government's role, Mr. Daurio believes it should buy new mortgage-backed securities to help get capital flowing to the home loan sector again, rather than bailing out investors in existing, troubled MBS.

Saying economic conditions are "horrific," Mr. Daurio said that even efforts to compare the net present value of a foreclosure with a modification may be flawed, because many models used to project future default rates on new or modified loans will not be accurate given the severity of the overall economic downturn.

Mortgage Servicing News - December 23, 2008

MBA Staff
MBA NewsLink sat down with Jon Daurio, chairman and CEO of Kondaur Capital Corp., Santa Ana, Calif. The company acquires, manages, services and liquidates distressed mortgage loans. Information about the company can be found at www.kondaur.com.

MBA NEWSLINK: How are lenders and servicers taking loss mitigation strategies more seriously, given the current economy and housing market?

JON DAURIO: I have not spoken to a single person lately who believes that our economy and the housing market will not suffer further in 2009. We believe that depreciation housing will average another 20 percent to 30 percent in 2009, relative to values in 2008, because the economy will be in serious trouble, which will lead to more default, which will mean more REO that will produce further housing depreciation.

Mr. Daurio is more pessimistic than some about the prospects for a housing market recovery, predicting that nationally home prices will fall another 20% to 30% under pressure from rising unemployment and a weakening economy. He still believes the country faces two to three more years of falling home values before markets stabilize.

As a result, I doubt any lenders or servicers are failing to take loss mitigation strategies more seriously. We believe that most loan owners are realizing that their existing servicing practices, including without limitation, loss mitigation strategies, are woefully inadequate. The most evident indication that lenders and servicers are taking loss mitigation more seriously is the magnitude of loan modifications in recent weeks. After months of failed attempts to modify loans, entities such as Ocwen, JP Morgan, Indymac, Citi and Bank of America have publicized significant new efforts they have take to succeed including both debt and rate reduction.

The core challenge, however, is determining whether the loan modification is truly in the best interest of both the borrower and the owner of the loan. First, there are a significant number of borrowers who simply purchased or refinanced "too much home." In other words, with the prevalence years ago of so many stated income and no-documentation loans — some with up to 100 percent of the value of the home being purchased or refinanced — some borrowers obtained a loan that had either or both: (a) too high a loan amount, and/or (b) too high a payment.

Furthermore, many of these loans had adjustment features that, despite some of the lowest long-term rates in history, would exacerbate an already bad situation. For example, "option ARM" and/or "pay option" loans, originated in 2004, 2005 and 2006, typically had a maximum five-year period during which the borrower had the option to make the lowest, or negatively amortizing, payment.

Many, if not a majority, of such borrowers typically obtained such loans so that they could make the negatively amortizing payment. Those borrowers are likely incurring a "payment shock" when the option terminates and they need to make a significantly greater payment, which is sometimes more than double the negatively amortizing payment. Moreover, such loans typically had a maximum loan-to-value ratio that, when reached as a result of making negatively amortizing payments, would also terminate the option.

Because of the rapid depreciation in housing prices over the last two years, many, if not the majority, of such loans have met and exceeded such maximum loan-to-value ratios, especially if the servicer and/or owner of the loan were to use the current, fair market value of the home securing the loan. Thus, in many cases, it would be in the borrower’s best interest to find a way to get out of the loan and the home in a manner that is least disruptive emotionally and economically.

Moreover, there is data being published showing that a significant number of modified loans have already defaulted. Therefore, it is extremely difficult for a servicer and/or owner of a loan to determine the value of a modified loan. Typically, value is determined by what a ready, willing and able buyer of loans would pay for the loan. If such value is less than what the owner of the loan would net by either foreclosing on the home or taking the home via a deed in lieu of foreclosure, the loan should probably not be modified and, rather, the loan should be sold.

It is our experience that many servicers are inadequately staffed both in terms of quantity and quality, to deal with the levels and types of defaults occurring today. Many such servicers are still being compensated under contracts entered into prior to the mortgage market meltdown and, therefore, do not provide sufficient compensation to hire a sufficient number of servicing personnel nor personnel with adequate levels of default management talent and experience.

NEWSLINK: Can any lender or servicer maintain an airtight loss mitigation strategy? If so, what would be its features? If not, how close can they come and how?

DAURIO: Nothing in the world of loss mitigation is "airtight;" however, some loss mitigation strategies are far superior to others. Superior loss mitigation strategies include each of the following features:

* Adequately trained and experienced staff;
* Staff with a minimal number of assets per person so that the loss mitigators can give each asset sufficient attention in terms of both magnitude and frequency;
* Comprehensive policies and procedures for determining the true, current, fair market value of the homes securing the mortgages, as well as for determining the likely depreciation in the value of such homes.

Resources necessary to determine the best resolution of the asset, be it:

* Modification of the terms of the mortgage;
* Sale of the mortgage;
* Refinance of the mortgage;
* Deed in lieu of foreclosure;
* Foreclosure;
* Eviction;
* Rehabilitation of the home that secured the mortgage; and
* Marketing and sale of the home that secured the mortgage.

Loss mitigation must be more like the custom building of a vehicle, rather than the assembly line process to build. Asset managers must be personally involved in the determination of a home’s current and future value, the price paid for the purchase of the loan, the best resolution of the asset and the best procedures for managing the asset through such resolution.

NEWSLINK: Where does customer service training come into play?

DAURIO: Customer service is critical to loss mitigation. It is absolutely necessary to have staff adequately trained and experienced to deal with borrowers in these times with sensitivity and knowledge sufficient to determine and execute the resolution with the best interests of both the loan owner and the borrower in mind.

In addition, we have been told of too many instances where, when a loan owner determines that the sale of the loan is the best loss mitigation strategy, buyers failed to complete loan purchases either at all or timely and efficiently because the loan buyer did not have the proper staff to conduct a proper due diligence review of the loans prior to purchase, true access to adequate funds and the knowledge and experience to handle the transition of the loans post closing smoothly and efficiently.

NEWSLINK: What key trends do you see in 2009 and how has Kondaur positioned itself for them?

DAURIO: We see housing price depreciation averaging another 20 percent to 30 percent in 2009, relative to values in 2008, so many loan owners will realize that selling the loans, rather than trying to mitigate losses on their own, will be the best resolution. We have made the capital commitments necessary to become not only one of the largest "scratch and dent" loan buyers in the country, but to more than double our staff in the next few months. Kondaur currently has the ability to purchase, and has purchased, hundreds of millions of dollars of loans.

NEWSLINK: Which foreclosure prevention strategy has the best chance of succeeding and why?

DAURIO: With respect to nonperforming loans, the best foreclosure prevention strategy is to pay the borrower for a deed-in-lieu of foreclosure from the borrower. In this way, you can get cash into the hands of someone who is likely in dire need of it. Also, a deed-in-lieu of foreclosure may significantly reduce the time line for gaining possession of, rehabilitating, marketing and selling the home that the mortgage had secured.

NEWSLINK: Which one is most likely to fail and why?

DAURIO: We believe that most loan modifications are likely to fail. Typically, the net present value of foreclosing on the home materially exceeds the net present of value of the modified loan. Also, given the state of the economy and the resulting instability of jobs, any projections of the performance of the modified loans are suspect, especially when you take into account that even the modified loan is likely to have a loan–to-value ratio significantly less in the near future than the ratio in existence at the time of the loan modification. This ratio is critical because most borrowers are not as enthused to make payments on a loan that is near or in excess of the value of the home.

NEWSLINK: Will the secondary market return and, if so, when and what will it look like?

DAURIO: We believe that the secondary market for mortgage will return; however, it will likely be materially different from what we experienced prior to the mortgage meltdown. We believe that the federal government will take steps to ensure that Fannie and Freddie will continue to buy loans; however, terms of such loans will reflect far more conservative underwriting standards, similar to those in existence in the 1970s.

NEWSLINK: Describe some successful methodologies for succeeding in the distressed assets sector.

DAURIO: We believe that, like Kondaur, you must handle each asset individually. You must devote sufficient resources to manage each asset individually, without an assembly line approach. You must offer top notch customer service to the loan owners seeking to sell the assets and you must absolutely be sensitive to the situations of each individual borrower.

(The views expressed in this article do not necessarily reflect the views or policies of the Mortgage Bankers Association.)

Kondaur Capital Corp. has $1 billion to help banks shed bad loans from their books.
The Orange County Register
By John Gittelsohn

Jon Daurio, chief executive officer of Kondaur Capital Corp., sits in the 16th-floor corner office of a building in Orange that was formerly headquarters of Ameriquest Mortgage Co., once the largest subprime lending company in the world. Daurio used to work for Long Beach Mortgage Corp., the predecessor of Ameriquest. He later worked for Encore Credit Corp. in Irvine. All three companies are essentially defunct, victims of the financial collapse. Now Daurio is making a comeback in the mortgage industry.  His company, Kondaur Capital Corp., trades in “scratch & dent” mortgages — buying bad assets off the books of banks and trying to sell or otherwise liquidate at a profit.  He talked to the Register about his company and the economy.  Some excerpts:

Q. Your company is called Kondaur which sounds like "Condor." Does that mean you’re a vulture company?
A. No. We see it as "soaring to better solutions" like a bird. The name is an amalgamation of my partner, John Kontoulis, and Daurio. Maybe some people see us as vultures, because of what we do, but that’s not our self image.

Q. You worked at Encore and Ameriquest, subprime lenders that are today's social pariahs. Should people be wary of you?
A. I anticipate a profit, but not like the entities I worked for on my resume. I take pride in helping 200 employees' families support themselves by working here in an economy that is very dismal. I made good money when Encore went public. I was general counsel and not a sales guy. Here, I'm the majority individual shareholder and the CEO of this company. I'm not a sales guy like Angelo Mozilo was at Countrywide or Roland Arnall at Ameriquest, who likely made billions. To me, it's a different mentality. I'm making decisions to keep the company alive for 50 years. It's not like a few years ago when people were making decisions for short-term profits.

Q. How does Kondaur make money?
A. We buy loans at a discount. For example, if there's a $100,000 balance, we'll pay less than that. We think we have models that make it work. But I've had guys ask how and they say, "Not enough upside." We haven't turned a profit yet. But of the loans we've liquidated from our portfolio, I'm coming out ahead on more than I'm coming out behind.

Q. What exactly do you acquire for your portfolio?
A. We are the owner and servicer of the loans. We call it “scratch & dent.” We do due diligence, look for the evidence of ownership of the note and mortgage. We only buy whole loans. We don't acquire mortgage-backed securities. It's too difficult to get all the approvals to get the ownership on those loans.

Q. How do you find the loans?
A. When we started, we were knocking on people's doors, trying to get our name out there. Now, people are coming to us. I believe we've developed a reputation for being a reliable counter party.

Q. With prices falling so fast, how do you know how much to pay?
A. It's risky. We have predictive models, taking into account that we will have carrying costs for 180 days and we might do repairs and renovations and deferred maintenance so they're what we call turnkey ready. We need to purchase at a sufficient discount to make money, which is especially difficult in a market like Florida or Las Vegas where the prices have been falling so fast.

Q. Who buys the loans from you?
A. Typically, the purchaser is a local investor, close to where the house is. They're not big hedge funds. They're usually individual investors, maybe a small group of three or four people.

Q. How big is the “scratch & dent” market?
A. I figure there are about $12 trillion in outstanding mortgages, about half of which are not securitized. So that's about $6 trillion dollars. Say 10 percent of those loans are scratch & dent, so the total potential market for us is something like $600 billion.

Q. How do your purchases break down?
A. It changes every pool we buy into. We can bid on a pool of 2,500 loans, but we make an offer on the individual loan level. We do due diligence on each one. I might buy 300. I might buy one. We review each loan meticulously to determine the value of the underlying house and the borrower.

Q. Who do you buy from?
A. I can't identify their names. I can say they are exceedingly large banks, Wall Street firms. Our sales agreements require confidentiality.

Q. Why do they want confidentiality?
A. I don’t know. That's a good question. Maybe it's this “mark to market” accounting requirement, which would force them to write down the value of a loan that's still performing. They don't want to show that on their books if they don't have to.

Q. Why do banks sell you loans?
A. Because the seller finally comes to the realization that the recovery isn't going to happen soon, because the recovery going to be more like an 'L' and than a 'V.' If you believe it's an 'L,' then it's better for you and me to get it off your books.

Q. Why isn't Kondaur making money yet?
A. I raised a lot of money in November and bought way more in December and January and February. We have technically incurred a loss, because we haven't liquidated as much as we've acquired. But our models predict that we are hopefully going to wind up making money. Sometimes we lose on a deal because the real estate market tanked way worse than predicted or the due diligence didn't allow us to get into a place and we over bid. Some places are amazing. They look OK from the street, but you go inside and you can see the basement through the floor and the sky through the ceiling.

Q. When do you expect the market to turn around?
A. I don't think it will turn until 2012 or 2013. I feel very negative about when the housing market might bottom out. You have the Alt-A and the pay-option loans that are going to hit. We believe that $1 trillion of the $12 trillion in mortgages are in that are in pay option or option arm loans. Most of those people are making negatively amortizing payments, and many have a high loan to value and stated-income loans. The majority of those loans have a five-year period before the option to make a negatively amortizing payment. That means loans made in 2004 adjust in 2009 and those in 2005 are in 2010. I think until 2011, you're still going to have significant defaults and more foreclosures. Then you've got all the unemployed people who will be losing homes.

Q. Why are so many people still losing their homes?
A. There are examples that are heart wrenching, but I believe a significant percent of the stories are that people got loans they never should have gotten and I believe they are culpable. As an originator, I had people who used their house as an ATM. There were people who qualified for loans with stated incomes because they would never have qualified with their real income. We all should've seen this coming: People with $3,000 a month incomes in a $600,000 house.

Q. What do you do if someone can't afford the home they're in?
A. We try to educate the borrower and say: “You have too much home. You're under water. You're sitting on a depreciating asset. The best thing you can do is move.” We'll sometimes offer a deed lieu of foreclosure. We'll sometimes give them money to move and a deposit so they can rent an apartment. The benefit to me is I get the property today. The benefit to the borrower is he gets to move on.

Q. What do you think will be different when we come out?
A. I think the problem started in the '80s with deregulation under Reagan. We got leverage that would be inconceivable. At Encore, we had 45-to-1 leverage, $45 for every $1 we invested. That's nuts.

Q. Do you think the stimulus will help?
A. I'm a member of the Republican Party, but I think I get my ideology from all over the place. I believe most entities should be allowed to die — AIG, GM — the way they did with Lehman Brothers. I believe the faster we get to the bottom, the faster private entrepreneurs will become creative and spur new business ideas to get things back in place.

Q. Why don't you support loan mods by the federal government?
A. From a purely selfish point of view, it doesn't help my business. Nevertheless, I've seen studies that most of the loans that have been modified have gone right back into default.

Q. Is your business being affected by the stimulus or the TARP ($700 billion Troubled Asset Relief) money?
A. Indirectly. Some of the banks selling mortgages got TARP money. One trade for us broke down because they got the TARP money and said “We're holding.” So it had a negative effect on me.

Contact the writer: 714-796-7969 or jgittels@ocregister.com

Feature Story
Managing REO
By Jennifer Harmon

There is a need for servicers to find the borrowers who are doing everything they can to make their mortgage payments but live in fear of someday losing their homes to foreclosure.

Janice Ramocinski, COO of Kondaur Capital Corp., a buyer of scratch-and-dent loans in Orange, Calif., said servicers must get to these borrowers before they are in default and address the character component of mortgage lending.

“These people believe that beyond any other asset or obligation they have, they believe their mortgage payment is paramount. They give up their cell phone, their fancy car, they’ve lowered their monthly out-go to keep that obligation going. They’ve taken a second job or part-time work. And the servicer doesn’t even know who that person is,” Ms. Ramocinski said.

Right now the industry does not have the statistics or tools to connect with these borrowers. “There needs to be a roundtable discussion or more brainstorming in terms of identifying those people. Servicers are so varied trying to deal with the delinquent borrowers that how do you ask them to devote those resources to the borrowers who are current. How do they find those resources?” she said.

The traditional way of dealing with borrowers is not helpful in this environment, adds Ms. Ramocinski. The borrower that becomes delinquent will be turned over to a collector where the conversation is based on collect, collect, collect. There is no relationship between the borrower and the lender for the longer-term solutions, she said.

“Don’t collect it. Let the borrower keep that $1,000 payment as a longer-term solution, which might be a complete loan modification or educating the borrower as to what they really can and can’t afford. Maybe they can’t afford that house any more. But in the meantime, you’ve collected $1,000. Does it do any good for anyone in the long term?”

Kondaur Capital, one of the nation’s largest buyers of nonperforming loans, uses a very high-touch approach to purchase these types of loans. The company spends an extensive amount of time and energy during the due diligence period reviewing these loans for purchases.

“One of the reasons is not only do we want to make sure we have a very solid understanding of what the value is of the underlying collateral, but we also want to make sure we have a good idea of what situation the borrower is in from a credit underwriting situation,” said Jon Daurio, chairman, Kondaur Capital.

The company communicates with its borrowers using extensive skip-tracing techniques to try and reach them. Kondaur is currently at 200 employees but its goal is to be at 400 by June 30. About half of time, the company is actually able to communicate with the borrower during the due diligence period. Half the time, it is not. Along with the three C’s of underwriting there is a fourth one that no one really talks about, Mr. Daurio said, which is character.

Character means taking into account the credit, capacity and the collateral, which all indicate whether or not the borrower has the character to make the payments. “It’s a good bet that someone who has been in their home for 25 years will do whatever they can to make their payments and not lose the home. If the borrower has been at his job for 20 years, that person may be less likely to lose their job when cuts are prevalent. The majority of these people are more likely to make their payments.”

There are times Kondaur cannot get a hold of the borrower because he or she is in denial. “We resell the note ‘as is’ or sometimes we get all of the information from the borrower. We look at the 4 C’s and we’re able to modify the loan. It has been properly underwritten and we are able to sell it,” he said. “We are able to help the borrower to understand that they have too much loan. The converse of that is too much house.”

Mr. Daurio brings up the example of a borrower with a 100% LTV stated-income loan for $600,0000 who makes $3,000 a month. “Under FDIC guidelines, even though the borrower can afford a $930 a month payment, is it fair for someone to live in a house worth $400,000 that in my opinion they never should have bought in the first place?”

Or perhaps the borrower has a $400,000 unpaid balance. The home is worth $300,000 today but they are making a mortgage payment on the $400,000. “The challenge for servicers is that they have an owner of a loan that has their head stuck in the sand that doesn’t want to realize the loan is not worth $400,000. That loan is worth at best a fraction of the $300,000 collateral value.”

The company has seen this tragic situation even on the loans it has purchased. For modified borrowers, their payment goes from $3,000 to $2,000 for six months. “We have the loan. We bought it. Now what after six months? We’re sorry they took your $2,000. That prior owner of the loan, when you were seeking your modification, should have educated you. Can you make the $2,000 payment? Yes. But for a $400,000 or $500,000 or $600,000 house, that modification is not, using normative terms, fair.”

Both Ms. Ramocinski and Mr. Daurio believe most loan servicers are doing a loan mod that addresses the payment part of the loan mod and not the principal reduction part. “That’s where they are doing a disservice to the borrower. It’s not good for the long-term health of the borrower, the lender, or the servicer,” Mr. Daurio added. “The problem with so many loan modifications these days is that many are not requiring proof of income. It’s almost like the loan mod is the new stated-income program.”

According to Ms. Ramocinski, the industry today tends to think more in terms of the borrower’s income and less or rarely about an old concept of the borrower’s residual income. After the borrower gets paid, certain deductions are taken out of that, such as federal and state taxes.

“What is left from that is the cash he can actually spend to pay his bills. Not everyone is the same. We haven’t seen a loan application yet asking, ‘What do you pay every month for out-of-pocket medical expenses? What do you have to pay every month out of that cash for your child’s special needs, education and daycare?’ In the heyday of originations, originators focused squarely on what was on the credit report. These are all things obligations that don’t show up on the credit report.”

One of the things that doesn’t happen during any loan modification is to take a look at the lifestyle of different people, she points out. Everyone has different obligations, she says, relative to their situations. “Someone may be caring for an aging, sick parent or child. We’ve not connected with that part of the borrower’s obligations when we’re looking at loan mods much less real lending. And I haven’t heard too many servicers talking about that side of it.”

Exaggerations of earnings in the boom cycle have been replaced by showing lenders payments are unaffordable.
Los Angeles Times
By Lew Sichelman

Reporting from Washington -- There's anecdotal evidence that an increasing number of homeowners are trying to pull the wool over their lenders' eyes. In some cases, they are lying in an effort to save their homes from foreclosure. But in other instances, they are trying to convince lenders to grant them new, more favorable loans they don't really deserve.

Frank Sillman, managing partner at Fortace, a Los Angeles-based fraud pursuit and recovery company, has seen a marked increase in loan-modification fraud, which could be described as just the opposite of the loan-approval fraud committed by many people to obtain mortgages for which they didn't really qualify.

"First, they overstated their incomes," Sillman says. "Now they are understating them."

In some cases, out-of-work industry insiders who have been sidelined by the housing recession and are no less desperate to generate a little income are coaching borrowers to hoodwink lenders.

Sometimes, in fact, they are being aided by those same supposed professionals who originally told borrowers it was OK to exaggerate their earnings or pass off someone else's sterling credit record as their own. "Crooks morph very quickly," Sillman says.

In other instances, borrowers are winging it, fudging tax returns and altering weekly pay stubs to show lenders they can no longer afford their house payments.

Coaxed or not, though, people who lie to their lenders are just as guilty of a crime as foreclosure-rescue specialists who fleece struggling borrowers out of their last few thousand dollars by promising to negotiate better loan terms and then failing to deliver.

Sillman says he's seeing "a ton of fraud," especially as it applies to fake "short sales," which is the industry term used to describe the sale of a property for less than what is owed on it.

Rather than stay in a home they can no longer afford, or one that is no longer worth what they paid for it, many borrowers can try to prove to their lenders that theirs is a truly a hardship case.

If a borrower can show there's no hope that he can make his payments as originally promised, he can pretty much wipe the slate clean. Uncle Sam forgives the difference between what he owes and the selling price, his loan is closed and, unless he is already behind on his payments, his credit record remains intact.

Lenders generally approve legitimate short sales because it is less expensive than foreclosure. But they want to make sure borrowers who want out honestly no longer have the capacity to meet their obligations. And what investigators are finding is that many applicants can still make their payments, they just would rather not.

Sillman's firm has uncovered numerous questionable short sales in which the "buyer" is really a friend or family member. Typically, lenders would rather see arm's-length transactions in which they buyer and seller do not otherwise know each other. But they will consider a sale to a family member or friend.

Fortace also has uncovered many instances where solvent owners are imploring employers to tell lenders they no longer work there or are temporarily signing over assets to friends or distant relatives. "Everyone's trying to hide assets," Sillman says.

Others have uncovered similar shenanigans. Jeffrey Taylor at Digital Risk, an Orlando, Fla., firm that analyzes loan portfolios on behalf of potential investors, has found numerous cases where co-workers are supposedly verifying income rather than the boss, or where people are claiming they have been told they will be laid off in 30 or 60 days so they qualify as "imminent defaults."

Many owners whom Taylor says "are trying to get their share of the free money, one way or another" are also failing to disclose bank and stock accounts, neither of which are listed on credit reports. "It's easy to hide assets if you don't want to disclose them," says Taylor, whose firm scours numerous databases to root out liars.

Jon Daurio of Kondaur Capital in Orange, a firm that buys nonperforming mortgages for pennies on the dollar and then works with troubled borrowers to get them back on track, has seen a proliferation of "canned" hardship letters borrowers are asked to write to explain why they became so far behind on their payments.

The letters are so similar, reports Daurio, it is obvious that people have been "coached" about what to write. Merle Sharick of the Mortgage Asset Research Institute says this is a growing cottage industry among out-of-work mortgage professionals who are now billing themselves as loan-modification specialists.

In many cases, according to Sharick and other observers, these are the same industry insiders who led borrowers blindly into loans they could not hope to afford, often coaxing them to lie on their loan applications. "Once a crime of opportunity," Sharick says, "fraud is now a crime of necessity."

Lying to purchase a home is known in the business as "fraud for property." Here, borrowers have no evil intention; they just want to get into a house. The other type of loan fraud is known as "fraud for profit," a term used to describe the scams often perpetrated by insiders, sometimes in conjunction with organized crime, to churn huge sums of cash.

National Mortgage News
Irvine, CA

Kondaur Capital Corp. here - an investor in nonperforming mortgages - expects its work force to triple to 900 workers by yearend.

In an interview last week, company chairman and CEO Jon Daurio described Kondaur's business of buying and selling troubled loans "as very good right now. We're definitely in a growth mode."

Indeed, rumors abound that Kondaur is quite active in the market but Mr. Daurio declined to comment on specific deals except to say that his company currently holds about 2,500 loans on its books. "We're buying and liquidating loans every month," he said.

Kondaur is presently working on six deals. (Mr. Daurio also declined to say which banks and lenders Kondaur is purchasing product from. However, Citigroup's name has surfaced on more than one occasion.)

A majority of the mortgages Kondaur owns are backed by homes in California and Florida. The company services the loans itself on a platform using software provided by FICS.

Each of the company's asset managers handle between 25 and 30 loans. "At some shops asset managers handle up to 100 loans," he said.

Kondaur's goal is to "reperform" and modify the loans. But in reality, the company takes a deed-in-lieu or forecloses. It then sells the underlying home.

During his career, Mr. Daurio has worked at such subprime shops as Long Beach Bank and Encore Credit. He is a majority owner in Kondaur with a couple of hedge funds as partners.

by Janice Ramocinski
Mortgage Banking
Orange, CA

A sage once advised, "If you don't know where you're going, any road will get you there." I'm reminded of this faintly tongue-in-cheek counsel each time a new report emerges on the foreclosure crisis sweeping the country, offering up fresh evidence that yesterday's "breakthrough" solution to stemming this toxic tide has fallen short. It behooves us, then, to take pause when considering today's newest nostrum, because it, too, has a high likelihood of being cast aside by tomorrow, in favor of ... you guessed it, yet another bright idea.

The proof of this mismatch is painfully obvious. Last year, more than 60 percent of mortgages modified for private investors missed a payment after six months and more than half of bank-owned (portfolio) loans faltered in the same time period. Even government-sponsored enterprise (GSE) loans were not immune. According to the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS), 58 percent of Freddie Mac-modified loans and 57 percent of Fannie Mae-modified loans were 30 days past due after six months.

Before descending too far into the darkness, giving readers the idea that I am a pure nihilist on the housing problem (as in: nothing will ever solve this thing), let me say I actually am fairly optimistic that we eventually will wade through the waste and come out the other side stronger. In order to do this, however, we must start looking at the default destruction for what it really is. This is not just a misfiring car engine (apologies to Detroit's once-Big Three) in need of only a modest tune-up. The housing market, and for that matter the entire economy, has very nearly crashed from a massive amount of self-delusion and wishful--or hopeful--thinking.

Straight talk is the only cure. So let's start the conversation with this understanding: A "foreclosure holiday" (a.k.a. moratorium), already offered by some lenders and put into effect in states such as Massachusetts, may feel good at first, but it's bad news down the road and essentially just delays the inevitable.

The cost of such a free lunch to our economic system and financial institutions is enormous, not to mention the pain it visits on our credibility with not only our citizen taxpayers but also with our foreign debt holders. They would be right to assume that our contracts mean nothing, if we say this in so many legislative ways.

Some debtors will never perform

So, let's start the solution process by acknowledging a little secret that keeps servicers awake at night staring at the ceiling, fearing the next sunrise. Some debtors will never perform as expected, because they just cannot afford their loans. You can mark down the monthly payments 30 percent, postpone the maturity date or even forgive some principal, but these poor folks (literally and figuratively) just don't have the dough--and won't, no matter what you do.

The reasons are legion, so pick one: job loss, family dissolution, fraud, health problems and so on. No matter. In those cases, the best and fairest settlement is a moving van. (Before you label me harsh, ask how much more humane it is to let people stay in a house with the inevitable sword hanging over their heads, i.e., with a debt they will never be able to pay short of another valuation bubble that is not coming back.)

For those pressed borrowers who can stay in and save their homes, I recommend they bypass the chat rooms and office water cooler and go straight to their servicers. Unfortunately, few people pick up the phone to do that even though some servicers are really willing to go out of their way to help.

At the Mortgage Bankers Association's (MBA's) National Mortgage Servicing Conference in February, one after another servicer lamented about the double-whammy delivered by customers they can't reach and others who can't reach them (the first because of fear, the second because of volume).

Fear does paralyze people who are in trouble, but you might be surprised how often it's more a case of "toy denial"--borrowers simply don't want to give up their big-screen TVs, cell phones, giant cars or the dozen credit cards that prop up this impossible lifestyle, even while they'd want their mortgages modified downward to their comfort levels. It creates a dilemma for servicers, who become social workers trying to figure out who really deserves help.

And it is a challenge made all the more difficult because traditional servicers are reeling under the strain of crashing collateral in this defaulting market. Budgets configured for uninterrupted collections, escrow accumulations and payout transactions are dwarfed by the giant-sized costs of tracking delinquent customers, multiple communications with them and proactively identifying people who can and should be helped. These are all extremely time-consuming tasks, especially in this case, where time is money.

Moreover, many servicers are neither qualified nor experienced enough to develop proper underwriting guidelines or implement them. And how many servicers have the staff, both in quantity and quality, to gather and review full documentation to prove a borrower's income? Furthermore, are servicers either fully trained or taking the time to train employees to determine the true debt-service obligations of a borrower? What are servicers doing to verify a borrower's accurate cash inflows and outflows?

Servicers also have a couple of feet on the proverbial banana peel with an inability even to take some basic and critical steps such as financing servicing advances.

Asset manager with authority

As a result, "big-box" servicers are now yielding to a next generation of boutique servicers with the resources and expertise to deal with these unprecedented problems. The smaller shops (sometimes called component servicers) are proving more nimble and adept at giving ownership of delinquent loans to a single asset manager who has the authority to make decisions on that asset. It is not done by committee requiring three levels of sign-offs.

This approach allows servicers to help people, but only if it can be done expeditiously--before conditions change further and make the new deal useless. But even then we have a significant normative, if not moral, issue. Even if servicers were able to determine a debt-to-income ratio accurately, such a ratio is only one-half of what's required for underwriting. The other part is collateral.

If someone can afford under prudent underwriting guidelines, for example, a payment of only $1, 200 per month, should that borrower be given the opportunity to make that payment on a home that today is worth $500,000 because the borrower purchased the home two years ago for $700,000 with a stated-income, 100 percent loan-to-value (LTV) loan? Why should the current owner of that loan--who more often than not did not originate that loan--take the hit so a borrower can stay in a home that the borrower should have never purchased in the first place?

Borrowers need to be educated and made to understand that sometimes old-world underwriting rules should be followed--such as never buying a home that has a value in excess of three times that borrower's gross annual income.

The name of the game, then, is talking with borrowers and getting them to not only take action, but to "get real." That requires a servicer with the ability to be both high-touch and efficient, with all solutions on the table.

Janice Ramocinski is chief operating officer of Kondaur Capital Corporation, Orange, California, which acquires, manages, services and liquidates distressed mortgage loans, She can be reached at jramocinski@kondaur.com.

by Paul Muolo
National Mortgage News

As every mortgage banker knows it takes a license to lend in a state, any state. But what if your firm only services loans? Does it need a license? And what if you happen to manage one of the dozens of new vulture funds popping up to buy delinquent and subperforming mortgages — if you purchase a loan and then modify it, does that count as an origination and if it does, do you need a license?

Welcome to the new reality that loan modification firms and investors in non-performing loans (NPLs) are facing. After two weeks of interviewing players in the NPL market the consensus seems to be that roughly 20 states require mortgage firms to carry a license of some sort if they're engaged in the monthly practice of collecting (or trying to collect) loan payments.

"It all depends on where your loans are," said George Ostendorf, a former executive at Hanover Capital, Chicago, who now plies his skills in the NPL market. "It's a real gray area. Some firms might be exempt if they have a relationship with a servicer. And some states are ambiguous."

But the servicing piece of the puzzle may not be the real problem for vulture funds. As Mr. Ostendorf noted, the issue is more philosophical: "If you attempt to restructure a loan it can be argued [by the states] that it's an origination, a new loan." And if it is a new loan that means the NPL investor (vulture fund, whatever you want to call it) needs an origination license.

Jon Daurio, CEO of Kondaur Capital, an NPL investor based in Irvine, recently found his firm on the wrong end of a 'cease and desist' order in Georgia for engaging in what the state called "mortgage broker/lending activities." Kondaur wasn't funding loans there but it had purchased some NPLs in the "peach" state.

Kondaur, noted Mr. Daurio, is licensed to service in "all states — except Georgia." Kondaur, though didn't have an origination license either, hence its problems and the C&D order. But Mr. Daurio — who cut his teeth on the subprime industry of yesteryear (the B&C niche that existed prior to the Wall Street-fueled debacle the nation is now dealing with) — has learned his lesson. Kondaur is in the process of getting licenses to lend in all 50 states.

What's at stake for Kondaur? Mr. Daurio estimates that there are 10 million "scratch and dent" loans that are available for purchase, that is, if only some of the sellers would be willing to part with mortgages at a price Kondaur wants to pay.

Currently, Kondaur has 2,000 whole loans in its portfolio. With backing from hedge fund Pequot Capital, Kondaur has the capacity to hold 10,000 loans that (depending on the average note size) could total $1 billion. (Mr. Daurio noted that even though Pequot is shutting down some of its funds, Kondaur's investment money is secure.)

But, getting back to the issue of licenses — without the proper approvals an NPL investor can find itself in hot water with the states. In its recent IPO filing vulture fund PennyMac of Calabasas, Calif., recognizes the issue, telling investors that its failure to obtain the necessary "licenses promptly or our failure to satisfy the various requirements or to maintain them over time will restrict our direct business activities."

One way to get around the licensing problem is to use a subservicer but not all NPL investors want to do that especially in a business where they're seeking high returns by purchasing notes on the cheap, cleaning them up (either through modification or foreclosure) and then selling them into the secondary market or maybe even through securitization (if that business ever returns).

But the key to licensing is passing the appropriate background checks and then obtaining bonding from an insurance firm that writes such coverage. And therein lies the problem, several NPL investors told me. In the old days, prior to the nation's financial meltdown, a $100,000 bond could be easily obtained by a company making a 10% down payment and carrying a note for the balance. But several bond insurers — including American International Group — have stopped writing coverage or greatly reduced their business. "That means I have to put up the full $100,000," said Mr. Daurio.

Thanks to seed money provided by Pequot (the subject of an SEC probe), Kondaur can afford the barrier-to-entry. Smaller players may not. For now, one of the biggest problems facing the NPL sector is the unwillingness of sellers to let go of product at a price firms like Kondaur find desirable. "Right now we're in a bit of a trough," said the Kondaur chief. "No billion-dollar portfolios are changing hands but we're looking at several smaller portfolios." And you can guarantee that after what happened in Georgia, Kondaur has its licensing in order.