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Law360 (June 11, 2020, 6:11 PM EDT )
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| Katherine Amador |
The economy and, in turn, real estate investors and borrowers are not looking much better than when this mess started. Lenders that provided a short payment deferral period to their borrowers should not be surprised when borrowers cannot simply pick up where they left off in February and continue making regularly scheduled payments, much less meet required financial and collateral ratios.
Sure, the reality is no one knows what the real estate industry will look like after the coronavirus droplets settle. As states ease up on stay-at-home restrictions in an effort to reopen and return to normal, we are all wondering what will normal now look like? Loosening of restrictions while there is no vaccine available means social distancing rules will likely stay in place.
People may be hesitant to resume normal activities, such as shopping at a mall, seeing a movie at a movie theater, or even eating in a restaurant. The impact of social distancing for retailers and businesses that focus on hospitality may mean limiting the number of customers in the business at one time. Will businesses be able to remain open and cover their expenses while operating at reduced capacity? For many businesses, sadly, the likelihood is no.
So, ready or not, lenders should start pursuing multiple options with borrowers now, including:
- Review your loan portfolio to assess status and identify loans that will likely be problematic based on the business industry. Contact the borrower to request financial information as well as financial projections. If there is a sustainable business plan, and the bank is willing to ride it out for a bit longer, contact legal counsel to assist in the preparation of prenegotiation letters, extension of deferral periods, loan modifications or forbearance agreements.
- Closely monitor the main thing that allows a borrower to service its debt — cash flow. Be on the lookout for factors that currently are or will continue in the future to negatively impact a borrower's cash flow such as a continuing decline in sales, decreasing profit margins, a slowdown in receivables and the inability to turn inventory quickly.
- Consider any opportunities to better position yourself in a problematic loan by increasing a borrower's interest rate, seeking additional guarantors or collateral, or bringing on a participant to share the risk. Also, subject to the terms of the loan documentation, a lender can implement the straightforward approach and advise a borrower that it has worn out its welcome and needs to move the banking relationship along.
- Get familiar with the collateral securing their loans, including property values, outstanding liens, carrying costs and any priority judgments against borrowers or guarantors. Assuming a lender takes possession of any real property serving as collateral, or ultimately acquires title to the property in a foreclosure proceeding, a lender should fully understand the costs associated with carrying the property.
- Factors such as amounts due in outstanding property taxes or code violations imposed by applicable governmental agencies, costs of insurance premiums necessary to obtain coverage from natural disasters and protect lenders from liability, and costs associated with renovating the real property to secure and protect the property from damage should be carefully considered as these factors require lenders to incur out of pocket costs which would add insult to injury in the case of a poorly performed loan.
- Factors such as amounts due in outstanding property taxes or code violations imposed by applicable governmental agencies, costs of insurance premiums necessary to obtain coverage from natural disasters and protect lenders from liability, and costs associated with renovating the real property to secure and protect the property from damage should be carefully considered as these factors require lenders to incur out of pocket costs which would add insult to injury in the case of a poorly performed loan.
- Understand the foreclosure process, including the timing of the process and potential costs involved in foreclosure litigation. Anticipate a backlog in the court system that will likely cause delays. Lenders may recall the backlog in the court system from the 2007 recession. The court's foreclosure calendars were often full and numerous foreclosure judges were added to the bench solely to handle foreclosure matters. Florida has an expedited foreclosure statute — learn about it. It may be the best tool in your arsenal.
- Explore potential options to collect on your collateral, other than what may be a timely and costly foreclosure action. For example, depending on the status of title and the presence of any potential liens that would need to be otherwise extinguished in a foreclosure action, a deed in lieu of foreclosure could be a preferred option as it would stop a borrower from dragging its feet through the foreclosure calendar slough.
- Build up your bankruptcy knowhow and get familiar with the requirements for filing relief seeking the lift of automatic stays. Many experts are predicting a record number of bankruptcies in 2020. Whether it is personal bankruptcy or corporate, bankruptcy filings are expected to surpass the number of filings we saw in the 2007 recession. Many borrowers will consider a Chapter 11 as a strategy play, as a business can continue to operate, and does not need to be insolvent to file, while potentially reducing debt and seeking the termination of expensive contracts.
- Although a Chapter 11 may be used by a borrower as a strategy play, reports and studies indicate that approximately 15% of Chapter 11 cases result in successful reorganizations. Most cases are converted to Chapter 7 liquidations or dismissed. In the meantime, however, lenders often find themselves along for the ride, so learning the ropes — and more important, learning how to get off the ropes — is key.
Certainly, while being prepared for disruption in the commercial market is always good advice, there is additional good news for lenders: History doesn't always repeat itself. Many lenders learned the hard way in the 2007 recession as their risky portfolios took a nosedive due to factors such as aggressive underwriting and high concentration of certain types of lending or certain types of borrowers.
When the dust settled, lenders, many unfortunately with the assistance of the Federal Deposit Insurance Corporation, took a hard look at their loan portfolios and modified their lending practices, which, in turn, placed lenders in a better position to handle volatility in the future — like now.
Additionally, lenders will likely enjoy another lifeline — interest rates are low and there are significant amounts of investors with hungry appetites to acquire distressed real estate. Already, investors are allocating billions of dollars in distressed real estate funds to position themselves for opportunity, and fund managers are raising large dollar amounts at inconceivable speeds, with some funds reporting the need to turn investors away.
The market is active and investors are familiar with the effects of a recession, which for most investors, means opportunity. For lenders, this type of activity will ultimately bring a positive result. Either the borrower will break out of its coronavirus lockdown cocoon successfully, or investors will be interested in seizing the opportunity — either possibility means a lender could quickly break out from the confines of a problematic loan.
In the end, many are holding out hope that the reopening of businesses will bring relief to the business and the economy in general. While that may be true, the ramifications to the economy and the real estate market will be felt for a long time. Many scientists claim what we have experienced so far is only the tip of the iceberg. Lenders should prepare for the long haul as borrowers try to manage the situation created by this pandemic and figure out how best to emerge from the coronavirus lockdown cocoon in near future as a monarch butterfly.
Katherine Amador is a partner at Berger Singerman LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the organization, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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