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MortgagePoint » Your Trusted Source for Mortgage Banking and Servicing News 36 May 2023 F E A T U R E and economic insecurity—some of which we're already seeing, and the impacts of which will no doubt echo throughout the remainder of the decade. Increased government debt has a knock- on effect on the macroeconomic environ- ment, which can have serious repercussions on the average person's financial well-being. One of the most evident impacts is in consumer debt markets, specifically when it comes to mortgages. Higher interest rates and inflation make it tough for borrowers to make their mort- gage payments, and the issue is compounded as the previously hot real estate market cools and makes quick sales difficult or impos- sible, leaving many underwater on loans they can no longer afford. This, in turn, can lead to an increase in mortgage defaults and foreclosures, which can have ripple effects throughout the economy. However, those ripple effects also offer an opportunity for investors to renew and reinvigorate struggling economies while diversifying their portfolio—an investment in both human and financial capital. Distressed Debt, NPLs, and REOs H igh debt ratios can also present invest- ment opportunities, particularly in the distressed debt market. Distressed debt investing, which includes nonperforming loan (NPL) and real estate-owned (REO) investments, are becoming increasingly safer despite a higher default rate as digitiza- tion and technology create new, advanced, and sophisticated markets with substantial liquidity. In real estate, distressed debt is debt tied to properties that are in financial distress, such as foreclosures or bankruptcies, both of which are rising. NPLs and REO assets are two forms of real estate distressed debt. NPLs are loans that are in default or at risk of default, while REO assets are properties that lenders have foreclosed on and now own. Investors who specialize in distressed real estate debt may purchase these assets at a discount and work to recover the underly- ing value of the property. This can involve restructuring the loan, working with the borrower to find a solution, or selling the property to recover some or all the lender's investment. In many communities, investors and management firms are leveraging REOs and NPLs, stepping in to fill the gap and keeping communities stable while providing options and opportunities to families in financial despair. Distressed Debt Today I n particular, the number of delinquent FHA-insured high-risk loans is a cause for concern, particularly among those who were hardest hit by the COVID-19 pandemic. As the ramifications of forbearance ending come to fruition, many of these borrowers may face foreclosure or need to sell their homes. This is happening while individual debt is increasing, creating undue financial pressure and stress on underrepresented blocs of American citizens. As of January 2023, the delinquency rate for FHA loans, mortgages insured by the Federal Housing Administration, was nearly 5% and represented a steady increase throughout the year. This means that over 1 in 20 FHA loans were delinquent and either in foreclosure or behind on their mortgage payments by 90 days or more. The higher delinquency rate in FHA compared to conventional mortgages (which are rising, albeit more incrementally) is likely due to the fact that FHA loans are typi- cally offered to borrowers with lower credit scores or otherwise an inability to afford a hefty down payment. These borrowers may be more likely to experience financial dif- ficulties and fall behind on their mortgage payments. How Distressed Debt Anchors Your Diversified Portfolio While Bettering Communities T he 60/40 investment portfolio is a tra- ditional investment strategy of allocat- ing 60% in stocks and 40% in bonds. This portfolio's performance can be influenced by the correlation between the prices of stocks and bonds. When stock prices rise, bond prices tend to decrease and vice versa. However, the correlation between stocks and bonds can vary over time, which can affect the portfolio's performance. Today, volatility and unprecedented monetary policy combine to challenge the conventional wisdom of the 60/40 invest- ment portfolio. Higher yields on bonds sup- press their price, and although the higher yield is great for fixed-income investors, the additional BPS annually have yet to match inflation, let alone surpass it. Most concern- ingly, the correlation between stocks and bonds is markedly in lockstep rather than inversed, meaning that the bond portion of the portfolio is providing less protection in current times of market stress. Investors are exploring alternative strate- gies such as increasing their exposure to nontraditional asset classes like real estate or commodities to provide more diversification benefits. Others are considering increasing their allocation to stocks or shifting to more active investment strategies that can better navigate changing market conditions. Investing in distressed real estate debt can present challenges due to the many factors that affect the market, including the property's location, market conditions, and borrower behavior. However, investors who are willing to take on these risks may find significant profit opportunities. Real estate investments and related private debt or lending markets have a relatively low correlation with stocks and bonds, as they are driven by factors such as local demand, supply, and economic growth. Including these types of alternative investments in a portfolio can help to reduce overall portfolio risk and increase returns by spreading investments across multiple asset classes. By investing in different types of as- sets with low correlations to one another, the portfolio's risk is reduced, and investors can benefit from the diversification benefits that alternative investments offer. Ultimately, investing in NPLs and REO assets are an increasingly reliable and dependable anchor in a diversified portfolio, as the markets remain viable and liquid. These types of investments not only promote homeownership and retention but also con- tribute to neighborhood stability by often improving homes and infrastructure while offering continued housing opportunities for disenfranchised Americans. For those seeking diversified investment opportunities with higher-than-average return profiles, working with a financial advisor to manage NPL and REO invest- ments may be the ticket to increased stability despite unprecedented volatility.