Tips for Selling Loans During Foreclosure

The borrower hasn't sent a payment in months and he is no longer returning your calls. Construction has been halted and the tax and insurance bills are landing on your desk. The new penthouse unit is leaking and you are worried about mold and water damage. You instruct your lawyer to file the foreclosure papers, but now what?

Your team doesn't have the expertise to complete the development. You can try offering the loan for sale. But it's difficult and time consuming to sell the loan before or during foreclosure because buyers can't quantify the legal risks or complete sufficient due diligence.

Time is not on your side. Foreclosure is a painfully slow process during which your collateral is often wasting away. How can you protect the value of your collateral, speed up the sale process and still get a decent price?

This problem has become more pressing as banks face mounting defaults. However, thanks to changes in the bankruptcy code and deal structures, the foreclosure process is more lender-friendly than in the early '90s. Since then, lenders have been requiring "bad-boy carveouts" from the non-recourse provisions of a loan document. This makes the sponsor personally liable if the borrower files for bankruptcy, a common delaying tactic. Under the new rules, the bankruptcy code also provides creditors of a single asset real estate debtor-which fits most borrowers in commercial mortgages relief from the automatic stay.

Still, veteran lenders will tell you fore closure is an unpredictable, expensive and time-consuming process, especially in states like New York where it is a judicial process. In a judicial foreclosure, a court order is required before a foreclosure auction can take place. To obtain a court order, lenders need to hire specialist litigators. Borrowers can introduce defenses, some legitimate, like lender liability, and some spurious, like reputational damage.

Although lenders generally prevail, the extended timeframe can take its toll on an under-managed or partially built property. A lender can petition the court to appoint a receiver, an independent property manager, who will completely displace the borrower, making large and small decisions, including how to spend the remaining funds.

Shortening the timeline and maximizing the price have been more elusive goals for loans in foreclosure until now. The optimal approach in most cases is for a lender to sell a note subject to delivery of the deed-obtained either through deed-in-lieu or a foreclosure sale. This deal structure allows the lender to make the most of a difficult situation by eliminating the uncertainty while expediting the sales process. This approach can also mitigate serious value deterioration. If a lender starts the sales process only after securing the deed, it could lose millions in value during that six to nine month window.

Another consideration is minimizing transfer and mortgage-recording taxes. These taxes can add up to several million dollars for large-scale projects in states such as New York. Intermediaries, who can view the entire scope of the transaction and advise principals as to market norms, are best suited for these negotiations.

Meanwhile, financial institutions and entities such as CDOs and special servicers often have unusual contractual and/or reporting requirements that can confuse or delay some purchasers. Working with experienced investment sales professionals, title experts and attorneys can speed up these negotiations and result in greater value to sellers of non-performing notes and REO properties.Traditional loan sales have proved largely unsuccessful for complicated assets. The time has come for lenders to re-evaluate asset disposition strategies. Development projects and underutilized commercial property can be successfully positioned for sale before the lender takes title. Selling loans subject to delivery of the deed expedites the sales process and mitigates the uncertainty that has exacerbated the disconnect between lenders and investors.

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