I receive calls every week from consultants asking how they can involved in the due diligence arising out of the sale of distressed loans. It is true that there are billions of dollars of distressed debt and assets, and that there are funds sitting with large piles of cash waiting to pounce on distressed loans or assets. However, the picture is much more complex than the cheerleaders and talking heads are suggesting.
First, one needs to distinguish between distressed debt and distressed assets. The latter involves the hard assets (i.e., real estate) while the former involves the paper evidencing the loans that are collateralized by the hard assets.
When only paper is being exchanged, there is very little environmental due diligence. This is because the debt is being sold at distressed prices-often 20 or 30 cents on the dollar. There may be numerous reasons why the debt may be considered distressed. For example, the seller may be forced to sell the debt because it has to raise cash because of margin calls or redemptions from investors. Similarly, the bank that is holding the note may have been taken over by the FDIC who is dumping the recover as much as the cost of the takeover as possible. Likewise, the paper may have been downgraded and the institutional investor may be required to sell the notes because it cannot hold such low rated paper. A mezzanine lender may have found its position is worthless and is willing to sell to a more senior investor. And of course, the borrower may be in default or unable to make a balloon payment at the term of expiration of the loan.
In many cases, the note purchasers are buying deeply discounted paper say at 30 cents on the dollar and telling the borrowers that they will forgive past due loans if the borrower can pay the rest of the loan at 60 cents on the dollar. Do the math. The investor will get a 30% return!
In other instances, the borrower is current with its payments but would be unable to refinance the loan when it expires in two or three years because of tighter underwriting requirements or because the property values have dropped so much that the borrower could not get sufficiently-sized loan to pay off the existing loan. In many cases, the purchaser steps in, buys a deeply discounted note and then collects the remaining interest until the loan terminates. The investor will then walk away from the loan with another 30% or so return.
In the foregoing examples, the investors are only interested in the short-term returns on the notes and do not care about the environmental conditions of the property....provided of course they do not impair the ability of the borrower to pay the remaining or re-negotiated loan balance.
It is primarily when the original lender or an investor will actually take title to the underlying collateral (i.e., real estate) that the environmental issues will come into focus. Thus far, the bulk of the deal flow seems to have been the sale of paper and not the hard assets.
In addition to knowing the nature of the deal, it is important to understand who your client is and where they are in the capital stack or layering of debt and equity since their positioning will influence the degree of tolerance about environmental concerns. In my next post, we will take our scorecards and check what players are in the lineup for distressed sales.
First, one needs to distinguish between distressed debt and distressed assets. The latter involves the hard assets (i.e., real estate) while the former involves the paper evidencing the loans that are collateralized by the hard assets.
When only paper is being exchanged, there is very little environmental due diligence. This is because the debt is being sold at distressed prices-often 20 or 30 cents on the dollar. There may be numerous reasons why the debt may be considered distressed. For example, the seller may be forced to sell the debt because it has to raise cash because of margin calls or redemptions from investors. Similarly, the bank that is holding the note may have been taken over by the FDIC who is dumping the recover as much as the cost of the takeover as possible. Likewise, the paper may have been downgraded and the institutional investor may be required to sell the notes because it cannot hold such low rated paper. A mezzanine lender may have found its position is worthless and is willing to sell to a more senior investor. And of course, the borrower may be in default or unable to make a balloon payment at the term of expiration of the loan.
In many cases, the note purchasers are buying deeply discounted paper say at 30 cents on the dollar and telling the borrowers that they will forgive past due loans if the borrower can pay the rest of the loan at 60 cents on the dollar. Do the math. The investor will get a 30% return!
In other instances, the borrower is current with its payments but would be unable to refinance the loan when it expires in two or three years because of tighter underwriting requirements or because the property values have dropped so much that the borrower could not get sufficiently-sized loan to pay off the existing loan. In many cases, the purchaser steps in, buys a deeply discounted note and then collects the remaining interest until the loan terminates. The investor will then walk away from the loan with another 30% or so return.
In the foregoing examples, the investors are only interested in the short-term returns on the notes and do not care about the environmental conditions of the property....provided of course they do not impair the ability of the borrower to pay the remaining or re-negotiated loan balance.
It is primarily when the original lender or an investor will actually take title to the underlying collateral (i.e., real estate) that the environmental issues will come into focus. Thus far, the bulk of the deal flow seems to have been the sale of paper and not the hard assets.
In addition to knowing the nature of the deal, it is important to understand who your client is and where they are in the capital stack or layering of debt and equity since their positioning will influence the degree of tolerance about environmental concerns. In my next post, we will take our scorecards and check what players are in the lineup for distressed sales.
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