COVER STORY, APRIL 2010

DISTRESSED WORKOUT TIPS
Useful guidelines for borrowers considering loan workouts.
By John Burke, NorthMarq Capital

Burke

With most real estate markets bumping along the bottom of this recent cycle, the potential wave of loan troubles is becoming a reality. A period of declining operating fundamentals, widening cap rates and illiquidity in the real estate asset class have placed many borrowers and loans in uncertain circumstances.

Many borrowers will face tough decisions about whether to save their marginal deals and maintain their fragile capital relationships or let the asset go back to the lender. How the borrower, guarantor and its partners act during these difficult times is important to all capital providers and is a defining element of their industry reputation in the long term. Borrowers should study their loan documents and learn their obligations and responsibilities. Documents are full of potential surprises that could create unforeseen liabilities if the wrong decisions are made early in the process. In most cases, borrowers need to retain the services of an intermediary or lawyer to help properly evaluate their options. 

There are three main types of lender groups. The first group, representing two-thirds of the market, is comprised of portfolio lenders. This group tends to have a more hands-on and flexible process for understanding and dealing with restructuring troubled assets. Securitized mortgage lenders and special servicers comprise the second group. They have a more formalized and mechanical process that involves many parties and regulations. The last group is comprised of asset-based or hard money lenders. Their interests will likely be different than other lenders, since most participants in this arena follow the “loan to own” mantra and tend to be less amenable to working out distressed properties.

A lender’s overriding concern is whether its borrower is acting to preserve the collateral’s value. For most borrowers, this role reversal will require a total mindset change from “risk-taking, value-creating entrepreneur” to “frugal capital improvement preservationist.” The short-term integrity of the collateral becomes the focus. Strict expense and tenant management will have more relevance to lenders in workout situations than creative future reposition plans with uncertainty of execution. To be considered a sound asset manager, borrowers should make every attempt to keep the loan current, maintain the physical condition of the asset, and try to operate the property using sound management practices. Maximizing economic potential through leasing efforts, communicating with the lender and having an approved organized business plan is also very important.

The true challenge for a borrower is to be realistic about possible outcomes and understand that for successful negotiations to proceed, both parties will need to give and take concessions, so that both parties believe that despite the circumstances, their positions have been protected. Like most business situations, an organized, thoughtful and collaborative effort will generally yield the best results.

So far in this cycle, the market participants have shown creativity, restraint and a longer-term vision when dealing with workout issues. Leniency in the commercial banking arena, modifications to REMIC law and the lessons learned by our government in the RTC days all seem to have laid the foundation for the financial services industry to successfully navigate through what is likely to be a major upswing in workout activity. The depth and pace of workouts and restructures will be significantly impacted by the future shifts in market psychology from the fear of further asset value deterioration and the counter balancing expectations of future value appreciation. If the universe of real estate owners and lenders can absorb and defer the impact of the medium term collateral shortages present in the market, we have hope in avoiding the chaos some predict.  Only time will tell.

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