If you are unfortunate enough to have a loan backed by a currently out-of-favor asset class such as an older office building, weak or unanchored retail center or a conference hotel maturing in the next 12 months, you may be facing some difficult choices.
The first half of 2022 witnessed an economy going strong, with unemployment at record lows. People were venturing back to bars and movie theaters; airports were crowded; and the boss was telling you to come back to the office (at least a few days per week). The second half of 2022 is painting a different picture, and the Federal Reserve is clearly saying, in no uncertain terms, that interest rates are going to continue to rise. Meanwhile, your lender is telling you to remove your loan from their balance sheet.
What’s up with my bank?
Is this just bad timing for a CRE loan maturity, or is it the start of a longer recession? The Fed has applied quantitative tightening so that the supply chain catches up and to curb inflation, but collateral damage will undoubtedly be felt in commercial real estate values. Will everything go back to “normal” once the Fed is satisfied that inflation is under control? Will the banks call and ask for new loans on these out-of-favor properties? Will these assets be repurposed?
The answer is yes, kind of, maybe, but the bigger nagging question is: when?
Banks are in an interesting position right now. They are well capitalized, had a record first half of 2022, and appear to be positioned to handle an economic downturn. However, now they are demanding borrowers remove maturing loans from their balance sheets. Will they act on this? Aren’t these the same lenders that fought so hard to get the lending relationship? And why is the bank limiting access to their balance sheet when borrowers most need their help?
The truth is the lender is not your partner. They are your lender and in business for themselves. Harsh reality, but true.
It’s not all their fault, kind of…
Banks are currently facing more scrutiny by the government to ensure their financial strength during this period of economic uncertainty. They are being criticized and forced to take increased reserves for marginal commercial real estate loans.This makes the risk and credit folks at the banks unhappy, so they start to look at other marginal commercial real estate loans and relationships that have been underperforming. They are applying pressure to have those loans removed from their balance sheet portfolios.
And the competition is doing the same. Banks move in tandem. Letting one of their largest borrowers know that they are closed for any new lending after the summer for “at least 90 days” and saying “We’ll let you know” when they are back open is not healthy for retaining good clients.
Now comes the interesting part of the bank as a business. The banks have an open balance sheet for the stronger clients with liquidity and deposits. Why not start to replace lower coupon loans with weaker sponsors and property types with higher coupons for more preferred property types? Makes good business sense once the lending spigot reopens.
First step, talk to your lender
So where does this leave the CRE borrower with a pending loan maturity? A bit stranded for the time being.
Breathe. These are strange times. First, come to grips that the lenders are in the power position and that fighting them may be futile. Second, understand your asset’s value in the current market and determine whether it is worth fighting to save. Third, if you want to keep the asset, then have a business plan for possible scenarios and be prepared to execute on all of them. Then, approach the bank with a thoughtful plan that addresses the lender’s concerns.
This means bringing money to the table for an extension, modification or loan terms, or a discounted payoff, if possible. Negotiating terms with a CMBS servicer is more difficult as there are layers of decision makers within a CMBS bond. In addition, limiting the time the loan is in special servicing is important to save on expensive servicing fees.
In my experience, clients achieve the most success when they are proactive with the lender. Communicating property performance, competitive position in the market and a thoughtful business plan enables the borrower to get a read on the lender’s stance if they are willing to negotiate new terms.
Dialogue with the lender needs to start at least six months prior to loan maturity. As the markets and regulations are constantly shifting, being in constant communication with the lender can provide clarity on which direction to move.
One thing is certain: Doing nothing is not an option.
Michael Cohen is managing partner at Brighton Capital Advisors, a CMBS advisory firm.