Rising mortgage delinquencies mean new business for scratch and dent lender Kondaur Capital Corp. With the expectation of a recession in 2008, depreciating real estate prices should lead to rising defaults and foreclosures until 2011. This would mean more buying opportunities in this troubled sector, said Jon Daurio, chairman and chief executive officer of Kondaur.
Daurio said that, over the next four years, he expects that just under 6 million mortgage loans will default. "That is an almost incomprehensible amount," he said. "Even if it is a very small percentage, that is a lot of loans sold in the scratch and dent market."
Daurio speaks from experience. Along with John Kontoulis, president and chief financial officer at Kondaur, the two started their first scratch and dent company, Park Place Capital Corp., in February 2001. In October 2002, they sold the firm's scratch and dent assets, including the name, to an affiliate of Ameriquest Mortgage Co., keeping the retail origination platform which became Sprint Funding Corp. Daurio was president, general counsel, secretary and director until its closure in May 2006.
In 2001, Daurio also co-founded Encore Credit Corp., a national, wholesale, residential mortgage banker, and its parent, mortgage REIT ECC Capital Corp. He remained executive vice president, chief administrative officer, general counsel, secretary and a director until 2004.
From September 2006 through February 2007, Daurio was a principal of, and consultant to, The Prieston Group.
In July 2007, Kondaur Capital Corp. was formed to purchase scratch and dent loans. The company does on occasion sell these loans, but it is not a broker. The firm purchases loans with its own cash and acts on its own account, Daurio said.
Swooping into the Market
Kondaur's name is not only an amalgamation of the last names of its founders, Daurio and Kontoulis, but is phonetically similar to the bird of prey, which the company incorporates into its slogan: "Soaring to better solutions." Incidentally, Kondaur incorporates a somewhat predatory strategy into its business model by taking advantage of the steep discounts in the market that have not yet bottomed out, Daurio said.
The company currently employs 33 people and expects to grow to 40 in the coming weeks, rehiring many of the employees that were laid off just over two months ago when Ameriquest seized the operations of what was the successor of Park Place.
Kondaur will certainly need the extra staffing as the number of buying opportunities in the market continues to expand, especially from some of its competitors. "Indeed, what drives the scratch and dent market as we believe is that the seller of the loan has a need for liquidity; otherwise the seller would not sell the loan at a discount," Daurio said.
A lot of scratch and dent buyers purchase with the intention to repackage and sell the loans, potentially through a securitization, Daurio said. But with almost no securitization activity currently, these opportunities are no longer there. "Now [scratch and dent buyers] are starting to sell some of the loans they have so they can stay in business and go out and buy other scratch-and-dent loans."
Furthermore, for public entities that use an independent auditor to look at their financial statements, they need to evaluate the extent to which they keep loans on their books, what these loans are worth and what the potential contingent liabilities are - either on the loans they own or on loans they have sold whenever they have a repurchase obligation, Daurio said. "We believe that is going to be a huge reason for an increase in the amount of scratch and dent loans."
To take advantage of these opportunities, the company is putting together a private equity fund to purchase thousands of loans. Kondaur is also exploring other capital-raising alternatives, including funding from "significant investors with offshore money," Daurio said. "We want to grow and brand the company so that we are to scratch and dent lending what McDonald's is to hamburgers." The private equity fund is expected to close next month and could be the first of many if successful, Daurio said.
Investor Properties Not Preferred
The company's business strategy aims to keep the borrower in the home, which is why Kondaur prefers owner-occupied properties. At the right price, Kondaur will look into buying almost all types of scratch and dent loans that are secured by one to four family residences throughout the U.S. However, its solutions work best when there is someone in the house who wants to stay there, Daurio said. The company also likes loans that are difficult to value. For instance, Kondaur recently bought a loan secured by a home far larger than the surrounding houses in a rural Illinois community.
Although there might be other scratch-and-dent funds growing at the same rate as Kondaur, Daurio said that many of his competitors "are buying the loans with the intent to foreclose on the property and monetize the asset that way."
By contrast, Kondaur spends roughly four hours reviewing each asset, Daurio said. While many other scratch and dent buyers will value collateral through broker price opinions, automated valuation models or drive-by appraisals, Kondaur's assessment focuses on borrowers and their situation, the original loan file and collateral analysis that includes a discussion of what solution works best for all parties involved, Daurio said. Kondaur's loan solutions are typically done within 120 days and can include methods such as restructuring or refinancing.
The firm said it is considering investing in a servicing company to be more closely involved in the servicing of their loans. Kondaur has also built some proprietary software for data due diligence and accurate loan pricing.
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