Distressed-Loan Sales About to Soar: PennyMac's Kurland

Banks will unload big volumes of distressed loans this year, the head of PennyMac predicts.

Stanford L. Kurland, the chairman and chief executive of the Calabasas, Calif., mortgage buyer and correspondent lender, said that it has taken much longer than he had expected for banks to sell their soured loans. When he founded PennyMac in 2008, he envisioned it primarily as a buyer of distressed mortgages but many sales did not materialize.

"We thought we would have reached the end by this point," Kurland, a former president of Countrywide Financial, said Wednesday at the Credit Suisse investor conference in Miami. Instead, distressed loan sales were sporadic — what Kurland called "a very lumpy business" — with sellers offloading large packages in one quarter, then absent from the market for several quarters.

Many banks would not take steep discounts, so they held off on selling. But with housing prices stabilizing in many markets, banks now see an opportunity to sell and buyers are more aggressive in bidding up prices, he said.

"This is going to be one of the largest years where distressed mortgages are being offered by banks," Kurland said. "We've seen a high volume of packages come to market in late January, early February, and it's going to be multiples of the volume offered last year."

Expectations are that $3 billion to $10 billion in distressed loans could hit the market this year, says Derek Katz, a managing director at MountainView Capital Group, a Denver advisor to buyers and sellers of residential loans.

"Whether or not those numbers come to fruition remains to be seen, but there has been a fair amount of activity in the first quarter" such as sales by Citigroup (NYSE:C) and Wells Fargo (WFC), Katz said.

Fannie Mae has announced plans to sell distressed loans, and the Department of Housing and Urban Development has said it intends to sell 40,000 severely delinquent loans from the Federal Housing Administration. The Federal Deposit Insurance Corp. also is expected to increase sales through auctions.

"Between Fannie, HUD, the FDIC and some new money-center banks selling, there should be more product that hits the market," Katz says.

Still, Kurland cautioned that he has "a little bit of discomfort" about how much price appreciation can be built into current models. Some bidders for distressed mortgages are now factoring in annual price increases of about 3% a year. But higher projected home prices mean bidders also are becoming more aggressive and overall returns on soured loan purchases will likely decline, he said.

Profits in the overall mortgage market also may decline as refinancing volumes slow and lenders compete more aggressively for business, he says.

For more than a year, large banks lacked the capacity to handle all of the refinancing volume, which caused gain-on-sale margins to jump dramatically. But outsized margins may be coming to an end.

"The industry has added capacity, and the fact that the volume of loans that can be refinanced has declined and interest rates are back up has resulted in greater competition," Kurland said. "We have operated with very wide margins in correspondent [lending], and those margins will normalize over the course of the year."

PennyMac — whose investors include fixed-income giant BlackRock Inc. and hedge fund Highfields Capital Management — had to switch gears and added correspondent lending when the distressed-loan business started slowly.

It has a real estate investment trust, PennyMac Mortgage Investment Trust (PMT), that is wooing community banks. It recently hired several account executives and wants to buy more home loans to grow its correspondent lending business. PennyMac expects to add $4 billion in correspondent volume by December 2013. Correspondent loan acquisitions rose 59% in the fourth quarter, from the third quarter, to $10 billion.

Due primarily to Bank of America's exit from the correspondent business in late 2011, PennyMac has grown dramatically, becoming the sixth-largest correspondent lender in the U.S.

Community banks often do not want to retain mortgage servicing rights, so they may originate a loan and sell it to a larger lender such as Wells Fargo or JPMorgan Chase. Those large banks then typically bundle the loans for sale to Fannie Mae, Freddie Mac or Ginnie Mae.

"Many originators don't have the financial wherewithal, capacity or desire to invest in the servicing asset," Kurland said. "As pricing for mortgages becomes more competitive, we believe the volume of sellers that choose a correspondent path will increase proportionately."

But there is some downside risk that a bigger lender will poach a smaller bank's customers. Kurland stressed that because his company is a REIT, community banks don't have to fear that their customers will be stolen by a competitor.

"Community banks would like to resist selling their loans to other banks, so we really present no threat from that perspective," he said. "Because we're not a bank, we wouldn't be cross-selling them."