Distressed Small Balance Market Grows

Woodbridge, NJ-A new advisory firm has found a goldmine in trading small-balance nonperforming commercial paper debt secured by formerly mismanaged good assets.

According to executives of Helios Capital LLC here, this largely unexplored market niche is growing along with investor confidence in its potential.

"We saw an opportunity to buy distressed small-balance commercial loans that are secured by all asset types in all performance classes," says Helios Capital senior managing director Jonathan Horn.

Helios Capital managing director, Josh Malka, says starting at the beginning of 2009 more banks were trying to discharge debt from their balance sheets. And small-balance commercial loans of anywhere from $ $1 million to $50 million that were not securitized "was the one area we thought banks would probably be more willing to discount their debt" to be able to get it off of their books.

The market proved them right. He says there is more capital available in the local and regional level as opposed to large institutional level. Clients tend to be high net worth individuals who own real estate offices, or traditional real estate investors that may have been sitting on the sidelines over the last couple of years, he says, but now are chasing deals and opportunities to buy distressed debt.

"What we're looking for is debt that is secured by good assets, in good locations, that were just simply mismanaged - that's what makes a difference," he says. "Our plan is not so much to get clients a return or yield. It is more of a loan-to-own, whether it is a foreclosure, or working out something with the borrower in order to get the deed."

Executives say since they started their commercial loan advisory services firm in January 2009 it has completed over $30 million in mortgage loan transactions in the tri-state area of New York, New Jersey, Connecticut, and in Florida. It facilitates the trade of nonperforming small-balance commercial real estate debt with loan balances of $1 million to $50 million for individual investors and banks.

"Despite the unique challenges that are currently in place in the commercial mortgage loan space, we have found that there are a number of significant opportunities available," Mr. Malka says.

Most recently Helios completed a $3.5 million loan transaction for a mixed-use, multifamily building in Brooklyn, N.Y., "sold at a compelling discount" to a private investor, and a $2.4 million structured sale of a 24 unit multifamily building in Harlem that included the property's debt and the deed-in-lieu for the building. Meanwhile, a $2.3 million loan transaction in Gloucester County, N.J., was closed on behalf of a local bank.

During this process they found that area investors purchasing on the local level bid and pay more for such deals since they know their market much better than larger institutions. Knowledgeable investors have the local expertise to evaluate a distressed debt and more information available compared to a foreclosure for which potential investors can access very limited information. As a rule it is limited to an original loan document that can be two to three years old or even more, Mr. Horn says, so included in that package may be an old appraisal or information about an old landlord, which in certain situations can mean lack of access to the building. "Local knowledge of the market allows a local investor to analyze and underwrite a deal very quickly."

What drives this market niche is its quite specific asset profile. During the past few years inexperienced borrowers and multifamily housing developers turned retail investors, also without experience, made many acquisitions that "may have spread their resources too thin when they entered the market," Mr. Horn says, creating a pool of debt now available for trade.

"Most of these distressed debt deals require little to no due diligence, so the process is fast. We work strictly with all-cash buyers so it's a very quick due diligence period, and the bank goes into a very quick closing," says Mr. Malka.

In addition to high-end buyers who are interested in cash-only investment deals, according to Mr. Horn, an emerging new trend is that more banks now offer financing for the acquisition of this type of debt. And that executives say indicates they have only touched the tip of the iceberg.

"I don't think we've really gotten into the true market," says Mr. Horn. "We're still in the very early stages. There's a lot of potential left in this market, and that's what makes us confident in its opportunities."

The overall economic and mortgage crisis is pressuring banks to clean up their balance sheets by trying to come up with workout options through the current borrower of a debt product. If workouts do not work, Mr. Horn says, they need capital to refinance these deals. "There's plenty of liquidity in the market for such deals, but our niche is a bit under the radar in the local and regional level."

Judging from various reports, the commercial market crisis also has been "under the radar."

Recently in an effort to improve credit to a troubled commercial real estate market, the Federal Reserve extended its emergency lending program, Term Asset-Backed Securities Loan Facility, for newly issued commercial mortgage-backed securities from Dec. 31, 2009 to June 30, 2010. In addition the Fed has extended its TALF programs for new securities backed by auto, credit card and small-business loans, including TALF for existing CMBS through March 31, 2010. Under TALF, investors can apply for nonrecourse loans whose proceeds are earmarked for designated securities. The Fed has lent $41 billion for ABS over six months and $669 million for legacy CMBS in one round. TALF-related buying has halved risk premiums on CMBS since March. Selling may have surprised dealers who bought CMBS in anticipation that the Treasury's pending toxic asset clean-up plan would spark demand, says Chris Sullivan, chief investment officer at the United Nations Federal Credit Union in New York.

According to a joint Fed-Treasury Department statement, ABS markets including residential and commercial MBS "are still under strain and most likely will remain so in the near future."

"I agree with those reports. I think people have not yet seen the floodgate open in the commercial market," Mr. Horn says.

However, both executives - whose previous experience is in buying performing nonperforming residential and commercial loans - say they are confident there are so many opportunities in their market niche that they cannot spread themselves too thin.

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