SEC Probes Rental Home Values in Private-Equity Bond Deals

(Bloomberg) -- U.S. securities regulators are investigating whether bonds backed by single-family rental homes and sold by Wall Street’s biggest residential landlords used overvalued property assessments.

Radian Group Inc.’s Green River Capital unit is among companies that received a request for information from the Securities and Exchange Commission in March about broker price opinions, or BPOs, Radian said in a regulatory filing late Friday. Green River provides BPOs that are used to value real estate in bonds backed by properties.

The agency has been looking at whether BPOs were wrongly inflated, and similar letters were sent to other companies, potentially serving as a starting point for an industrywide probe, said a person with knowledge of the matter. The SEC is scrutinizing how BPO providers compete for business and whether their customers shop for providers willing to put the highest value on their properties, said the person, who asked not to be identified discussing private matters.

Radian, the second-biggest U.S. mortgage insurer, said in its filing that the SEC was seeking information from “market participants.” The company said it routinely gets such requests from regulators, and the disclosure didn’t indicate that Green River was the focus of the agency’s inquiry. An SEC spokeswoman declined to comment.

Radian’s Processes

“We believe that our company processes are both robust and comprehensive, and we stand behind our work,” Radian said in an emailed statement to Bloomberg. “We have solid quality control processes in place, including for our property valuation services, and those processes have been reviewed and validated by both internal and external sources.”

Broker price opinions are a cheaper and less-stringent way than appraisals to estimate what a property is worth. Valuations are a sensitive subject in the housing industry because regulators said inflated appraisals contributed to the U.S. housing bubble.

Green River is one of several firms that provide BPOs to private-equity companies and other investors who bought up hundreds of thousands of properties after the bubble burst. Many of those buyers focused on distressed homes whose owners were evicted during the Great Recession.

The biggest private-equity landlords, led by Blackstone Group LP’s Invitation Homes, have sold more than $15 billion in bonds since 2013 backed by some 120,000 rental homes, according to data from Morningstar Credit Ratings, and many of those deals were valued using BPOs. One recent bond deal tied to Invitation Homes was backed by guarantees from U.S. taxpayers. The broker opinions were provided by Green River. Claire Parker, an Invitation Homes spokeswoman, declined to comment.

Bond Values

The BPOs are key elements in rental home securitizations, determining basic figures such as how much rent to charge tenants, how much leverage and risk is embedded in the deal and how much investors could recover if the bonds go sour. Many of the securities were assigned AAA grades and sold off to investors such as pension funds.

In traditional real estate deals, these opinions help establish sales prices, but in these bond deals, they help estimate how much could be recovered in a liquidation. Some analysts say the BPOs don’t take into account a possible plunge in home prices, and the values tend to be more optimistic than a complete appraisal. BPOs also aren’t necessarily done by a licensed professional, nor does the inspector always go inside to look around, which is standard procedure for an appraisal.

‘Drive-By’ Value

In one April securities offering of about $944.5 million, Green River submitted BPOs that relied on “drive-by” evaluations, according to a deal prospectus issued by Fannie Mae. Homes were “assumed to be repaired and in good condition,” and the BPO “is not intended to be a representation as to the past, present or future market values of any of the properties.” 

The underlying mortgage in that deal, tied to rental properties owned by Invitation Homes, was guaranteed by Fannie Mae. The Invitation Homes securitization was the first time the taxpayer-backed home finance company guaranteed such a loan. Freddie Mac is also looking into getting involved in the market by providing its federal guarantee.

Fannie Mae conducted on-site inspections on a sample of properties representing 5 percent of the deal’s overall balance, bonds documents show. That sort of due diligence is less stringent than what is typically acceptable in post-crisis private mortgage-bond deals, which require full appraisals with site visits on close to 100 percent of the loans. This year, Fannie Mae began waiving appraisals when its automated systems show the valuations were valid.

“A number of factors were used to confirm the valuation assigned to each property," said Pete Bakel, a Fannie Mae spokesman. Fannie Mae used third-party reviews of BPOs and used its own property valuation tools to "verify that each individual property value that ultimately was used was consistent with sound, conservative underwriting. As a result, we are confident in the values used to underwrite the transaction.”

When private equity landlords first began using BPOs instead of appraisals in their securitizations, some investors expressed skepticism and bond graders applied discounts to the BPOs. Moody’s Investors Service, for example, applied a 15 percent haircut to BPO valuations when grading a transaction last August, citing inherent risks of using BPOs on residential properties instead of an appraisal.

Green River is part of Clayton Holdings, Radian’s mortgage due-diligence arm that became known for warning underwriters and ratings firms of dangers in subprime mortgages before the housing crisis of the previous decade. Clayton’s work was used by state and federal agencies to aid their previous investigations of mortgage-backed securities.

--With assistance from Katherine Chiglinsky

To contact the reporter on this story: Matt Scully in New York at mscully17@bloomberg.net.

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Rick Green