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Zillow Group Inc.’s roughly $1.15 billion pile of mortgage bonds tied to its home-buying business has been thrust into the spotlight, after the real-estate giant on Tuesday called it quits on its iBuying home-flipping business.
Zillow
Z,
ZG,
blamed a faulty algorithmic model for its overpaying of homes purchased in the second half of this year. As a result, the company said it would lay off about a quarter of its staff and anticipates taking a more than $550 million loss on homes it bought.
Where does that leave the pair of unrated mortgage-bond deals that Zillow quietly sold to investors over the past three months? It still is early days, but MarketWatch asked four mortgage-bond investors familiar with the deals for more insights.
Here are four key takeaways:
Testing the water
At least one Zillow mortgage bondholder briefly listed a $12 million parcel for potential sale on Wednesday, via a “bids wanted in competition,” or BWIC.
Such lists happen every day on Wall Street and can help bond sellers and buyers gauge the value of a security. However, the roughly 2.3% coupon senior Zillow bond, which was on a list of four “prime” residential mortgage bonds, was pulled before its scheduled bid time Wednesday morning, according to bond-tracking platform Empirasign.
Such an action indicates there’s considerable uncertainly around what price Zillow’s bonds might fetch as Wall Street digests the company’s exit from home-buying.
In the past four weeks, three parcels of Zillow bonds traded at $100 and $99 prices, according to Empirasign. But on Wednesday, two broker-dealers put forth indicative bids on $5 million slugs of senior bonds at $95 and $96.
Revolving pool
Unlike many residential mortgage bonds sold under the “fix and flip” umbrella, Zillow’s bonds are backed by a revolving, not fixed, pool of collateral.
That could be considered a risky feature, since it can mean uncertainty in terms of credit risks. This time, however, it may mean a quicker outcome for bond investors.
That’s because if Zillow no longer buys homes to replenish the deals, its bonds will “turbo down quickly,” said one investor, meaning the most recent bonds could repay — or be written off — in six months, rather than roughly 2.5 years at maturity.
A Zillow spokesman told MarketWatch that while it isn’t signing new contracts to buy homes, it will move forth on ones it already signed up to purchase, as disclosed in its third-quarter shareholder letter.
When asked about its mortgage-bond repayment plans, the spokesman said the company intends to “fully perform on these bonds in full accordance of the terms.”
Corporate mortgages
Another key way that Zillow’s mortgage bonds are different than the norm is that Wall Street banks lent to the company itself, not a pool of thousands of different homeowners.
To that end, even though the company expects to take a huge loss tied to its underwater homes this year, it has other avenues of revenue it could use to make bondholders whole.
Zillow bought almost 10,000 homes in the third quarter and sold about 3,000, with sales producing an average loss of $80,000 per home. Revenue rose 164% to $1.74 billion from a year ago, but was below the $2 billion forecast of analysts surveyed by FactSet.
“This is a prime example of why people should make decisions vs. an automated algorithm,” said another mortgage-bond investor of Zillow’s home-buying process.
Also, the mortgage to Zillow is “non resource,” meaning creditors can’t come after the company’s other assets if it fails to pay, making it easier to walk away. Although, if Zillow defaults on its mortgage debt, a loan servicer would be put in place to handle existing properties to maximize recoveries for bondholders.
Potential impact
Zillow shares ended 24.9% lower Wednesday and are down 49.6% for the year so far. The S&P 500 index
SPX,
Dow Jones Industrial Average
DJIA,
and Nasdaq Composite Index
COMP,
all ended the session deeper in record territory and up 18% to 24% this year.
Of note, investors didn’t expect senior Zillow mortgage bonds to take a loss, particularly since those sold in September were structured with a significant 30% credit cushion before even a dollar would be wiped out. The junior bonds, however, have a smaller 15% buffer.
Furthermore, about 79% of Zillow homes are currently listed for at least 95% of the purchase price, said one of the investors, who has been combing through listings to get a sense of the potential impact of its sales on the U.S. housing market.
He found almost 2,600 homes with a total purchase price of about $1.18 billion that currently are listed for $1.16 billion, or a roughly 1.6% discount. Those figures tentatively point to Zillow having capacity to fully repay its mortgage bonds, unless it ends up selling homes at much steeper discounts.
