In these stressful economic times, many lenders and their investors are looking at acquiring existing loans, or are considering selling loans they currently own.
There are many reasons loans are bought and sold. Often times the reason has more to do with the individual situation of the seller than of the note itself, or the condition of the borrower. The most common reasons loans are sold are for liquidity, dissolution of a partnership, change of financial circumstance, deterioration of the underlying collateral, or the default of a borrower.
There are many opportunities for buyers and brokers to acquire loans at a discount to the principal balance which may result in substantially better yields than originating a new loan. Buyers and their brokers should consider several factors when purchasing a note, including the strength and payment history of the borrower, the quality of the underlying collateral securing the loan, and the strength of the guarantors, if any.
Loans can be purchased individually or in pools. Although the legal agreement differs for each, the basic process flow is the same whether you are buying or selling one or more loans. For simplicity purposes, I’ll refer to the transaction as a loan asset transaction. The term “loan sale” and “note sale” will also be used interchangeably throughout.
The basics of the purchase and sale process are relatively straight forward, but like any transaction, the devil is in the details. Following are eight steps involved in the purchase and sale of loan assets followed by a discussion of the most common pitfalls to avoid throughout the transaction.
Step 1: Confidentiality and Non-Disclosure Agreement
It is customary to execute a confidentiality and non-disclosure agreement to protect both parties. Sensitive borrower information is typically exchanged and both parties need to agree to safeguard this information.
Step 2: Make an Offer
Make an offer for the loan asset in writing. Work with an attorney who has handled loan purchase and sale agreements in the past and can walk you through the various nuances to the agreement. An entire article can be written on the ins and outs of this agreement, and is a topic for another time.
Step 3: Good Faith Deposit and Open Title
Typically a seller will provide a good faith deposit to get the process started, but this is a point to be negotiated between the parties. It is a lot of work to gather the loan files together and you want to make sure you have a serious buyer before you go through the effort. You should also prequalify the buyer and verify that the funds are in place and that this buyer isn’t going to try and “raise the funds” once they review your files.
After a deposit is received, the seller should open a title policy. Most of the time the seller can buy an ALTA assignment endorsement (10.6-06) which insures the assignment vesting and lien position to the new party. The endorsement is less expensive than a full title policy and is recommended if it is available.
Step 4: Due Diligence
Once a deposit is received, conduct thorough due diligence on the loan asset. Your level of due diligence will vary depending on the asset itself, and on the number of assets you purchase. Most purchasers will conduct an independent appraisal, re-underwrite the loan, examine the chain of title, review the original promissory note, review all correspondence with the borrower, the trustee, and any other parties to the loan.
There are a number of third party companies that specialize in performing independent due diligence on loan assets and generally charge $250 per loan depending on the type of appraisal and underwriting conducted.
Most of the time you will not be able to inspect the interior of the property, or conduct an interview with the borrower, but that can be a point of discussion between you and the loan seller at the time the offer is negotiated.
Step 5: Sign Documents
Besides the purchase and sale agreement, two additional documents must be signed in order to transfer ownership of a loan. The first is an assignment, which is a notarized document referencing the original mortgage or deed of trust and is recorded in the same county in which the real property securing the note is located.
The second document is a signed endorsement of the original promissory note. This endorsement can be handled by either typing language on the back of the note (e.g. Pay to the order of….) much in the way a check is endorsed when signed over to a third party. If there is not room on the back of the note, another way to endorse the note is by attaching an Allonge which effectively has the same language that would otherwise be placed on the back of the Note. The Allonge must be securely attached and at all times kept with the original promissory note.
Example of language that may be used in an Allonge is:
THIS ENDORSEMENT IS TO BE ATTACHED TO AND MADE PART OF THAT CERTAIN PROMISSORY NOTE dated Month, Day, Year, made by Borrower Name Here, in favor of ABC Company, the payee, in the original principal amount of $x,xxx,xxx. Such Note is hereby transferred pursuant to the following Endorsement with the same force and effect as if such Endorsement were set forth at the end of such Note:
THIS PROMISSORY NOTE is herby Endorsed and Assigned without recourse to: ABC Loan Buying Company
PAY TO THE ORDER OF:
ABC Loan Buying Company