by RUSHI SHAH
As owners in one of the hardest-hit industries, many hoteliers who have enjoyed a long run of healthy growth are now scrambling to cover loan payments, support employees, and maintain operations. Even those able to wait out the current crisis will face uncertainty on when demand drivers will return to levels necessary to stabilize cash flow. Government programs can provide some relief to small businesses, including many hotel owners, but borrowers with loans through the Commercial Mortgage Backed Securities (CMBS) market face specific challenges as they navigate these unprecedented economic conditions.
CMBS IN UNCERTAIN TIMES
There are clear reasons why commercial real estate owners, including hoteliers, have turned to CMBS loans instead of bank and other conventional loans; the top driver being that they couldn’t get what they needed from their current lender. For example, CMBS loans have historically provided owners with the highest leverage loans at the lowest personal risk in the form of non-recourse. This scenario is equivalent to owning stock in a company and having a put option as an insurance policy. Savvy hotel owners have also used non-recourse CMBS loans to create liquidity for their personal balance sheets.
For most CMBS borrowers, however, this loan mechanism was chosen because it afforded low interest rates, longer fixed-rate terms, longer amortizations, and allowed them to pull tax-free cash out to use for growth and to distribute to their partners. This is similar to a corporation issuing bonds and then using the proceeds to execute stock buy backs.
CMBS has been proven to be an effective tool for calculated growth, allowing borrowers to continue to keep the upside with almost no downside. Post pandemic, however, no one knows if every borrower will only need three to six months to successfully weather the proverbial storm. This creates an ambiguous environment. The fact that many property values have already dropped or will fall below the CMBS loan amount only contributes to this ongoing uncertainty. This ambiguity is particularly problematic to CMBS loans because special servicers, who are appointed by the b-piece buyers and control any loan modifications, are wary about restructuring terms. For assets where the disruption due to the COVID-19 crisis is truly temporary and are therefore expected to bounce back and preserve value as countries re-open for business, special servicers may grant short-term relief through forbearance or deferment. As a result, it is critical for borrowers to understand the role and motivation of the master and special servicer before requesting any temporary concessions or permanent modifications.
Unlike bank loans that are kept on a balance sheet, CMBS loans are governed by securitization agreements. In exchange for non-recourse, long-term lower rates, higher leverage, and the ability to pull cash out, borrowers pledge to satisfy the loan in a predictable manner as outlined upfront in the loan documentation. To ensure this predictability, CMBS loans have strict servicing guidelines that are not at all flexible and involve multiple layers of decision-makers that each have their own incentives. This is somewhat done by design to prevent fraud and serve as checks and balances for the ultimate bond investors. Under normal circumstances, this setup works. In a time of wide-spread crisis, however, it can break down. And likely because of the potential political optics of the government bailing out Wall Street, there is no wholesale government action to provide relief for CMBS borrowers or bond investors. Borrowers remain at the mercy of the special servicers representing the b-piece buyers’ best interests.
Master servicers are borrowers’ primary contacts for day-to-day business. Their main role is to provide ongoing cashiering service and they have little control over the actual mechanics of the loan.
Subsequently, master servicers are not staffed to handle an influx of inquiries due to a mass event like the COVID-19 pandemic. Master servicers are currently inundated with requests from hotel owners with diverse situations and needs, making it extremely difficult to keep track. Some borrowers are asking for forbearance or deferment. Others want to reduce their principal balance or have reserves waived, while some want a lower interest rate, an interest-only period, or a combination of concessions. All of these requests are being made in the same timeframe, borrowers need answers now so they don’t miss payments, and the master servicers have to obtain consent from the special servicers to respond with any solutions. This also runs the clock because in order for the special servicer to grant a relief, it will need to take time to review the loan, the borrower history, the asset history, that particular market’s conditions, and the specific hotel’s data.
TEMPORARY RELIEF VS. LOAN MODIFICATIONS
Changes such as adjusting the principal payment schedule, making the loan interest-only, or taking principal reductions in the loan amount are considered substantial restructuring or modification of the loan and require that the loan be transferred into special servicing by the master servicer. They also typically carry additional fees for the borrower because the special servicer must re-underwrite the deal, re-appraise the property, and potentially re-inspect the asset from a structural and environmental standpoint to ensure the integrity and the quality are consistent with when the loan was originated. When the loan is in special servicing, there are likely other costs associated such as default interest, late charges, and/or modification fees.
A special servicer can authorize other forms of relief that do not require modification of the loan documents. These may include the ability to use FF&E and seasonality reserves toward loan payments. Typically, these concessions can be used for a temporary period and do not require the loan to be transferred to special servicing. Additionally, the special servicer may consent to temporarily halt the collection of reserves. B-piece buyers are discussing collaborating to create a fund to make loan payments on behalf of the borrowers on certain loans that are truly only temporarily disrupted. Implementing this program may not be feasible, however, as it would require a coordinated effort among all b-piece buyers and would require altering the special-purpose entity guidelines.
Borrowers seeking relief should communicate with their master servicer. However, they need to be extremely careful how they communicate and should engage an expert to guide them. Under CMBS loan documentation, if a master servicer has reason to believe that there will be an imminent default, they could move the loan into special servicing and the borrower will start incurring special-servicing fees.
The minute you tell them you won’t be able to make a payment they, will queue you for special servicing, whether you wanted to take that leap or not. In order to avoid automatically triggering this move, borrowers that are well-capitalized, have healthy reserves, or may be eligible for other options should not be overly pessimistic or imply that they are going to default in their communication to the master servicer. Borrowers should instead tell the master servicer that they are looking for temporary relief due to the COVID-19 crisis.
When requesting either temporary relief or a loan modification, borrowers will need to compare current and historical revenue for the same period, outline booking cancellations, and prove direct COVID-19-related impact. Borrowers also will need to demonstrate their willingness to manage out of this crisis and their intention to hold onto the asset for a long period of time. Arguments must be backed up with facts and data, and expert support can help.
PRE-PAYING A CMBS LOAN
Many CMBS borrowers are considering paying off their loans to avoid using their assets for non-payment default. Because interest rates are at historical lows, the cost of defeasance or yield maintenance to prepay the loan may be high. To help borrowers avoid these heavy pre-payment penalties, legal experts are lobbying to allow borrowers to pledge similar maturity investment-grade corporate or government-sponsored bonds as substitute collateral for the subject property. At first glance, this seems like a possible solution. Unfortunately, in the current market, there are few lenders who are willing to finance a hotel to take out the CMBS loan. Most banks or bonafide lenders aren’t financing hotel assets right now. Special servicers believe the substitution of collateral with risky bonds (other than Treasury bonds) increases the risk of the bond holders and is a cost-prohibitive proposition.
PAYCHECK PROTECTION PROGRAM CONSIDERATIONS
Many hotel owners are looking to take advantage of the Paycheck Protection Program (PPP) and other SBA relief loans offered under the CARES Act. SBA loans are sure to conflict with CMBS loan documents, which means servicer consent is required before putting one on. There are mixed feelings in the industry on whether PPP loans also conflict and require that same consent. Some people believe because PPP loans are unsecured, they do not present a conflict, while others argue that the PPP loan is being made to the entity that holds the CMBS loan and therefore could conflict. To avoid potential future fallout, it is best for borrowers to confirm consent with their master servicer in all instances.
Rushi Shah is principal and CEO of the commercial mortgage and real estate investment banking firm and AAHOA Club Blue Member Mag Mile Capital. As a leader in hospitality financing, Shah specializes in structuring and placing high-leverage, non-recourse bridge and permanent debt with cash out for full – and limited-service hotels nationwide. Since joining the firm’s predecessor, Aries Capital, in 2015, Shah has structured and closed hundreds of millions in financing for all property types. Shah has held previous positions at Northern Trust and has an MBA from the University of Chicago’s Booth School of Business.