Loan In Default

Among key considerations of acquiring a note in default (whether through economic, technical or maturity defaults) is to understand and examine alternative remedies available to lenders and borrowers. Foreclosure is not always the best remedy for lenders, but it is a primary starting point. Simply put, the key question is: what is the net present value basis of the asset after the collateral recovery costs, asset carry expenses and disposition costs?

Foreclosures

Lenders may choose foreclosure over a workout for several reasons:

• Borrower may be mismanaging property.
• Borrower may be diverting capital from the project.
• Lender may lack confidence in the integrity or competence of the borrower.
• The dynamics between lender and borrower may jeopardize any workout solution.
• To get the borrower's attention to make payments or lose their asset; to get borrower to make greater concessions.
• To get a deficiency judgment against a strong borrower or guarantor.
• A timely resolution is critical, as time usually works against the lender.

Economic Analysis of Foreclosure

A lender's foreclosure analysis should begin with an unbiased evaluation of the collateral and the collectibility of any personal guarantees. The current value of the collateral is usually the controlling economic factor. This is the dollar value resulting from a successful foreclosure, taking into consideration the holding period, as well as legal, brokerage and carry costs.

Other Foreclosure Alternatives

In addition to foreclosure, lenders and borrowers may agree to a form of a "workout:

• Reduced payment rate while keeping accrual rate constant.
• Borrower places additional collateral against note for time and economic considerations.
• Bankruptcy court may "cram down" lender if additional capital is placed by borrower into project.
• Lender may accept "pre-packaged" bankruptcy plan against increased capital base or transfer of control of asset to lender.

Successful Workouts

Successful workouts are achieved when both parties honestly accept the reality of their respective positions and honestly work towards a mutually beneficial solution.

Workouts

A real estate workout is a negotiated settlement outside of the loan documents. A workout creates an excellent solution to a default note buyer and a borrower, who each may be able to engineer a settlement that the bank resisted for internal reasons. Workouts can usually be accomplished in one of the five following forms:

• Reinstatement of the defaulting loan (renegotiation of original terms).
• Lender takes over control of the management of the asset.
• Deed in Lieu (voluntary transfer of property from borrower to lender).
• Voluntary sale of property.

Indemnity from borrower not to pursue lender liability issues or promise to avoid bankruptcy in exchange for a short-term re-instatement and extension agreement or other considerations.

Note Buyer Strategy

Default note buyers are motivated to maximize every opportunity to recover their investment and earn high yield. The borrowers are motivated to protect their collateral equity and financial statement balance. They will seek to minimize damage by avoiding the more costly foreclosure and uncertainty of the subsequent suit for a deficiency claim.

Default Note Buyers

Must take several factors into consideration including, but not limited to, the following: Collateral Net Market Value: Not just the specific asset, but any additional collateral and the strength and (collectibility) of the guarantors.

• Careful review of the Note and all correspondence between lender and borrower.
• Borrower profile: ascertain if borrower contemplating bankruptcy, lender liability claims, destruction of property or any negatively impacting income stream. Are workout solutions possible and the best alternative to foreclosure?
• During a workout negotiation, is the property losing value?
• If foreclosure is necessary, what are state laws and time lines and costs?
• If note buyer takes control of asset, will it be a value add project or an immediate sale?

Note buyers techniques to move the borrowers into a more conciliatory position.

• Accelerating debt
• Offsetting accounts
• Assigning rents
• Acting as mortgagee in possession
• Obtaining writs of attachment
• Obtaining an injunction against use of rents
• Placing collateral in receivership
• Suing on the debt
• Beginning an involuntary petition in bankruptcy
• Utilizing remedies under the UCC and various other contract remedies