Six Questions on the $33B Signature Bank Loan Portfolio

Tom Galli, a partner at Duane Morris, represented more bidders on loan portfolios sold by the FDIC than perhaps any other lawyer in this country.  He talked with GlobeSt.com about loan portfolio sales, including the $33 billion Signature real estate loan portfolio being marketed by the FDIC.

Why should real estate industry participants pay attention to the Signature Bank loan portfolio transactions and other FDIC structured transactions if they otherwise have no interest in investing in them?

Galli:  The Signature Bank loan portfolio includes $33 Billion of commercial real estate and multi-family loans which will be offered in separate pools.  Those transactions will be among the largest of the year.  With the recent relative stabilization of interest rates for new loans, pricing on pools in the Signature Bank portfolio will provide measures for property valuations by the most sophisticated investors in real estate.  

The fundamental elements of the FDIC’s structured transactions on loans portfolios are being vetted by investors, banks and other real estate industry participants for the purpose of replicating some of those elements in sales by banks and others.  During the last six months, I have received an increasing number of calls to discuss transaction structures for investment in loan portfolios owned by banks on terms similar to those for the FDIC’s structured transactions program.

How much work have you handled for clients on loan portfolios in structured transactions with the FDIC?

Galli:  During the last recession, I represented different private equity funds to close on billions of dollars of commercial real estate loan portfolios in FDIC structured transactions, including awarded bidders in a run of 10 out of the last 18 such loan portfolio transactions then executed by the FDIC.  I am not aware of any other lawyer or law firm which represented more than one awarded bidder on these transactions.  Colleagues and I have also represented investors on the acquisition of billions more in loan portfolios from banks.  Following closings, we handed legal work on asset management for loans in those portfolios.  Through our platform of offices across the U.S. and a variety of practice areas related to the real estate industry, we are serving as a consolidated source of legal services for geographically disbursed loan portfolios.  We do so through teams in each of the states in which we have offices, with those teams having a balance of talent ranging from paralegals to mid-level associates to senior partners, and including a combination of attorneys in our real estate, bankruptcy, litigation, tax, environmental opportunity zones, ESG and related practice groups.

How are investors approaching underwriting for bids on portfolios?

Galli:  One of the most challenging aspects of bidding on non-performing portfolios is controlling the cost of due diligence to support underwriting.  Modeling is more appropriate for small balance non-performing portfolios.  For other non-performing portfolios, bidders are taking advantage of a program I developed to significantly reduce legal fees for due diligence efforts.  That program offers clients a competitive advantage in the bid process as it offers them the opportunity to share in our fees for work on diligence (which limits dead deal cost for unsuccessful bidders and can be significant on large portfolios), and thereby permits them to engage in more extensive diligence to verify the existence of risk or the lack of risk.  By verifying the lack of risk in a particular portfolio, a client is able to increase its bid amount (substantially reducing or eliminating the discount otherwise associated with a lack of diligence) and, therefore, increase the likelihood of that clients’ success on a bid.  This program is a winner for all in the process – our clients, sellers and brokers who are usually compensated based on the amount of the winning bid on a sale.

Why have you invested so much time in developing a knowledge base and network of relationships to assist clients on transactions for loan portfolios with the FDIC?

Galli:  Successful attorneys must develop business plans which address continuously changing market dynamics.  To do so, one must envision coming waves of business opportunities and ways in which we may bring value to clients.  In order to envision those new business opportunities, one needs to well understand the capabilities of a law firm and how those capabilities may best be used to serve clients.  In 2009, I came up with a five-phase business plan to capitalize on opportunities I believed would become available with distressed real estate assets.  That business plan required analysis of where markets were likely going (or not), how markets would mature (or not), the strength of competitors and a practical approach to seeking out and executing on new business opportunities.  The FDIC’s structured transactions program was the first phase, among five, of that plan.  I continue that approach to date.

In 2009 and as appears to have occurred now, I expected the FDIC would be the first opportunity for the acquisition of any meaningful volume of distressed assets, as there would be a significant bid-ask spread for distressed assets among private sector parties.  My focus on FDIC structured transactions was not only for the prospect of executing on those transactions, but also the prospect of representing clients on the acquisition of loan portfolios from banks and others and handling work on the asset management and servicing of those portfolios.  The next waves of loan portfolio acquisition opportunities will soon reach shore and continue for some time thereafter.  Additionally, as structured transactions with the FDIC are partnerships between the public and private sectors, those transactions also provided an opportunity to raise the profile of our firm’s brand on public private partnership transactions.  I expect the volume of those transactions will be significant as the capital markets recover and double-digit returns are generally no longer available on distressed real estate assets.  As government entities (federal, state, and local) are largely tapped out on their capacities to borrow, they will turn to the private sector for funding solutions on their real estate requirements.  Through that volume of experience and the spectrum of practice areas available in our firm which are required to effectively represent clients on public private partnerships, I am very confident about the volume of opportunities available for us in this space.

What trends do you expect to occur over the next two years on the sale of loan portfolios?

Galli:  Based on what occurred during prior economic downturns, I expect, a number of trends.  First, the substantial majority of loan portfolios which will first come to market will be small balance portfolios.  Small balance loan portfolios are usually marketed through auction platforms, while portfolios with modest and large balance loans are usually marketed through large brokerage firms.  Second, we will see an increasing number of portfolios bid through an indicative bid process, rather than an absolute auction process.  This gives bidders the opportunity to delay due diligence and related costs until a later round in the process to which a limited number of others is invited.  Third, we will see teaming arrangements among investors bidding on geographically dispersed NPL portfolios secured by a variety of real estate properties, with different investors in the group focused on loans secured by real estate assets on which they have expertise and in the regions on which they focus.  Fourth, bidding will become increasingly competitive on all portfolios as hundreds of billions of dollars available for investment remain undeployed and in search of acquisition opportunities.  Fifth, financing will become increasingly used to acquire loan portfolios in an effort to reduce investors’ average cost of capital and increase bid amounts.  While acquisition financing has largely been limited to modest and large average principal balance loan portfolios, investors will search for financing options for small balance portfolios as bidding becomes more competitive.

How do you see loan portfolio sales evolving over the next two years?

Galli:  I expect a number of developments in this space.  First, the turmoil in capital markets which occurred over the last 8 months, increased the volume of non-performing and sub-performing loans, and therefore their values.  That caused a delay in marketing efforts for the volume of those loans.  Now that interest rates appear to have stabilized, banks and other owners of loans will begin to market them for sale as values are more readily determinable.  The volume of those portfolios will be split between off-market transactions to which a limited population of bidders is invited, and portfolios that are marketed through auction platforms and brokers.  Second, as banks increasingly realize profits, they will be able to absorb losses from write-downs on loan portfolios they elect to sell and, therefore, be able to sell more loans.  Third, we will begin to see banks take pages out of the FDIC’s playbook for the sale of non-performing loan portfolios by offering take-back financing, retaining “upside” on loan portfolios in the form of equity kickers, and entering into joint ventures for non-performing loan portfolios.  Fourth, as investors are seeking to deploy hundreds of billions of dollars in real estate opportunities and a relatively modest volume of opportunities are available, investors continue to reduce return requirements.  Lower return requirements will result in higher prices paid for assets.  Fifth, we will see increasing availability of financing for the acquisition of loan portfolios with large average loan balances.  We are hearing about increased interest by banks and other sources to provide financing for the acquisition of small loan balance loan portfolios.  Sixth, pricing will continue to trend upward as (i) investors’ return requirements continue to trend down, (ii) acquisition financing for loan portfolios becomes increasingly available, and (iii) the capital markets recover.