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    PORTFOLIO TRANSACTIONS Buying & Selling Portfolio's of Mortgage Loans

    (and Owned Real Estate)

    Alan Lascher

    EXECUTIVE SUMMARY

    Buying and Selling Portfolios of Mortgage Loans reached its zenith when the

    Resolution Trust Corporation, charged by Congress with the task of cleaning up the

    mortgage loan mess left behind by the savings bank industry, decided to tackle the

    problem by auctioning off troubled bank loan portfolios en masse. The practice of selling

    pools of loan assets spread to banks, insurance companies and other traditional lenders as

    a means of clearing out their own portfolios from time to time, and, of course, is a major

    part of the practice of securitization transactions.

    This paper addresses the WHAT, WHERE, HOW, WHEN and WHY of Portfolio

    Sales and Acquisitions, and sets forth some of the pitfalls to watch out for and issues to

    be dealt with.

    DISCUSSION

    I. Buying and Selling Loans and Owned Real Estate.

    A. Why do entities buy and sell loans, rather than simply making new loans

    themselves? For several reasons:

    1. To make money, as a business, as if they made the loans themselves

    (earn interest, etc.). These entities pay the originator of the loan for the loan (plus, often,

    an origination fee) and do not need to do all the leg work involved in originating loans

    themselves.

    2. To free up money to lend again, for fee making purposes.

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    3. To take advantage of mortgage market dislocation, for example, the

    RTC take over of banks; the collapse of the Asian Capital Markets, creating a "no loan"

    atmosphere here among certain investment bank lenders, or as interest rates change, to

    take advantage of changing loan values.

    4. To create securitizable or syndicatable pools of sufficient size (the

    entity often needs to acquire third party loans to own enough to make a workable pool);

    and finally,

    5. To "work" the loans or owned real estate as assets (i.e., either assist the

    borrower in the recovery of its asset by doing a "workout", or foreclose and "work" the

    asset itself and then sell, or simply selling it back to the borrower at a lesser discount than

    it paid to acquire the loan.)

    B. What is bought and sold? Loans and owned real estate of all shapes and sizes,

    for all of the purposes mentioned above. This includes good loans, bad loans, good

    properties, bad properties, environmentally tainted properties, etc. If you put enough bad

    "assets" together, and create "tranches" of investment interest, you can always find a

    buyer for the "top" tranches. However, in order to be able to acquire a portfolio, the

    Purchaser needs to do two things:

    1. It needs to learn about the assets in the portfolio being purchased, and

    2. It needs to determine the price its willing to pay, based on what is

    learned.

    C. How does the Purchaser do that? There are two ways the Purchaser can

    acquire enough information to make an intelligent determination of a possible purchase

    price. They include:

    1. Conducting a significant amount of due diligence with respect to the

    pool of assets to be acquired; or

    2. Entering into a purchase agreement that includes representations and

    warranties covering at least the minimum information necessary to formulate a value and

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    risk profile for the asset pool. Best yet is to get a combination of both, since certain

    information (i.e. outstanding balances) is not obtainable simply by doing due diligence.

    D. Which should the Purchaser rely upon, if given a choice? It depends on the

    nature of the portfolio, as well as the financial strength, staying power and willingness of

    the Purchaser to make and stand behind the representations and warranties. Generally

    speaking, if the loans are good loans the Purchaser can rely more on the representations

    and warranties; on the other hand, if they are bad loans the Purchaser is probably better

    off relying more on due diligence, and filling in the gaps with representations and

    warranties.

    II. Due Diligence

    In all cases, doing due diligence, although time consuming and very

    costly, yields much greater information about the asset, and will produce a better

    understanding of the two things the Purchaser really needs to know: Is there anything in

    the legal file which would affect either: a) the ability of the lender to realize on the

    collateral in a timely fashion in the event of a default; or b) the value of the asset, once

    the lender forecloses.. These two items have a significant affect on determining the

    purchase price a Purchaser would be willing to pay since any variation in either has a

    direct affect on the IRR, or rate of return, the purchasing entity expects to realize on the

    portfolio.

    A. Diligence Checklist - The use of a due diligence checklist is a must. Since we

    are always dealing with lots of assets, we, of necessity, need to use lots of attorney

    reviewers, and they need a uniform guide as to what they should be looking for. Each

    transaction requires its own checklist, since each group of assets have different basic

    properties. The checklist must be designed to (1) produce uniform results from different

    reviewers (so that the business people using the information for pricing purposes can

    understand what is meant), and (2) must answer the two questions set forth in Section II

    above.

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    B. What happens to information collected? It is used to determine the value that

    the client's underwriters (i.e., the business people who decide how much the portfolio is

    worth) will put on each individual asset, as well as what risk factors are attendant to each

    asset, and the likelihood of such risk having an effect; then aggregating the individual

    values to determine a Portfolio value. But the due diligence information alone is not

    enough. Certain information can only be obtained through the Purchase Agreement, and

    the representations and warranties contained therein; so knowledge of what the Purchase

    Agreement contains is important in determining the Portfolio value.

    III. The Purchase Agreement.

    Purchase Agreements for loan portfolio transactions have all the attributes

    of purchase agreements for the acquisition or sale of real estate (price, down payment,

    closing date, adjustments and representations and warranties); sometimes, the Purchase

    Agreement is negotiated and sometimes it results from an auction process whereby the

    Purchaser takes the Seller's form agreement, marks it up, fills in the purchase price and

    submits it to the Seller.

    A. Typical Representations & Warranties

    - The type of representations and warranties that a Purchaser obtains in

    portfolio transactions varies depending upon the deal; the extent of the

    representations and warranties can be full blown, on a par with what

    you would expect to receive in a single asset deal, or the Purchaser can

    get something less than full blown representations, in which case the

    added risk will cause application of a discount factor to the purchase

    price. (For example, we saw a 50% discount in RTC deals where the

    government was unwilling or unable to provide significant

    representations). In determining the purchase price and whether (and

    to what extent) to apply a discount factor, the Purchaser must also

    consider whether or not the Seller has the financial wherewithal, and

    willingness, to back up the representations and warranties. This

    became very clear in the days of the RTC, when its avowed purpose

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    was to go out of existence as quickly as possible! One had to question

    the long term viability of representations and warranties under those

    circumstances.

    Typical representations and warranties include the following:

    1. Representations and warranties as to the Seller organization. These

    would include (a) that the transaction was duly authorized; (b) that there is no conflict

    with existing agreements; (c) that no litigation is threatened or pending with respect to the

    Seller, the Portfolio or the Transaction, except as disclosed; (d) that the loans were made

    by an entity that was qualified to make and/or hold the loans ; and (e) that no consents

    from governmental agencies or others are required.

    2. Representations and warranties as to loans and loan documents.

    These would include (a) that all of the loan documents are disclosed, (b) that Seller has

    provided true, complete copies thereof, and that there are no undisclosed modifications;

    (c) that the information contained in the loan schedule (i.e., loan amount, rate, lien

    priority, maturity date, extension rights, type of property, recourse or not, additional

    collateral, guarantees) is accurate; (d) that there are in the file a current clean Phase I

    environmental report and engineer's report with respect to each mortgaged property or

    real property; (e) that Seller is sole owner of the entire loan; there have been no

    assignments, pledges, participators or other outstanding interests not reflected therein; (f)

    th