It comes as a surprise to many commercial borrowers and lenders that they can be one another’s best allies in a successful workout. Where the commercial borrower has an investment of both hard work and money to preserve, the banker has a loan to collect. Working together, borrower and lender can often find common ground that results in a successful turnaround for both. The third installment of my Urban Land Institute article, “What to Do Before Defaulting,” discusses ways that a commercial borrower can work with its lender to avoid losing the property to foreclosure. Workout professionals often use these tried and true techniques to make sure that their troubled borrowers know what the bank needs to forbear rather than to foreclose.
Work with the Lender to Avoid Foreclosure
Owners should put themselves in the position of the lender. In the lender’s eyes, the building does not produce adequate cash flow to service the debt and maintain building operations at an acceptable level. The lender’s only realistic move is to foreclose and acquire the building.
If the owner has a nonrecourse loan, the lender usually has no choice but to foreclose. Most lenders do not want to foreclose because they realize they will face the same problems as the owner, only the lender, not being in the real estate business, does not know the building as well as the owner does.
The owner should consider the value he or she can add to the lender to help bridge the gap during these difficult times. Most studies indicate that the real estate industry is in for at least two or three years of difficulty. How can the lender protect its investment and, at the same time, allow the owner to protect its own investment?
The lender will demand additional fees, additional interest, attorneys’ fees, other professional fees, new appraisals, and perhaps other consultant fees. The owner should resist as many of these as possible; if cash is in short supply, the owner will not have the money to pay those fees upfront, maintain and operate the building, and service the debt. The best way for the owner to minimize these external fees is to come prepared and offer the lender a thoughtful alternative to foreclosure.
The owner should set up a meeting with the lender and come armed with all the knowledge that can be mustered about the building, its tenants, the local marketplace, the financial marketplace, and the lender’s situation. The best workouts start with an open dialogue between borrower and lender. There is no reason to hide facts about the operation of the building: chances are it would perform well if this were even an average marketplace, but in this difficult market, it, like hundreds of other buildings, has been hit hard.
The owner should present the facts as they are to the lender, providing the best estimate for the months and years going forward. Owners should resist the temptation to project revenue increases that take the shape of a hockey stick–a sharp increase after a flat period. The lender will know the owner did not spend the necessary time carefully projecting future revenues if the projections show an unwarranted steep increase in revenue.
The owner’s goal is to convince the lender that his or her ownership adds value to the building. Otherwise, there are building managers looking for business, and the lender can simply foreclose and replace the owner with one of the many companies looking to operate the building.
The lender wants to avoid foreclosure as much as the owner does because it results in a loss for both parties–for the lender, the loss of any opportunity to recoup the money loaned. Interest income has gone by the wayside, and the expense of capitalizing and operating the building will fall squarely on the shoulders of a foreclosing lender. The lender will try to cut off the bleeding by selling the property as soon as possible. But in today’s market, a quick sale may not be possible, so the lender must come to understand that it may be operating the building, possibly at a loss, for many months or years to come.
A thoughtful presentation by the owner can offer the lender hope, just as the lender offers the building owner hope. While the owner needs to talk to the lender about forgiving or restructuring payments, it also is important that the owner explain what can be done to direct some cash flow to the lender in the early years to give the lender an opportunity to be made whole toward the end of the loan. The owner should make certain that any payment restructuring plan entered now will be realistic tomorrow–in short, that a deal made today will not result in default a year from now.
The owner should ask the lender to keep the interest rate low and try to determine the lender’s cost of funds to obtain a clue regarding an acceptable interest rate. Although it may not be possible if valuations have dropped dramatically, the owner should try to find a way to restructure the loan so it becomes or could become a performing loan.
The owner also should try to determine whether there is additional collateral that might be offered to the lender. In some cases, there may be other real estate that can be offered, although in the case of special purpose entities, it can be extremely difficult to find additional collateral that can be offered.
Lenders may ask for guaranties of the debt, but the owner should consider the ramifications of offering a personal guaranty. Is the owner really willing to risk other assets in order to save the investment in the property? If the owner cannot truly answer yes to that question, he or she should tell the lender no as soon as the issue is raised and be prepared to defend that response.
This is Dick Rogan, bank lawyer and author of www.SpecialAssetsLawyer.com, signing off for now. Join us again soon to check out what’s new in the World of Workouts.
Year after year, day after day, workout professionals in the know rely on JMBM’s Special Assets Team™ to handle problem commercial and real estate loans. Whatever problem loans you have, chances are, we’ve seen it. Give us a call.
Our Perspective. JMBM represents commercial banks, special servicers, private lenders, asset-based lenders, hard money lenders and factors. We help lender clients throughout the United States craft business and legal solutions to their commercial and real estate troubled loans. For more information, please contact Dick Rogan at RRogan@JMBM.com, or (415) 398-8080.
Richard A. Rogan is Chair of the JMBM Special Assets Team™. He also serves as the co-managing partner of JMBM’s San Francisco office and co-chair of its Bankruptcy Practice Group.
JMBM’s Special Assets Team™ has represented hundreds of lenders in California and throughout the United States. We regularly appear in bankruptcy courts, district courts and superior courts. We are proud to serve as trusted counsel and advisors who look for a business solution and try to help lenders find the best possible resolution for each troubled loan. Whether a loan is being newly documented, restructured or litigated, JMBM’s Special Assets Team™ has the skill, know-how and experience to solve your problem in a practical no-nonsense way.
NOTE TO CONSUMERS: As a matter of Firm policy, JMBM does not represent individual consumers who have disputes with their lenders. Many lenders have specialized consumer workout professionals who have the time to help consumer borrowers. There are many fine attorneys who specialize in representing consumers. Individuals with consumer lending problems should contact a lawyer or law firm who specializes in consumer insolvency and bankruptcy in their local area. When in doubt, we suggest you contact your local bar association’s Lawyer Referral Service. [For example, see Bar Association of SF or LA County Bar Association Lawyer Referral Services]
JMBM does not provide legal advice to consumers, and cannot respond to consumer inquiries.