Playing Mortgage Market Proves Tricky

By RUTH SIMON As mortgage delinquencies have climbed, hundreds of investors have sought to profit by buying troubled loans from banks and other institutions, restructuring the mortgages to keep borrowers in their homes and quickly moving loans that can't be saved to foreclosure. But as hedge-fund manager Ralph DellaCamera has learned, it has been a difficult strategy to pull off. Banks have been reluctant to sell loans at the price investors will pay for them. Meanwhile, the time it takes for investors to get their cash back has lengthened. Still, interest remains high. "You may not like the price, but there is plenty of buying power out there," says William David Tobin, a principal with loan-sale adviser Mission Capital Advisors. Banks' unwillingness to sell loans at steep discounts has also been an obstacle for the government's Public Private Investment Program, which was designed to help rid banks of troubled loans and securities. Ernst Henry got refinancing for his Charlotte, N.C., house, seen Tuesday. Banks generally would rather hold on to assets they believe have more inherent value, rather than sell them at a low point in the market. Mr. DellaCamera bought his first distressed residential mortgages in December 2006, paying about 60 cents per dollar of unpaid principal. The following May, he set up a mortgage-servicing company to gain more control over negotiations with financially troubled homeowners. DellaCamera Capital Management has so far invested about $150 million in residential mortgages and mortgage servicing, operating principally through a company called National Asset Direct and its affiliates. Mr. DellaCamera hasn't bought any mortgages since last summer, though he continues to look for more. Instead, he has been focusing on the mortgage servicing unit, which now handles about 1,100 loans for Mr. DellaCamera's firm and a handful of other investors who have bought mortgages at a discount. "Initially, we thought there would be a plethora of opportunities" to buy loans, says Mr. DellaCamera, 55 years old, who headed trading at hedge fund Elliott Associates for more than a decade. "But we pulled back from buying these loans because the pricing isn't there and we were having trouble hedging." He calls servicing troubled loans a "tremendous opportunity." Because most mortgage-loan sales are private, statistics are difficult to come by. Prices currently vary from 20 cents per dollar of unpaid principal for some of the riskiest subprime mortgages to nearly 90 cents on the dollar for current loans to borrowers in strong housing markets, says Kingsley Greenland, chief executive of DebtX, an online marketplace for loans. Those types of prices would produce losses far greater than most have reserved for, says Keefe, Bruyette & Woods analyst Frederick Cannon. "Banks are essentially holding loans in the system at a value of 97.5 cents on the dollar," he says. Investors can be more flexible in working with financially distressed homeowners, in part because they buy loans at a discount. Marix Servicing, which services loans for Marathon Asset Management and other hedge funds, will sometimes reduce the loan balance by an increasing amount each year for two or three years, provided the borrower stays current. Arc Westwood Home Saver Management, which bought a small pool of distressed mortgages last September to test its strategy, "can offer principal reductions in some cases of $100,000 or more," says executive vice president Michael Mattera. National Asset Direct's iServe Servicing recently offered $50 American Express gift cards to 50 hard-to-reach borrowers, provided they agreed to a meeting. Four wound up with loan modifications; two sold their homes for less than the amount owed, with the company's approval. Jimmy Cagle, a lumber salesman, was several months behind on the $313,000 mortgage on his Prosper, Texas, home, when his loan was purchased by an affiliate of National Asset Direct for an undisclosed discount. Ultimately, iServe cut Mr. Cagle's interest rate to 7.5% from 8.65%. It will likely reduce his loan balance to about $200,000 and refinance him into a new mortgage, provided he makes his loan payments for 12 months. Staying current is still a challenge, "but we are getting it done," says Mr. Cagle, who has cut out luxuries such as trips to the local Cineplex. Some mortgage investors have made principal reduction a part of their strategy, in part because it gives borrowers who owe more than their houses are worth an incentive to keep making payments. It is also easier to ultimately refinance or sell the mortgage if the borrower has equity. But it can be difficult for investors to cash out. In the past, "reperforming" loans were packaged into securities and sold to investors, but such opportunities have become rare in the wake of the credit crisis. Refinancings have become more challenging as lenders have tightened standards. Foreclosure moratoriums and other government actions have also increased the time it takes for investors to rid themselves of loans that can't be saved, lowering returns. IServe hopes borrowers such as Mr. Cagle will ultimately refinance into Federal Housing Administration mortgages. The FHA doesn't generally require a minimum credit score, but borrowers must be current on their last 12 mortgage payments for a traditional refinancing. Many FHA lenders have set their own, tighter standards. National Asset Direct has so far been able to arrange for less than a dozen refinances, mostly for people who were current on their payments, even though their loan was sold in a package of distressed mortgages. Among them: Ernst Henry, a respiratory therapist in Charlotte, N.C. Mr. Henry hadn't missed a single payment on his $149,000 interest-only mortgage, though falling prices meant he owed more than the house was worth. When he opened a letter from iServe offering to reduce his mortgage balance, "my first reaction was to shred it," Mr. Henry recalls. Instead, he wound up with a $53,000 principal reduction that brought his mortgage in line with his home's value and made refinancing possible. Mr. Henry's monthly payments fell by about $380, though he now pays interest and principal. National Asset Direct this month bought United Residential Lending, a mortgage banker, in part to speed such refinances. "We're holding on to a fair amount of loans we want to exit out of," said Chief Operating Officer Louis Amaya. Write to Ruth Simon at ruth.simon@wsj.com