United States: Note Sale Expansion: Its Source And Implications (Part One Of Three-Part Series)

As intangible pieces of personal property, promissory notes are freely assignable in most instances, aside from contractual limitations. There has historically been a market for note sales in the realm of real estate. Today, however, there exists a market for the sale of various types of notes. In recent years, not only banks, but hedge funds began to consistently make loans, which were in turn bought and sold to third parties. This expansion of note sales has led to complications regarding what party possesses the right to enforce, and thus sue on the note or foreclose against the maker-mortgagor. Many investors and financial advisors now encourage individuals and entities to participate in note transactions. While note sales present numerous benefits, they also encompass risks which require evaluation by buyers and sellers. Both parties should seek capable legal assistance when entering into a note sale agreement, due to complexities that can arise in such arrangements.

This three-part E-Alert will describe the relatively recent expansion of note sales and discuss its implications. This week's E-Alert will explain the reasons why note sales have expanded. Part II will describe the basics of  note sales and how transfer of the note and management occurs. Finally, Part III will discuss the recently issued OCC bulletin regarding the transfer of notes and mortgage loans.

Various opportunities may be realized pursuant to the acquisition and sale of promissory notes. For lenders, note sales are a means of disposing of distressed loans and recouping losses without having to endure the often timely and expensive process of foreclosure. For buyers, note sales often present an opportunity to acquire promissory notes—or the underlying secured property—at a discounted price.

According to some, "There has arguably never been a better environment for the opportunistic acquisition of real estate assets than the one that exists now."1  This ideal environment is the result of several factors, namely the Great Recession of 2008. In the years during and following the Recession, "The volume or purchase and sale of performing and non-performing real estate loans . . . picked up dramatically" as banks sought to "shrink their balance sheets" due to decrease in capital base, and investors sought to take advantage of these failing banks selling their assets.2

The growth of note sales continues today for multiple reasons. First, there remains a surplus of under-performing and non-performing notes. According to the acting commissioner of the FHA, its "inventory of REO properties available for sale is at its lowest level since FY 2009. At the same time, the inventory of seriously delinquent loans is near an all-time high."3

Second, lenders have realized that note sales are more beneficial than enduring the time and cost involved in foreclosure proceedings. As noted by industry leaders, "[W]hen faced with non-performing loans, lenders often prefer to sell the note rather than go through the foreclosure process for a variety of practical and financial reasons."4 Note sales are quicker and allow lenders to avoid paying insurance and real estate taxes on the foreclosed property. They also allow lenders to remain outside the chain of title, thus avoiding costly environmental regulations and other associated risks.

And third, government entities have shifted their focus from foreclosures to note sales, arguably because they believe note sales assist the "consumer and housing market more efficiently."5 According to the FHA Commissioner, "With many neighborhoods still fighting to recover from the housing crisis, going upstream will allow us to help more borrowers before they go through foreclosure . . . ."6 The HUD Secretary has also asserted, "With this program, we will increase by as much as ten times the number of loans available for purchase, while making it easier for borrowers to avoid foreclosure. Finding ways to bring these loans out of default not only helps the borrower, but helps the entire neighborhood avoid the disinvestment and decline in value that accompanies a distressed property."7

Due to the foregoing reasons, note sales have become a pervasive and integral part of our economic system. While these transactions cannot be avoided to a certain extent and pose several benefits, they should be fully understood by potential participants. Next week, Part II of the series will focus on the basics of  note sales and how transfer of the note and management occurs.


1. Jeffrey J. Porter & Jeff Mosteller, Real Estate Note Purchases, SettlePou Blog (Mar. 7, 2012), http://blog.settlepou.com/real-estate-note-purchases/; see also Joe Varnadore, Non-Performing Note Sales Outnumber Foreclosure Sales, Baltimore REIA (Jan. 10, 2014), http://www.baltimorereia.com/nonperforming-note-sales-outnumber-foreclosure-sales/ ("The note business is now the hottest topic in all of real estate and for good reason.").

2. The Buying and Selling of Distressed Notes, Bryan Cave LLP (Aug. 5, 2009), http://www.bryancave.com.

3. See Varnadore, supra note 1 (quoting Carol Galante, FHA Commissioner).

4. Id. (quoting Charlie Brake of Hartman Simons, an Atlanta-based Commercial Real Estate Law Firm).

5. Id.

6. Id.

7. Id. (quoting Shaun Donovan, HUD Secretary).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Elizabeth Lee Thompson
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