Non-Performing Commercial Loans for Sale

Pricing

A prudent purchaser in both cases will re-underwrite the underlying property in order to confirm whether it supports the debt level. However, the purchase price for a performing loan is much more closely tied into the actual outstanding balance of the loan, because there is a reasonable expectation that it will be repaid in full, and the anticipated return to the purchaser is based upon the underlying interest rate of the loan and the amount of the discount, if any, off of the outstanding amount of the loan.

With respect to the acquisition of a non-performing loan, however, it can be argued that in calculating the purchase price, the amount of the loan is wholly irrelevant for two reasons. First, a non-performing loan is most likely in default because the underlying cash flow does not support the debt, and therefore whatever amount theholder of the debt had originally advanced to the borrower some time ago (and in a completely different economy) has little or no correlation to the value of the property and the amount of debt the property can service today.

Second, unlike a performing loan, there is little expectation that the debt will be repaid in full, and therefore the anticipated return to the purchaser of a non-performing loan is wholly linked to the value of the underlying property, not the debt amount.

For example, the purchaser of a non-performing loan will expect to recover its investment by either foreclosing upon the property and re-selling it, restructuring the loan with the borrower at new (and sustainable) loan terms, or accepting a discounted pay-off when and if the non-performing loan is refinanced. All three exits are driven solely by the then underlying value of the property and have nothing to do with then outstanding balance of the loan. Therefore, the fact that a non-performing loan is acquired at a 50 percent discount does not in and of itself reflect a good deal for a purchaser, whereas a 50 percent discount off of the outstanding balance of a performing loan that is expected to pay off in full is certainly more meaningful.

Representations

Even though the discount from the loan amount of a non-performing loan is not meaningful to a purchaser of non-performing debt, it is certainly meaningful to the seller of that debt for the simple fact that it determines how much money the seller is going to lose in that transaction. Accordingly, and as might be expected, sellers of non-performing debt may most likely view these dispositions as “fire sales” or “as is” transactions in which the seller retains little or no liability after the closing.

The seller’s primary motive in the loan sale is to “cut its losses.” Therefore, unlike in a performing loan sale where it is more reasonable for the purchaser to expect all of the customary representations regarding the loan, the borrower and the underlying property (which representations can be quite lengthy), the purchaser of non-performing debt may have to settle for minimum representations as a tradeoff for the loss being incurred by the seller.

If a purchaser of a non-performing loan is being pressed to accept the bare minimum with respect to the seller’s representations in order to get the deal done (or is looking to bid aggressively for a non-performing loan and is trying to entice the seller with an offer that is as close to an “as-is” transaction as possible), then such a purchaser should bear in mind that there are still seven basic representations that are necessary to insure that the purchaser receives, in essence, what it is bargaining for.

These representations should be made at contract and at closing, survive the closing for a reasonable period of time (anywhere from one year to the life of the loan) and be backed with adequate remedies. These seven fundamental representations are as follows: