Buying Discounted Mortgages – Terry Vaughan’s ‘Call Option’ for buying

On buying discounted mortgages:

Two weeks ago I had the pleasure of meeting Terry Vaughan (whose wife runs creonline.com), and who’s a genius when it comes to paper of any kind.

Terry was royally entertaining us at a conference that John Behle was running in Provo Utah, about how he deals with bankers when he’s buying discounted mortgages. He was doing a one-man skit he called “At the Banker’s Office” that had us all rolling.

But then he said something that made me stumble. I literally dropped my pen as I was writing.

“Did you know that you can get banks to FINANCE your own purchase of their discounted mortgages?” he asked us?

I was floored.

What?! You mean the institution that you’re buying discounted mortgages from would actually LOAN YOU MONEY for you to buy their paper?

No way. He was off his rocker, I thought. What a crazy idea!

Well, Terry, hats off to you. You da man. (Did you actually train Lone Star Funds to do what they just did, by the way? Because if so, you should have charged them a royal little sum of consulting money.)

Lone Star you ask?

Who are they?

Well, I don’t know if you fully digested the news out of Merrill last week when they sold $30.6B of CDO’s to a Texas hedge fund, Lone Star Funds, for $6.7B. (Consider CDO’s toxic derivatives of non-performing mortgages and leave it at that.)

But here’s how the actual transaction went down: Merrill “sold” these discounted mortgages to Lone Star at a price of 21.90%, or $6.7B.

But wait, it gets better.

Merrill then FINANCED 75% of the transaction. So it made a loan to Loan Star of $5B, and Lone Star came up with $1.7B in cash.

AND . . . get this. In case Lone Star defaults on the Merrill loan, the only recourse Merrill has is to the assets that it just sold to Lone Star.

So what just happened in this ‘buying discounted mortgages‘ transaction?

Merrill effectively sold a “call option” on $30.6B in CDO securities for $1.7B.

If the securities increase in value by 5%, Lone Star is made whole (5% of $30.6B is almost the value of Lone Star’s investment).

And if the securities increase in value by 10%, then Lone Star doubles its investment.

If the securities drop in value, Lone Star can walk away from its discounted mortgages investment and lose its $1.7B.

The upside is obviously huge for Lone Star.

But the point I want you to take away is that we all should listen to what Terry said a couple of weeks ago in Provo, Utah: “you CAN get banks to finance their own sales of discounted mortgages to you.”

I have yet to do it, but then guess what? I’ve never asked for it.

Can you imagine on your next note buying deal, offering 50% on a non-performing 1^st mortgage and after you’ve won the bid telling the Seller – “hey, you know what I want you to do for me, now that I’m getting you that fat 50% bid you were looking for?”

“No, what?”

“I want you to loan me the money for me to buy your note from you.”

You never know what you might get. Mention the Lone Star – Merrill deal. Better yet, print out a copy of the article describing what Lone Star did, and then send it to your Seller and say “Hey, this happens ALL the time – and if it was good enough for Merrill Lynch, I’m sure it would be good for your bank, don’t you think?!”

Terry . . . Thank you for blowing my mind.

A fascinating twist for buying Discounted Mortgages.