Over the past few years we have been anticipating a significant amount of distressed assets coming to market. After all, there are over 3.5 trillion dollars worth of Commercial loans currently outstanding in the US and over a trillion dollars worth of these loans will be ballooning between 2010 and 2012. Only half of these commercial mortgages will be able to qualify for a refinance and at the same time there are hundreds of millions of dollars worth of Pay Option Arms and other types of non-conventional loans due to reset.

So, why aren’t all these distressed assets on the market? There are two primary reasons for this. First of all, everything the government has done from a regulatory standpoint is allowing lenders and special servicers to avoid dealing with their problem assets. Regulators have essentially said to banks that if they have bad loans on their books at par and they know the collateral is only worth 60 percent of par, they can leave asset values as they are without incurring any write-downs.

The second reason banks are not selling is that the Federal Reserve’s monetary policy is allowing banks to borrow at close to zero and, if they are lending, they are making huge spreads of 500 to 700 basis points depending upon the loan type. Even if they don’t lend at all, they can simply buy Treasuries and make nearly 400 basis points.

Just a couple of years ago, spreads were as narrow as 30 or 40 basis points on some loans because there was intense competition to put debt on the street. Today’s massive spreads are allowing the banking industry to recapitalize itself, which was, of course, the reason for the Fed’s intervention in the first place. Tremendous profits are being generated which can be used to gradually write down all those bad loans.

The banks are able to make huge quarterly profits, write-down bad loans and wait until the write-downs reduce book value to market value. Once this is accomplished, distressed assets can be disposed of without incurring losses. This is why the banks have been holding on to assets that they would ordinarily write off and dump on the market.

In spite of all this, we have seen a significant increase in the amount of distressed assets coming to market recently. Although the flow has increased, it remains a drop in the bucket compared to what actually exists in the market.

As interest rates start to rise it will put additional stress on under water loans and could motivate sellers to act quickly as they realize that holding on to distressed assets is causing them to miss other opportunities.
Adding to the increased flow of distressed assets is the fact that advantageous mortgage terms are beginning to expire. We have seen interest-only periods provided on loans originated in 2006 and 2007 beginning to evaporate.

Floating rate loans originated in 2005 and 2006 are either at or nearing maturity. If these loans were floating over LIBOR, debt service rates may only be 2 or 3 percent today and no lenders are willing to renew or extend a loan at those extremely low interest rates. We, therefore, expect the flow of distressed assets to continue to increase as we move farther into 2010 and 2011.

One of the riskiest things you could do is to buy a second or third position non-performing note. In this case the holder of the first position note will almost certainly foreclose and recover some or most of the first loan amount. You on the other hand will be in a weak position and will probably get nothing. To avoid this risk, don’t buy second position notes! You can also choose to invest only in notes that are performing, that is, the payments are being made on time. Yes, the banks do sell performing notes at an extreme discount when they need the cash and when the balloon payment comes due.

One of the biggest risks for a note investor is the risk that the borrower will declare bankruptcy and you will get nothing. What can you do to avoid this risk? The best way to limit most risks when investing in notes is to know as much as possible about the borrower and the asset.

What do the borrower’s financials look like? What personal assets does he have? What is his payment history? Is there any chance that he will file for bankruptcy? Finding the answers to all of these questions is called due diligence. Doing proper and complete due diligence is what takes the risk out of investing. As a note investor all of this information is available to you. It is provided by the financial institution you are buying the note from. To quote Robert Kiyosaki- Investing is only risky when you don’t know what you are doing.

There is a huge learning curve involved when it comes to buying notes. You may have noticed that there is a lot of material being sold on the internet that claims to teach you how to make a ton of easy money in the note buying business. The truth is that you could easily spend a lot of time and money on courses, software and books and still never figure out how to make a dime buying a note.

Another way to approach note buying is to align yourself with a strong team of professionals who have years of experience in the note business and know how to avoid the risks and reap the rewards. You will need good attorneys and people who have personal contacts at the FDIC. These people can guide you through the process and make sure that you pay less for a note than you would if you tried to buy it on your own. They simply know how to play the game at a very high level. If you plan to buy large notes and acquire multi-million dollar assets, you really do need a professional team to work with.

What will the FDIC do with all these loans? They will sell them. This is great news for you and me because you most likely you would like to profit from real estate but you are not so keen to deal with the terrible three- tenants, trash and toilets. When you buy notes from the FDIC you have the opportunity to be the bank, not the landlord.

Now the $10,000 question is how do I buy notes from the FDIC? Great question! The FDIC was formed during the Great Depression to protect the bank customer’s deposits. When a bank can no longer cover its debt, the FDIC must take over the bank. Of course, the FDIC does not want to run the bank so it begins to sell the bank’s assets and return the deposits to its customers.

At this point, the FDIC can allow a strong bank to purchase the failed bank. Good banks can buy bad banks. The FDIC may also hold public sales or create Public Private Partnerships that allow non-bankers like you and me to purchase these notes.

You must have cash to play this game. There are no loans involved; the FDIC wants to get rid of the loan for cash. You could sign up with an auction site like Debt-X that will show you where and when to bid for an asset, or you can enlist the services of a private note buying company that will do all the proper due diligence on the assets you are interested in and give you bid guidance so that you can be more successful in your bid. This is very important when you consider that 40% of all internet bidders end up losing their 10% hard money deposit and fail to complete the purchase of an asset.

A Loan Service Provider can work with you to create several viable exit strategies. The time to plan your exit strategy is before you bid on a note. Once you are the successful bidder you will own the note on an asset that you bought for cents on the dollar and you will have several choices of how to profit; you can settle with the current borrower on the loan, take a deed in lieu of foreclosure, foreclose and take possession of the property or sell the deed to another interested party. Any way you choose to proceed you can make a tidy profit.

In the mid-1980’s, the FDIC had to create a loan sale program that could market these loans and package them into pools. Due to the sheer volume of loan sales in the late ’80s/ early 90’s, the Resolution Trust Corporation (“RTC”) implemented a bulk sales program to dispose of the assets from troubled banks and Savings and Loans. Even then, the FDIC and RTC were forced to look outside themselves to third parties to process the loan sales. These third parties assist in pre-receivership balance sheet clean-ups, as well as post-receivership asset sales. These third parties are generally referred to as Loan Sale Advisors, and include First Financial Network, DebtX, and Mission Capital.

Nowadays the FDIC still holds loan sale auctions brokered through loan sale advisors and also used other programs such as their Legacy Loan program and LLC Structured sales. If you haven’t ever visited the FDIC website, you should take a peek of their “Asset Sales” webpage to learn more about how one qualifies for loan sale programs.

There were 140 bank seizures in the year 2009, the highest level of closures since the Savings and Loan crisis. If you think last year was record breaking, 2010 could possibly meet if not exceed those levels. The FDIC is poised to dismantle and sell off more failed banks, having increased their staff to over 2,000 agents that are charged with resolving distressed banks. In the midst of our economic recovery, this may come as a surprise to some, but the banking industry is bracing itself for the aftershock of the economic earthquake of 2008. The meltdown of the housing market may be reaching bottom, but the trouble in the commercial sector has just begun.

The results of all this is that performing, first position notes are being sold by the FDIC for as little as 40 cents on the dollar. If this is something that interests you, we would be happy to discuss it with you personally.