Lost about 17k on a performing second whose pay history told me nothing

Closed this one out last month after 19 months, so the numbers are final.

What I bought: performing second lien, UPB 41,000, coupon 10.5%, P&I 402, 27 consecutive on-time payments in the servicer ledger. Paid 62, so 25,420, plus about 1,100 in collateral review, boarding and assignment recording. Senior lien balance 198,000, BPO 246,000. Combined ITV 97%, which I saw, wrote down, and talked myself past because the coupon was fat and the borrower had a three-year record.

Months one through eight, paid on the first every time. Month nine, nothing. Month ten, nothing. I called the servicer and got the thing I should have been getting from day one, which was the status of the senior. The borrower had stopped paying the first two months before he stopped paying me, and the senior servicer had already sent a demand. He'd lost a contract job in July.

So I had the standard junior lienholder decision. Bring the senior current and keep my position alive, or stand down. Senior arrears plus fees to reinstate were 14,300 at that point and climbing, and I'd have been advancing that into a property where the first alone was 198,000 against a value that, after a fresh drive-by, looked more like 232,000 than 246,000. Advancing 14,300 to protect a 41,000 second on 34,000 of gross equity before any selling cost is just buying a bigger loss. I stood down.

Foreclosure ran, and this was a state where the sale produced a surplus. After the senior payoff, fees and costs, 6,400 came to my position. Plus the eight payments I collected, 3,216.

In: 26,520. Out: 9,616. Loss 16,904 over 19 months.

What I'd do differently, plainly. I'd pay for monthly senior lien monitoring on any junior position from the day I board it, because I'd have known about the first going delinquent two months before my own payment stopped and I don't know that it would have changed the outcome, but I'd have had the choice earlier and cheaper. I'd cap combined ITV at something like 80% on seconds regardless of coupon. And I'd price a second as though it will go non-performing at some point in its life, then ask whether the price still works, instead of pricing off a clean pay history that only tells you what a borrower did while he still had a job.

8 replies

-1nataliehsuSO1BPRO7

Sorry, 62 cents on a second at 97% combined? What was the pitch for the discount being enough there? Genuinely asking, I'm trying to learn what a fair price for that risk even looks like.

2monica_tran3SF4CPRO6

I'll disagree with your own conclusion a bit. Monitoring wasn't the failure. You'd have found out two months earlier and been staring at the exact same 14,300 reinstatement against 34,000 of gross equity, and you'd have made the same call. The failure was 97%.

A second at 97% combined has no collateral behind it in any practical sense. You were an unsecured lender with a recording fee. Everything after that was just the arithmetic playing out. Monitoring is a good habit and it wouldn't have saved this one.

1bmoreno23AB1B

Can someone explain the surplus part? I thought a second lien got wiped out in a senior foreclosure and got nothing. Cobalt got 6,400, so it clearly isn't nothing.

2diane_kowalskiPassivePRO9

ember, the lien gets wiped from the property, and if the sale brings more than the senior debt and costs the surplus goes down the line by priority, so the second can get paid out of the excess. Whether there's a surplus at all and how you claim it varies a lot by state and by whether the sale is judicial, and in plenty of sales there's nothing left. Cobalt got lucky that the property brought a number.

Cobalt, did you have to file to claim it or did it come automatically?

2kevin_lombardPG1BPRO5

He saw 97%, wrote it down, and went ahead anyway. That's the part that scares me, because the information wasn't hidden.

1mitchell_ray4 Get yoursPRO6

My near miss was the same shape from a different angle. Performing second, combined around 88%, and during diligence I asked for the senior's current statement and the seller said he didn't have access to it. That's when I found out the senior was a HELOC with a draw period, which meant the balance I'd been underwriting could go up while I sat there. Walked over that. I'd never thought about a senior lien that grows.

thatch is right that 97 was the whole thing, but I'd add that on a second you're underwriting two loans and you only get a file on one of them.

3gregpowell66AG4BPRO8

The number that bothers me is 62. If a second at 97% combined can reasonably be expected to go non-performing at some point and you've got a real chance of getting most of nothing, the price has to be in the 30s or 40s, and at that price the seller doesn't sell. Which is the answer, cobalt. There wasn't a price at which that loan was a good buy for you, so the discipline isn't better monitoring or a tighter ITV cap, it's recognizing the trades you can't win and passing on the whole category until you have the capital to advance on the senior when you need to.

Appreciate you posting the real out-of-pocket. Most people round these off.

Lost about 17k on a performing second whose pay history told me nothing

8 replies