Acceptance by commercial real estate lenders of a partial payment in full satisfaction of the loan (as a “discounted payoff” – a “DPO”), prior to the maturity of the loan, is a topic that receives little “public” attention.
Here are a few reasons why we hear so little about this topic, and the challenges in actually paying off a commercial real estate loan at a discount (prior to maturity):
- Confidentiality: many payoff agreements require the borrower and the purchaser (if different from the borrower) to NOT disclose the payoff
- Segmented lender market: not all lenders are alike (life company; CMBS servicer; bank; mortgage REIT; etc.), and each type of lender has different regulatory constraints. So, there is no “one size fits all.” And, even within each lender type, each lender has its own balance sheet, loan allocation and credit policy limitations
- Debt stack: the existence of multiple debt layers, and a debt holder who might not be “happy” with the payoff amount offered to it. Complicated debt structures make a discounted payoff very, very difficult. Indeed, combine this point with the second point (the “wrong” lender), and . . . difficult can be impossible
A DPO could be a sound business decision for a lender. For example:
- Accepting less than full payment on the loan could be a better economic decision than incurring the costs in exercising remedies, and then owning, reviewing and managing property (often called real estate owned or “REO”)
- The loss incurred by the lender (by being paid less than the full loan amount under the DPO) is less than “loss” of capital caused by the loss reserve for a bad loan on its books (bad loans are also referred to as “impaired” loans). Impaired loans trigger increases in a capital reserves, which for some types of lenders (such as life insurance companies and the “mortgage experience adjustment factor” [or MEAF]) is an amount well in excess of the loan amount
- Impaired loans generate intensive management reviews (another cost)
- A DPO can close quickly and efficiently, typically much quicker than a deed in lieu of foreclosure
- If lender is in sound financial conditions, and already has recognized the loan loss, the quick loss inherent in the DPO is a non-event
In a future post, I’ll cover some of the details in a DPO.
If you have other thoughts or experiences in this, please comment below.