Hanson credits Phil Flynn, Associated's new president and CEO, as key to getting its books in order and dumping its distress. However, other banks have had a tough go at this approach, he tells Distressed Assets Investor. "Banks haven't been in a position to sell loans at market value because of the large hit that would be taken in earnings," Hanson says. "Plus, it's difficult for some executives to look at portfolios they've nurtured in a completely objective fashion."

He adds that an improved economy has boosted interest in some product types, and that the industry is hungry for bank performance, which will force some asset sales. "You're going to see an increase in bulk-loan sales simply because there hasn't been much movement until now," he states.

Chris Crowley with Boston-based Capital Crossing Servicing Co. says the bid-ask spread is just too wide, and he doesn't see buyers raising prices anytime soon. What he does see is more activity in the past six months than in the 12 months prior, including bigger bulk sales. "Where we were seeing $60 million as a big pool, now we're seeing $150 million to $200 million," he observes. "We've been doing a bit of bulk buying ourselves over the past year, though they were more private, negotiated trades than public auctions." The clearing will need to happen, experts agree. According to data from Foresight Analytics, about $1.7 trillion in mortgages (including multifamily paper and construction and land loans) will mature between 2010 and 2014, an average of nearly $350 billion per year. With asset values down by 45%, about $900 billion worth of the accompanying assets are distressed, with the maturities increasing starting this year. Delinquent and defaulted debt is estimated at $230 billion, according to Foresight.

Bliss Morris, CEO of First Financial Network in Oklahoma City, saw far more portfolios being marketed around the country in the fourth quarter of 2010 than in the year prior. "We're seeing something like $2.7 billion of bulk sales going on," she tells DAI. "Technology has helped and is creating competition among different investors."

Morris says one of the reasons that bulk sales have been slow is it took a while for buyers and sellers to bring their value assessments closer together, especially in late 2008 and early 2009, when prices dropped quickly. "You look at what a property appraisal was seven or eight years ago, compared to a couple of years ago, and it had been cut in half," she notes. "Then six months went by and it was cut by another 25%. It was horrific. The institutions were trying to get their head around value.

"It's a misnomer that buying bulk is going to garner a cheaper price," Morris continues. "If you take a portfolio of loans, subdivide it and stratify the portfolio into small groups, those groups can have a better value. We're doing these deals where we have $250 million in loans and all but four pools are individual borrowers. A borrower with $30 million to $50 million can submit bids on different pools and have a much better shot at acquiring that product. Just in Q4, we'll probably trade close to $200 million to $300 million in one-off loans."

The benefit to sellers, Morris says, is that you can bring in vetted, qualified investors who are likely to buy, at a time when many new companies are springing up to chase distress or established companies are forming distress arms. "Today, it's more important than ever to know if a potential buyer has the ability to do an acquisition," she notes. "We've had to do more research on vetting investors recently. There are more loans being sold, banks don't want to be in that business and these new companies needed education on due diligence of a loan sale. You can't go tour a loan sale property; it's just not possible."

Morris says she's a glass half-full sort but admits she's nervous about the global economy. "There's a narrow opening of banks starting to put bulk loans out there, and we should see more of this in the next 36 months," she says. "At some point there's going to be some market clearing, and it's going to happen over time. It's just going to be a slow, slow process."

Part of the explanation for the bulk loan backlog is that the government believes it has learned from what worked in the previous recession. From December 1992 through October 1995, the RTC created 72 partnerships in the form of limited partnerships and business trusts. These held real estate loans and assets with a total book value of $21.4 billion and another $18 billion of partnerships holding judgments, deficiencies and charge-offs.

In 2008, the Federal Deposit Insurance Corp. again turned to the partnership model to sell large numbers of distressed assets, entering into two basic types of structured transactions with private-sector investors: participation transactions and partnership transactions. As of October 2010, the corporation had closed 18 structured deals, disposing of more than 32,000 assets and $21 billion in unpaid principal balance. This included Starwood LLC's $4.5-billion purchase of Corus Bank's assets and Colony Capital's buy of more than $2.8 billion in commercial real estate loans from the FDIC.

Chris Moench, CEO of Directed Capital Resources LLC in St. Petersburg, FL, says to guard against a loan flood, which is a valuation threat, the FDIC has been heavily involved in keeping bulk loans to a minimum. The corporation sold the assets on the open market through agencies.

However, about two years ago, the government stopped these sales, Moench says, to avoid overwhelming the market with product and devalue prices. Now, a weak bank will be sold to a strong bank, with caveats that constrain the disposal of assets for a few years, resulting in greater government control over what is sold and when.

Directed Capital bought about $100 million of assets in the past year, and this year will hit about $85 million, Moench says. His firm isn't sized to handle billion-dollar bulk sales, and there's been only about a dozen of these sales as part of the government's effort to protect the market.

"There are only so many players out there that can compete for those large sales," he explains. "And even in those deals, you haven't seen a lot of re-transacted assets out of these pools. The FDIC still has constraints on those deals, resulting in the acquiring entity having to try to work out the asset. However, these loss agreements typically run only four to five years. You're going to see this timeframe come to an end, after which an acquiring institution gets to do what it wants. You're going to see more of these assets come out in the next three years."

The other major sector where we're seeing assets come out is securitizations, says Moench. "In the past six months we've seen a number of special servicers bring to market, either directly or via one of the loan-sale advisory groups, packages of assets in bulk from around $20 million to $200 million. That water's been backing up behind the dam, and it's starting to spill over the top."

Rick White, a partner in the real estate practice of Jones Day in Atlanta, says securitization complexity is a large reason why the bulk-loan market hasn't materialized. "I don't know any bulk loans where mezzanine financing was involved," he states. "It's just not clean and easy. Also, there are differing interests." While the senior class holders are more open to selling bulk, the holder in the bottom tranche controls the special servicing, "and they are likely to push to hold the loan."

While it's probably not a good idea to keep putting off the distress problem, White agrees that financing could make a comeback and save some of the properties, depending on the economy. "The mood across the industry has improved greatly," he notes.

Clayton Gantz, a partner in real estate and land use at San Francisco based Manatt, Phelps and Phillips, says that during the RTC cycle he made 60 bulk-loan deals on the buy side for Lehman Bros. in a two- to three-year period. "When it all hit the fan this time around, it didn't work out that way," he tells DAI. "They aren't open to the general market like they were then."

This time, the government has stuck to allowing good institutions to take over bad and arranging a handful of large sales, such as the Corus Bank/ Starwood deal. Of course, banks are generally uninspired to put out large portfolios for pennies on the dollar.

"This time around it's the tale of the haves and have-nots," Gantz says. "The haves are the banks that have reasonable capital levels and have been permitted to extend and pretend to defer loss recognition on loan portfolios and grant extensions to the borrowers to avoid the day of reckoning. The have-nots? They were taken over and closed down." He says banks also just didn't have the wherewithal to absorb the losses that would have been incurred when selling, especially in 2008-'09 when the market was at its worst. Also consider, he says, that the bid-ask spread was so large that both sides' expectations could be called unrealistic. "And don't forget another important reason," Gantz adds. "If a financial institution manager sells assets before the market actually hits bottom, the board of directors will all think he or she is an idiot." With the start of new activity, Gantz thinks that maybe people are coming to their senses. "For one, the financial institutions that are approaching us to sell assets are doing better than a year or two ago, and they're thinking that they may absorb losses from a market rebound," he says. Also, buyers' expectations have diminished. "If they were looking for a 20% return in the past two years, now they're looking for the mid-teens."

Gantz says lenders have found other ways to move assets off their books. "If we've learned one thing from the 1990s, it's that a one-size solution doesn't fit all," Gantz says. "We're finding that banks are doing transactions systematically by going to the borrower to get a discounted payoff of the loan. They can usually achieve a bigger payoff rather than if they sold to a private equity or hedge fund. For example, if I want to pay off a $100,000 loan, I'll guarantee $75,000 in principal. The alternative is for the lender to take my property and sue on the guarantee and maybe get $35,000. We've seen 40 or 50 deals like that."Richard Gaudet, a principal with Atlanta-based GlassRatner, says part of the reason for the lack of bulk-loan sales was that buyers' expectation of yield was not realistic, making deals difficult. Buyers who want a 20%-plus return are asking banks, who have to answer to stockholders, to sell at an extraordinary loss. "When you start seeing mid-teen returns, such as we're seeing now," he says, "you're going to see the non-government sellers enter the market. A bank targets an 18% return on equity. It doesn't make sense at 25%. We're seeing increased traffic, there have been a few regional banks that are doing bulk sales and others that want to step into the market."

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