Hey Buddy, Wanna Buy A Note?

Hey buddy, wanna buy a watch?   It’s the refrain that immediately conjures up the image of a shadowy figure in a back alley opening his trench coat to reveal a selection of watches hanging from the inside of his coat.  Not exactly the most progressive way to sell watches (or anything else for that matter), but it’s not that far off from the way that most lenders have been marketing their non-performing commercial real estate loans this year (commonly referred to as notes, as in note and first trust deed).  To be more accurate, lenders have been quietly offering their non-performing loans primarily to a small circle of good customers and business relationships.

Most of these lenders went to good business schools and took marketing classes that taught them that that the best way to market something for sale is to offer it to the broadest possible number of people, creating the proverbial “efficient marketplace”.  They also know that in this internet based world, you can easily access over 100,000 brokers and principals with the push of a button.  Since they are clearly not doing this, the question is, “Why?”  There are three very basic and very human reasons why otherwise sophisticated lenders are marketing their notes like the guy in a trench coat:  (1) to avoid embarrassment, (2) to avoid unwanted attention, and (3) to manage limited staff time.

It turns out that when a lender widely markets a note for sale, a number of things happen. First, the borrower finds out and gets angry because he’s embarrassed that the world now knows that he’s not making the payments on his loan. He calls the lender and lets them know that he’s angry, and if he has other loans or other business relationships with the lender, it creates a very stressed borrower/lender relationship. Next, the lender’s other customers, competitors, the press, and the public find out that the lender has “non-performing” loans, which at the very least embarrass the lender, and maybe even generate some unwanted attention from analysts, regulators, and shareholders. Last, but not least, as a result of the first two issues, most lenders are using their own production or asset management staff to market the note(s), and face a very practical issue – fielding the hundreds of phone calls from interested note buyers, and then qualifying them simply takes too much time. So you quietly call a few trusted buyers and hope they’ll offer to pay you enough for your note to reach the price that you’ve written it down to.  It’s not surprising that most lenders and note buyers report that the trench coat system of marketing is not working.

Earlier this year we marketed and sold a non-performing loan on a partially completed condominium project in Northern California for a large regional lender.  It does consume a lot of time preparing well organized marketing and due diligence materials, qualifying prospective buyers and negotiating terms and managing the sale.  However, given the billions of dollars of non-performing commercial real estate loans that have to be worked through one way or another, eventually non-performing notes will have to be marketed just like all other real estate, by trained professionals to the widest possible number of buyers. It’s just a matter of time.