Market Basis for Company Operations

     The Wall Street Journal reports that of the approximately $2.5 trillion in sub-prime loans made during the last few years, $1.5 trillion of them were made between 2004 and 2006. About one-third (1/3) of those outstanding loans reset with higher interest rates in 2007, and nearly two-thirds (2/3) are scheduled to reset in 2008.

As these mortgages reset to significantly higher interest rates both owner-occupants and investors have had to struggle to make the higher payments. They have often have been unable to do so. As a result there are a historically high and increasing number of non-performing trust deed secured mortgage notes and of foreclosed single-family homes owned by banks in their "Real Estate Owned" (hereafter "REO") portfolios. (See Wall Street Journal Article, front page, October 11, 2007.)

     Mortgages Held in Large Pools

Most real estate mortgages are held in "pools" typically ranging from several hundred million dollars to well over one billion dollars in size. Even in today's credit market most all of the mortgages held in those large mortgage pools continue to perform well, with the borrowers making regular monthly payments.

Nonetheless non-performing mortgages are estimated, as of the date of this memorandum, to be at least one out of every thirty one mortgage notes, with that number expected to increase throughout 2008 and into the early months of 2009. When a mortgage pool contains a large number of REO properties it greatly reduces the marketability of that particular pool, reducing its overall value substantially. Moreover, significant additional cash reserves must be held against all REO properties by a financial institution that owns and controls a mortgage pool with REO assets in it.

For all of the above reasons banks and other financial institutions with non-performing notes and REO portfolios often liquidate them through a variety of avenues, including bulk sales at very large discounts.

Bank Efforts to List and Sell Foreclosed Properties with Brokers 

In normal markets banks and financial institutions managing large mortgage pools will most often list properties acquired because of foreclosure with local real estate brokers. Those financial institutions usually establish an office called a "work-out department" staffed by mid-level bank officers who are instructed to work within a rigid set of parameters while attempting to negotiate and close the sale of those properties, one-by-one, to individual buyers. Their mandate is to obtain the highest possible price they can for each REO property file that crosses their desk. Such bank officers are typically limited by written bank policy to giving a maximum discount of between 5% and 10% of the then-current value of the property to facilitate the sale of any particular property. Moreover they are (a) never authorized to carry any financing on behalf of the bank, (b) are limited by written bank policy as to the amount of closing costs they can credit to an otherwise qualified buyer and (c) are typically required to pay below industry standard commissions to real estate brokers assisting them with the sales.

In addition, where an individual property owner will usually respond to a purchase offer immediately and then work diligently with the buyer and his real estate agent to close the sale, bank officers in work-out departments were already well-know for their slow responses prior to the credit crisis, and for the slow speed at which even very good transactions progress. Not surprisingly, with so much more work crossing their desks their already slow response times have generally slowed even further.  

As a result of the above, and because of the large and increasing numbers of foreclosures now and anticipated well into next year, bank REO inventories are climbing dramatically. The board of directors of affected banks and financial institutions are therefore taking extraordinary steps to liquidate their REO inventory, including both the pre-foreclosure sale of non-performing mortgage notes as well as selling REOs in bulk.

Board Level Decisions for Bulk Liquidations

When REO decisions about liquidating non-performing mortgages and REOs move from mid-level bank managers making "one-at-a-time" decisions to the board of directors of the financial institution holding those assets the parameters change substantially, becoming far more favorable to buyers. This is because liquidating non-performing assets significantly increases the market value of the remaining mortgages in any given mortgage pool. Regarding REOs, liquidating in bulk quantities substantially reduces the amount of cash reserves a bank is required to hold against them, and allows the bank to put the money received back to work in their normal business model. With both non-performing mortgage notes and REOs, the loss experienced by taking these steps, as a percentage of the portfolio value, is relatively small. Moreover the losses at that point have already been written off. By selling non-performing assets those already recognized losses are promptly mitigated by a cash infusion.

The board of directors of any bank is never interested in selling such non-performing assets "one-at-a-time", however. When such decisions are made at that level they typically want to sell them quickly, in large quantities for cash, in amounts of tens of millions of dollars at a time.

Cash Requirements, Discounts and Usual Buyers

When decisions are made at the board level of a financial institution to REOs in bulk, residential properties will often be liquidated at discounts of 30% to 50% below current market value, or more. Non-performing mortgage notes are often liquidated at even greater discounts. The buyers are normally other large financial institutions and very sophisticated wealthy investors. Smaller investors are not typically able to participate in these large bulk sale liquidations. However our company is set up to participate in this market. We have the the potential as well, although there are no guarantees, to participate in the market described in the paragraph below.

Extreme Discounts for Government Backed Loan REO Liquidations