Views from the Frontlines – the Current State of Debt Financing

Every passing month seems to bring with it a new set of “market making” events that consistently catapults the deal and debt financing economy in a new direction. Nonetheless, there are certain trends that the JMBM attorneys on the “financing frontlines” see repeatedly, and this fall seemed as good a time as any to convey them. By sharing these points, we hope to better prepare our friends, colleagues and clients for navigating through the current debt and restructuring markets, in preparation for the months and quarters that lie ahead.

1. Traditional Lenders are Still Largely Retrenching, and Financing Options May Be Narrowing. For anyone who has sought out new debt financing in the past year, it will come as no surprise that traditional institutional lenders have been on a retrenching track for quite some time. This is forcing borrowers to consider new sources, which will often be much more expensive than traditional lenders. The change is creating a wealth of opportunity for alternative and credit fund lenders looking to increase market share, and has served as an entry point for new lending entrants. We expect that the institutional lending market will continue to remain constrained for some time, forcing a greater need for creativity to work around already jolted markets. Even so, alternative financing sources have also shown an increasing need to scrutinize opportunities, which may result in complications for borrowers. In the coming months, borrowers and lenders alike will be well served in leveraging professional networks, regardless of which way interest rates turn, as a key resource towards finding needed capital and investment opportunities.
2. Even Small Covenant Defaults Now Matter. Gone are the days where a default is easily overlooked or corrected and merely requires a friendly call to the bank relationship manager to fix. Many companies are struggling due to micro and macro-economic headwinds, and much of private equity is equally strained to float portfolio companies, as well as manage their own leverage in some cases. What seemed like minor infractions on a credit even six months ago is requiring tremendous hurdles to overcome now. Borrowers will need to remain vigilant on their covenants and continue a dialogue with their lenders. Lenders, in turn, will need to tread carefully in working through borrower challenges. In both cases, care will need to be taken in addressing developing issues upfront, particularly to avoid triggering defaults or foregoing unintended leverage points later down the road.
3. Bankruptcy is An Expensive Yet Increasingly Utilized Tool. The world of the “Great Recession” is a lifetime ago for many, and fewer and fewer feet on the ground have seen a bankruptcy, restructuring or workout market. That said, “Chapter 22’s” and even traditional first-time bankruptcies seem to be, even ever so slightly, on the rise. In this environment, an understanding of bankruptcy and its leverage points can be a critical game-changer for borrowers, lenders and creditors caught in between. Moreover, creative non-bankruptcy alternatives, such as ABCs, foreclosures and workouts, are increasingly being sought or employed to level out the playing field. Parties who shirk on utilizing professional help in this area may find themselves in traps for the unwary that could have significant monetary consequences.
4. Office Vacancies May Bring Real Estate Opportunities. The landscape of hospitality and real estate has been evolving since the aftermath of the COVID-19 pandemic, ushering in a complex blend of outcomes. The repercussions continue to reverberate, with office properties witnessing the most substantial impact, suffering an approximate 25% decline in values since 2022. Retail malls follow closely, with pricing down by 19% since 2022 and a staggering 44% since 2016. These declines can be attributed to factors such as overleveraged debt, the shift towards hybrid work, tenant migration, corporate downsizing, and substantial capital expenditure requirements. Unlike previous cyclical downturns, the current scenario exhibits a nuanced pattern, varying significantly based on specific circumstances, markets, and asset classes. Office vacancies are on the rise, exacerbating the challenges faced by this sector. This will undoubtedly necessitate further forbearances, workouts and, where available, refinancing options.
5. Hospitality Continues to Show Varying Signs of Distress and Opportunity. Hotels are overall faring better than their commercial real estate brethren, but this is market by market, sector by sector and case by case. No one story fits all – other than that hotels have also felt the significant rise in interest rate spreads. But unlike other real estate classes, hotels change rates daily, and resort post-covid travel is hot with room rates expected to rise as much as 8.8% over the next 18 months. For the next few years, hotels will likely be able to push up ADR both strategically and opportunistically as demand rises faster than supply. The main question is by how much. While there are certainly opportunities for investors, there are also plenty of land mines. This is not the post-2008 market bottoming out, where all values will escalate from here. At least not yet. Investor mirages abound. Today, fortune favors more than just the brave. Investors, owners and lenders in this space need tremendous experience, knowledge and a well thought-out business plan, and are highly cautioned to accept nothing less regardless of how apparent the opportunity.

The financing landscape is consistently shifting, and will likely remain turbulent in the months ahead. Yet the current slate of financing issues are complex and riddled with potential and consequential mistakes, which require knowledge and expertise to navigate. With a broad array of professionals – particularly in the debt financing, restructuring, hospitality and real estate space – the attorneys at JMBM are ideally situated to provide practical, streamlined and relevant advice in all these areas. We welcome any inquiry or question at your convenience, and we are happy to lend our thoughtful approach.

Authors:

Marianne Martin is a Commercial and Corporate Finance partner in JMBM’s Corporate practice. Having executed debt financing transactions of collectively nearly $1 billion over the past several years, having been engaged in restructuring and financing transactions of collectively well over several billion throughout her career, Marianne is known as a commercial confidante who can really “cut to the chase” in complicated situations. Her niche practice includes private equity and alternative lending, distressed and specialty financing, private credit, syndicated and acquisition financing and real estate financing, for both borrowers and lenders, and bankruptcy and restructuring situations, including in the hospitality industry.

Ben Young is a partner in JMBM’s Bankruptcy Group, which is recognized by U.S. News & World Report / Best Law Firms® with a Metropolitan First-Tier Ranking (San Francisco) for Bankruptcy Litigation and Bankruptcy and Creditor Rights/Insolvency and Reorganization Law. He represents parties in insolvency matters and has extensive experience in workouts, restructurings, bankruptcies, and assignments for the benefit of creditors. His clients include lenders, financial institutions, secured and unsecured creditors, distressed investment funds, businesses, receivers, special servicers, and creditors’ committees.

Guy Maisnik has over four decades of commercial real estate transactions with a strong expertise in hotels and finance. A partner and Vice Chair of the JMBM Global Hospitality Group®, Guy is a senior member of the JMBM Chinese Investment Group, and a partner in the JMBM Real Estate Department. Guy advises clients on hospitality transactions, with both a practical business and legal focus, representing buyers, sellers, lenders, opportunity funds, special servicers, REITs and developers in hotel transactions, joint ventures, hotel management agreements and franchise agreements, buying, selling and ground leasing of hotels, hotel management companies, and complex mixed used development, fractional and timeshare structuring.

This update is provided to our clients, business associates and friends for informational purposes only. Legal advice should be based on your specific situation and provided by a qualified attorney.