The Ins and Outs of Loan Administration and Disposition
Notwithstanding that bank balance sheets are bulging with troubled real estate loans, lenders have been reluctant to sell these loans at heavily-discounted prices. However, the banks’ strategy of holding these troubled assets has not been successful given the continued decline in real estate prices. As market conditions further deteriorate, lenders may finally consider selling at least some of their non-performing loans as a means of mitigating this risk. Also, sales of problem loans can reduce a lender’s loan servicing costs and limit the losses incurred by the seller in connection therewith.
When a decision is made to sell a loan, as a first step, the seller should consult with market advisors to obtain an estimate of the price the loan is likely to obtain from a third party purchaser. The seller should then provide the borrower with a one time opportunity to purchase its loan at a discounted payoff by a specified date, and accept any offer that meets or exceeds the expected sale price. After “harvesting the low-hanging fruit” through this discounted payoff process, we recommend that sellers implement the procedures set forth below in order to maximize the potential recovery from a loan sale. Further, a well-run sale that minimizes surprises on either side creates greater certainty that closings will occur in an efficient and timely manner.
Due Diligence Process. To give order to the loan sale process, and to provide the bidder with a finite time to formulate its bid, sellers should be prepared to make disclosures and to establish a hard due diligence cutoff date after which no further information relating to the loan will be provided to bidders. Creating and maintaining orderly files for the loan in advance of bringing it to market is essential to this process as the information in these files can both maximize value and minimizing losses. Sellers must assure that adequate information regarding the loan has been assembled, and that the files and documentation pertaining thereto are well organized and have been thoroughly reviewed. This process includes compiling all documents pertaining to the loan (including junior/mezzanine loans, participations/syndications and modifications, amendments, etc.), the property and the borrower/sponsor, and verifying that the title policy is in the file and that insurance policies are current. It is also vitally important that the lender obtain current information regarding the property and the borrower/sponsor. The lender may also wish to review the loan documents to determine what information the borrower is required to provide. Even if the extra effort required to obtain such current information does not result in a higher price, this information base is fundamental to decision making regarding the administration of the loan if it is not sold.
Purchase Agreement. The form of the seller’s purchase agreement should be furnished to prospective bidders at the commencement of the due diligence review period. While the seller should aim for an “as is, where as” sale of the loan, at a minimum, the seller’s representations and warranties therein with respect to each loan must be subject to all information disclosed to the bidders prior to the due diligence cutoff date and should only survive for a prescribed period of time after the closing (e.g., six months to one year post-closing). In addition, the seller’s potential liability with respect to a sold loan can be further reduced by establishing a damage threshold that must be exceeded before the buyer can bring a claim for damages against the seller with respect to a breached representation, and, even then, the seller should have the ability to satisfy such claim by curing such breach, indemnifying the buyer with respect thereto or repurchasing the applicable loan.
Bidding Process. Bids should be scheduled for submission within seven to ten days after the due diligence cutoff date, and should include the bidder’s comments to the purchase agreement. Structuring the bidding process in this manner allows the seller to balance the risk that a sale may not occur (because the parties are unable to agree on the terms and conditions of the purchase agreement) and the price being offered. Also, a seller may want to negotiate the purchase agreement with one or more of the top bidders, not only to assure that the purchase agreement is final before selecting the winning bid, but also because the time period before the bid is selected is when the seller has maximum leverage.
If properly implemented by a seller, the procedures set forth in this article can have a positive impact upon the financial results of a loan sale, because a seller that invests the time and money that is necessary to prepare a loan file prior to an attempt to sell the loan, will be able to both maximize the value of the loan and minimize the losses associated therewith.
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