Trading Distressed Debt Gets Murky

For many investors attempting to buy distressed real estate debt and for lenders seeking to sell, the process has taken an ugly turn. For potential buyers, identifying loans for sale, obtaining enough information to make an informed purchase decision, and trusting the party on the other end of the negotiations table all are proving to be more difficult tasks than first anticipated.

For sellers, an equal level of frustration arises. Counterparties claiming to represent investors are often unable to deliver basic information, such as what types of loans their prospective investors are seeking to buy. And these investor representatives — often brokers fishing for new clients — rarely have the ability to negotiate or close loan sales. So to say the environment for trading loans has become quite muddy is an understatement.

Skepticism abounds

Smaller investors, usually with as little capital as $1 million and as much as $10 million to invest, find it difficult to buy loans in this environment. These buyers expect to be viewed as white knights armed with checkbooks. Instead, sellers often greet these small investors with skepticism. The result is that most attempts to buy loans today fail even before reaching the stage of price negotiations.

One New York-based small investor recently told an audience at a mortgage investment conference that smaller investors feel they are getting little or no respect when they attempt to buy notes.

“You would think people with distressed notes would open the doors and welcome us,” the irate investor said. “Instead, we are rudely asked to hand over the names and contact information to our bank branch managers and account officers, and we soon discover we are talking to parties who don't even have access to the decision makers for loan sales.”

In defense of the skeptical sellers, they may have good reason to doubt the credibility of many investor representatives. To be sure, some who claim to be representing investment sources may be third parties attempting to gain access to information by falsely claiming to speak on behalf of buying principals. There are equal shenanigans coming from parties claiming to represent loan sellers.

The investor representative's point is well taken since most of the capital seeking to buy loans is identified as “private,” and details about these investors' ability to perform are sketchy at best. Many of the distressed loans being shopped around are from current note holders who are simply testing the waters to determine the feasibility of closing a loan sale with favorable pricing. Thus, skeptical buyers do have their fair share of frustration to deal with as well.

Deal pipeline

Real Capital Analytics recently reported that there were more than $124 billion worth of distressed and potentially troubled commercial and multifamily developments in the U.S. as of Feb. 24, up from $106 billion at the end of 2008. In light of this, one can be assured this muddy loan trade process will persist. Absent well-known loan trading platforms such as Boston-based DebtX or the New York firm SecondMarket, where fees are charged to trade loans that have already been vetted, the frustration will likely persist among both buyers and sellers.

Real Capital Analytics indicated that of the $106 billion of distressed properties, some $4.5 billion worth of assets had already returned to the hands of lenders. Mortgages in default totaled another $21.2 billion. The owners were either bankrupt, or the properties had already been foreclosed. Problem loans maturing in 2009 accounted for another $80.9 billion, or more than 3,700 properties.

With maturity defaults on the rise, it's easy to see how chaos and distrust can set in even before the grim task of loan pricing can be accomplished. So whether the dire predictions of many analysts come true or not — that real estate values will drop significantly further and cause more distressed loans to pile up — a large number of loans are already under some form of distress.

In addition to the problem of legitimate buyers and sellers being unable to agree on price, there are muddy waters to contend with. Determining who is or is not a legitimate loan seller or buyer, and with whom to even negotiate price is no easy feat to accomplish.

DISTRESSED ASSETS ON THE RISE

With more troubled commercial and multifamily assets in the pipeline, successful trades become more elusive.

Assets	No. of assets*	Volume ($billion)*
Lender REO (foreclosed properties):	393	$6.7
Troubled loans (usually missed at least one payment):	1,453	$38.4
Potentially troubled loans (difficult to refinance):	3,428	$79.4
Total: * As of Feb. 24, 2009	5,274	$124.7
Source: Real Capital Analytics

W. Joseph Caton is managing director of Oxford, Conn.-based Hartford One Group, a real estate finance consultant.