March 04, 2009
By Joel Ross

Over the next year or two many of you will find that you are in default on your loan. Either there will be a maturity that you cannot refinance, or you will not have the cash flow to pay full debt service on time. There is almost certainty that most of you will be in some sort of technical default in the next two years.

Most lenders and servicers have few, if any, staff qualified to deal with defaults of the magnitude and nature of what is happening. There were hardly any defaults in commercial real estate during the past 10 years, so the staff tends to be young and not always the sharpest people. In addition, under commercial mortgage-backed security rules, servicers can face the potential of a lawsuit if they do anything that bondholders consider detrimental to their economic interest, so the servicers prefer to do nothing.

Lenders who held the loans on book also have no workout people who know anything, so they have been shifting their remaining loan officers and underwriters to workouts. Loan officers are salesmen. Underwriters are youngsters with no real-world experience or lending experience. There are few grown-ups handling the problems. In addition, the lenders are now swamped with defaults and are under-staffed, so only emergency cases get attention.

Add to this the fact that some lenders are having their lines called and so they have their own issues to deal with.  That can force them to do things that don’t add up to the right answer. For example, instead of a workout and restructure of the loan, they may call or foreclose to get cash to repay their own lines that are being called.

Write again, call again, keep a log

I recommend that you go to your lender or servicer now and try to get his or her attention to talk to you. That is extremely hard since the servicer does not want to talk to you because he’s afraid he will say something that will get him in trouble. The portfolio lender is likely to be so buried in already-defaulted loans that he doesn’t want to know about you. If this happens, start sending letters saying that you foresee problems arising with the economic decline and you want to meet to discuss a plan to avoid future default and foreclosure actions. Chances are you will not hear back. Write again, call again, keep a log. Have a suggested workout plan ready. Paper the file. You want to try to get things worked out before they blow up, but if the lender will not work with you, then you have a file for the judge to show you tried everything and he should not grant summary judgment in a foreclosure or other action. You need to always be the good guy.

All my lender friends have told me if they consider a borrower to have been a good borrower and a loyal customer they will workout the loan if they can. If you are considered a bad borrower and to have lied, you are toast. Their attitude is you lied before so now everything you say is a lie, so there is no sense trying to work with you.

If you do get into a workout negotiation make sure you get a qualified advisor and a lawyer who really knows workouts and loan documents. Just because someone is a lawyer or maybe did your loan docs originally, does not mean they know anything about workouts. They usually do not. You need the gray hairs that did it in the early ‘90s and lawyers and advisors who understand real estate mortgage investment conduits (REMICs) and collateralized debt obligations (CDOs). You also need someone who really knows how to deal with lenders and servicers. General practice attorneys do not.

Everyone in the lending world knows that appraisals today are worthless and that they can often lead to more problems than they solve. There are several high-profile cases right now where the appraisals are absurd and have led to major litigation.

Lenders at odds

The next issue is warring lenders. If you have a larger loan issued from 2005-2008, there is a high probability it has a mezzanine piece. There may be syndicated portions of the senior loan and layers of mezz. You are now dealing with multiple lenders with differing agendas, which can greatly complicate resolving problems. The mezz is likely a lender who is possibly going out of business himself, so he does not want a foreclosure. The most senior holder is money good, so he may just want to foreclose. This can mean long delays, legal costs and bad solutions. You need very good advisors and lawyers here as well.

Getting a one-year extension—the most allowed in most CMBS docs—does you no good. Your hotel is just going to do much worse as the year goes on, so you will be in even worse shape a year later. You need to have a three- year fix, not one year, and it needs to assume that you will not be able to meet required debt service for at least two years or more. CMBS docs make this hard to do. You will not be able to refinance at the existing level of debt you have for several years, if ever. Those items need to be renegotiated now.

Assess value

Be very realistic about the new, severely reduced value of your property. Assume it is worth 40 percent less than what it was when you bought or built it if that fell from 2005-2008. If you reject this thought you will only fool yourself and delay the day you will be in serious problems. Maybe in three years the value will rise again to a discount of only 30 percent, but that is not how you need to go into the workout. Assume the worst and protect yourself, or you may be feeding a dying patient only to lose it all later—far better to be surprised on the upside than the downside.

In many cases it might be best to offer up the keys now. Probably the lender does not want them. That is when you can hopefully negotiate a loan reduction and rate reduction and maybe a partial debt-for-equity swap. If you are highly leveraged now you will never be able to repay the loan, even in three years, so make a deal now that you can refi in three years. The lender is going to demand you invest more cash equity. You can count on that. Plead poverty. Trade an equity piece to the lender for a receivables line, or maybe the right to use FF&E reserves for working capital. There are a variety of ways to work the deal, but go in assuming Armageddon--and not that all will be OK soon.  It will not be.

Now is the time to act, not when the default notices appear.