For smaller asset management firms, residential and commercial mortgage-backed loan portfolios (both performing and non-performing) continue to represent an attractive and accessible investment opportunity. Banks are continuing to sell their loan portfolios at a discount in order to raise capital, clean up their balance sheet or implement a change of strategy. These assets are in demand, and are often the subject of competing bids.
If you are considering bidding for such a portfolio - whether it is made up of thousands of loans or just a few – there are some practical things you can do to put yourself in the best position to secure a deal. This article sets out some of them.
1. Due diligence strategy – the due diligence process for purchasing debt secured on real estate requires planning. The associated costs are usually irrecoverable, in that you will need to pay them whether or not your bid is successful. External advisers should be chosen wisely, as a lack of experience in this area can significantly increase costs. The due diligence should involve a security review of the underlying assets (including title checks at the Land Registry and at Companies House) and drive-by or desktop valuations to ascertain current market value. On a large portfolio, a sample of properties is usually chosen on which to complete the due diligence. The underlying loan documentation should also be checked to ensure a bidder can actually have the loans transferred to it free from restrictions such as borrower consent or financial institution status which may make the transfer too expensive or impractical.
2. Structuring - a bidder for a loan portfolio may be asked to show how it plans to structure the purchase of the loans, and what its investment objectives are. Things to consider include: jurisdiction of incorporation of the purchaser, contingency plans if the underlying documents insist on a financial institution being the permitted transferee, the transfer of the security especially if there is not a security trustee involved and what licences and approvals are required from regulators.
3. Do you need finance? – increasingly, lenders are looking to fund the purchase of this type of asset. However, their appetite for risk may not match yours, and they will have their own requirements as to due diligence in relation to the portfolio. This takes time and involves cost. To increase efficiencies, the project should be managed carefully and all information available communicated with the potential lender as and when received.
4. Are you regulated? – although acquiring loans and realising the secured assets are generally not regulated activities, advising on and administering Regulated Mortgage Contracts and providing further advances (amongst other activities) are regulated. As part of your preparations, you will need to get clear on the regulatory issues and, if necessary, establish a relationship with a third party service provider which does have the requisite authority and licences.
5. Can you perform? – a purchaser of this type of portfolio will need to be confident that it can transfer these mortgages smoothly onto the necessary software packages and service them from day one, including dealing directly with borrowers. If you are not in a position to handle this in house, the 'on-boarding' process and day-to-day functions of servicing a portfolio of mortgages (both performing and non-performing) can be undertaken by an independent servicer which will need to be appointed under a servicing agreement. Conversations with third party servicers would need to be running in parallel with the purchase process.