Dealing with someone who buys your government-held mortgage.

For the last several years, the Resolution Trust Corporation (RTC) has been aggressively disposing of its mortgage portfolio, one reluctantly acquired in the aftermath of the savings and loan debacle. The Department of Housing and Urban Development (HUD) has followed suit by selling off holdings of defaulted mortgages, recognizing the extra administrative burden they place on its staff.

Beware, the days of bureaucratic complacency - where some HUD defaults have been virtually ignored for as long as two years - are quickly coming to an end. With both the massive disposition of the RTC portfolio and the ongoing auctions of HUD defaulted mortgages, it is possible that your mortgage is no longer in the hands of a lenient, passive party, one who will sit idly by while you remain in a non-performing status. HUD, in particular, is allowing profit-hungry third parties to purchase these loans and pursue aggressive collection efforts, which may include forcing litigation and/or bankruptcies.

This article will address concerns and propose strategies for owners of projects that have not been meeting debt service and thus face having their mortgage sold to another party.

Why Do They Buy?

The Wall Street money machines that back this new breed of buyer want to see your mortgage quickly converted to cash, either through re-packaging your mortgage into a performing marketable debt instrument sold to other investors (interested in holding mortgages that meet their underwriting guidelines) or by simply disposing of the underlying collateral through foreclosure actions.

Although the second alternative can be costly, time-consuming and difficult, the buyer of the defaulted mortgage is usually not interested in holding the real estate, but is rather motivated to produce a quick return at outstanding yields. Purchasing the defaulted mortgage at a deep discount allows sufficient room to negotiate and maneuver the mortgage into a performing interest, even taking into account the time value of money and the legal and other costs of aggressively "leaning" on debtors.

Sometimes, Both Sides Can Win

In RTC transactions, many performing mortgages held by defunct savings and loans were sold at a discount to facilitate a portfolio liquidation. In one situation I know of, a performing mortgage was sold at fifty cents on the dollar to an investment group who quickly flipped their position to the property owners at seventy cents. The investment group (IG) achieved a quick 40 percent return and the property owners significantly enhanced their economic position by discounting their mortgage.

Not all transactions are this rosy, but it does illustrate that the IG's are motivated by quick and superior returns and don't need the last dollar on the table to make a deal. A Wall Street investment banking firm involved in these transactions suggested that many singles and doubles were preferred to the occasional home run.

Another Kind of Thinking

Let's take a case where the project's economics are not as bright. I was involved in another situation where an IG bought the mortgage of a property that generated sufficient income to service debt at a market interest rate - except the mortgage term had expired. The IG realized that under current after-market underwriting guidelines, the commercial property, because it lacked a credit-rated anchor tenant, would not have adequate loan-to-value or debt service coverage for the loan to be re-written for ultimate re-sale.

Consequently, the IG was faced with extending the maturity of the existing loan and holding on to it, an unacceptable position, or forcing a liquidation of the asset. The IG actually hoped that the debtor would contribute more equity to pay down the loan, allowing either the IG or another party to underwrite a new loan under current market guidelines. Forcing legal action is more risky. If unsuccessful in the bankruptcy court, the IG might have to swallow a "cram down," thereby effecting a long-term mortgage position. When this happens, the IG, uninterested in the long-term position, faces taking a loss because it is forced to discount the mortgage for sale in a secondary market. Essentially, the IG "makes up" the equity for the discount by recognizing a loss on their position.

As I've warned, things will heat up for many now in default to HUD. An aggressive, profit-driven buyer of your mortgage will soon be calling. Unlike HUD, the new mortgage holder will be anxious to restructure your mortgage - one way or another. This restructure may include a write-down from your existing balance. The new buyer, who acquires all rights currently held by HUD, including accrued interest and outstanding principal, may also see foreclosure, rather than the value from the mortgage balance you can debt service, as the quickest and surest route to profits. In order to get a write-down - and keep your property, - you may need to provide new equity.

Keep in mind, however, that most new holders will threaten, but not relish, long and costly legal action. If you can put reasonable cards on the table, your hand may be accepted. Protracted battles hurt both sides - the owner faces diminishing access to new equity funding, and the mortgage-holder's break-even expenses keep climbing.

In conclusion, the good news is if you have access to new equity, there is a possibility you can substantially reduce your mortgage obligation. The bad news is your new mortgage holder will likely be much more aggressive in asserting the rights of your lender, which may lead to a flurry of legal activity. If your HUD property is in Michigan, there is time to determine your strategy and position yourself, as the HUD auction for this state is anticipated to be scheduled for late '95. In any event, have a sound game plan in place as soon as possible. Your new mortgage-holder may have more financial resources than you, and, like the gunslinger of the Old West, is apt to shoot first and ask questions later.