The Market Price of Delinquent Loans, a.k.a. Non-Performing Assets

Premise

The value of a delinquent primary note is not zero.

If a bank/lender wants to sell a delinquent note to convert a non-performing asset into a significant lump sum of cash then we need to establish a process for establishing the value of these assets.

Facts

1. Real estate value have deteriorated in many parts of the country.
2. The number of foreclosures is at an historic high.
3. Large banks have incurred loses on large portfolios on non-performing notes and/or real-estate secured instruments that is jeopardizing their solvency.
4. There is too little cash in the private sector to purchase these notes.
5. GSEs are the only institutions with the funds to purchase these notes
6. Delinquent primary notes in markets where drops in property values have experienced significant declines are not worth the current amount of the note.
7. Markets that have experienced significant delines in propert values have not hit bottom.
8. Delinquent primary notes have a value greater than zero.
9. Equity in the property or lack thereof is an important factor in establishing the value of the note.

Discussion

Many markets have experienced a drop in property values. Some areas have experienced drops in property values greater than 30%. In many cases the primary note exceeds the current market value of the property. The property buyers/owners have lost all of their equity and the note holders/owners have lost equity. However, the note holders are not in the business of owning and managing property. They want to sell the asset.

In areas where properties are selling professional appraisers have a sufficient amount of data to establish a professional opinion of a property's market value. In areas where properties are not selling it is more difficult to substantiate the appraiser's professional opinion of a property's market value but it can still be accomplished. If necessary you could have three separate appraisers submit their professional opinions of a property's market value and then use their findings to establish an appraised value for the asset.

In a declining market buyers are not going to pay the appraised value of the property. They are going to factor in an amount of the expected decline in the market into their offer price. If the buyer expects the property values to decline another 15% then they will not make an offer greater than 85% of the asking price. Using this practice as a benchmark we can create a model for GSE purchases of non-performing primary notes.

If the private market will not pay more than the appraised value minus the forecast for the market decline for the next year then the GSEs should establish a policy that they will pay an amount equal to the appraised value minus the forecast for the market decline for the next year, less a 20% margin to establish an equity position in the asset.

Therefore, if a home was appraised at $200,000 and the forecast in its market area was for another 15% decline. Then the private buyer in this market would pay no more than $170,000. If the note holder wanted to sell their non-performing asset to one of the GSEs then the price would be 20% less than $170,000 or $136,000. This amount is approximately 68% of the appraised value.

This is one method of establishing a bottom for these markets. There are certainly other methods that could be used to establish the bottom including an approach that just lets the market flounder until it can establish a bottom on its own.

What are your thoughts?