How to Price Distressed Loans?

What's the price you are willing to pay for a distressed loan? Likely it's below principal or payoff balance but by how much? To answer the question - find the value of the expected cash recovery. On a high level - there are only three forms of cash recovery:

(i) Full payoff of the loan: The lender expects the borrower to fully pay off the loan, including principal and accrued default interest. For example - the property itself is performing well but the JV owning the property ends up in cross-hairs and stops serving the debt.

(ii)?Discounted payoff of the loan: The lender and the borrower revise the debt agreement and agree to a discounted payoff of the loan. This usually never happens with the original lender but is part of resolution strategies for distressed loan buyers. A standard strategy is waiving default interest accrual to entice the borrower to sell the property and salvage the equity in the deal. Of course, the borrower is expected to waive all measures to obstruct a potential foreclosure process.

(iii) Work-out of the property. The lender takes title and sells the property. Before that can happen, often, the property has to be fixed, upgraded and stabilized due to potential neglect during default of the loan. This scenario is likely when the total payoff amount (principal plus accrued default interest) has increased to an amount exceeding the property value.

The challenging part. The value of the distressed loan can change quickly over time (default interest can accrue at double-digits) and the value of the property, especially when neglected, changes as well over time. Not to mention the current market uncertainty. This makes it more difficult to define the date of "break-even" (payoff balance ~ property value). Legal advise is needed to understand hurdles and to time to resolution. Always avoid a legal battle with the property rotting away because nobody is managing it.

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