by RUSHI SHAH
Hotel owners are knock-ing on capital sources’ doors asking for help as they struggle to make payments and navigate the ongo-ing ramifications of the COVID-19 pandemic. At the same time, they are looking to lawmakers and government executives to intervene and create guidelines for CMBS lenders, private market lenders, banks, credit unions and other financial institutions to offer some sort of relief. As an immediate gesture of support, most community banks, regional banks, local banks, credit unions, and other local financial institutions have stepped forward and provided hotel owners with 90 days of initial forbear-ance or some sort of payment deferral. Additionally, government-controlled entities such as the Small Business Administration (SBA) were able to move quickly and provide up to six months of principal and interest payments. However, CMBS lenders have been unable to offer borrower’s blanket relief. This is due to the very nature of the CMBS loan. Let’s examine why.
MORAL HAZARD AND PROTECTING ALL INVESTORS
CMBS loans are pooled together, packaged, and sold as bonds to investors. A single CMBS loan may be chopped up and sold to 14 differ-ent investors, where one investor group is charged with controlling the financial decisions surrounding the loan. Known as the controlling class, this group has a fiduciary responsibility to the other investors, or the non-controlling class. As a result, the controlling-class inves-tors do not have the authority to simply stop collecting or making payments across the board. The group must collect and distribute payments because the trustee that holds the loan is obligated to make the monthly payments to all the investors of a bond. If the con-trolling class failed to collect the payments from the borrower of the CMBS, this breach would be viewed as abuse of control and likely lead to litigation from the other investors.
Enter the Special Servicer. Nominated by the controlling class investors, Special Servicers can provide acceptable relief to borrowers and are actively reviewing the influx of CMBS borrower requests in earnest to try to work out fair and sustainable solutions. Their efforts are augmented by the combined pressure from lobby groups such as AAHOA, the America Hotel & Lodging Association (AHLA), and the International Council of Shopping Centers (ICSC), who have banded together to convince the Federal Reserve and other government offi-cials to devise creative ways to alleviate hotel owner pain. Additionally, these loans are governed by strict contracts between the lenders and the borrowers. By intervening, some argue the government could potentially create moral hazard and defeat the principles of con-tract law.
THE RELIEF CONTINUUM
The following solutions have been deemed reasonable and seem to be acceptable for both the controlling and non-controlling class of investors and are being offered by the Special Servicers to CMBS loan holders. Some relief measures are more temporary, while others can be considered more permanent in nature. Either way, when discussing restructuring with a Servicer or Special Servicer, it is critical that borrowers do not admit any sort of intent to default. Instead, borrowers must strike a balance between providing too optimistic or too pessimistic projections to protect their negotiating position.
SHORT-TERM OPTIONS
The majority of hotel CMBS loans are 10-year terms with 25- to 30-year amortizations. Two short-term solutions are on the table for most hotel owners that have suffered from COVID-19-triggered shutdowns. The first is a 90-day forbearance where no payments are collected for 90 days. Once the grace period is over, the skipped payments are due in full or the hotel owner may move into some sort of a pay-ment plan. Hotel owners with healthy FF&E reserves may qualify for the second type of temporary relief, where the Special Servicer al-lows the borrower to divert a portion of accumulated reserve funds toward the property’s debt service. Both options appear to only be available to borrowers whose hotels are still performing, who have continued to make their payments, and who are not in default when they ask for assistance.
MODERATE-TERM OPTIONS
Another popular option Special Servicers are offering is six months to 12 months of forbearance. Under this restructuring strategy, a Special Servicer will defer payments for up to a year. At the end of the forbearance period, the non-paid principal and interest is either added to the end balloon payment due at maturity or a cash-management mechanism is put in place. With the cash-management ap-proach, after the six months to 12 months, the excess cash flow after paying regular expenses and debt service is applied toward the deferred loan payments. While this interim solution can help borrowers get through these challenging times, it also requires them to present a full historic cash flow analysis as well as projected cash flow analysis.
LONGER-TERM OPTIONS
There is another more sustainable and long-term restructuring solution for CMBS borrowers. In this work out scenario, the Special Ser-vicer divides the borrower’s loan into two pieces: an A-note and a B-note. Although this solution is more difficult to negotiate, it pro-vides the most long-term relief if successful. For example, if a $10-million CMBS loan is taken in for restructuring, the Special Servicer will re-underwrite the deal to determine the asset’s long-term cash flow generation and then right size the loan to that amount. In this example, the original $10-million loan may work at $8 million. As a result, the payments from the amortizing existing loan are moved to an $8 million interest-only loan, or the A-note. The remaining $2 million balance, the B-note, would be restructured as a preferred equity note at a higher interest rate, typically upwards of 8 percent. The B-note is only paid if a certain performance hurdle is met. For example, if in four years the hotel starts operating a maximum capacity and is throwing off more cash flow than what is needed to service the A-note, the B-note also will get paid at the higher interest rate. But in the event the asset does not perform, the B-note will not need to be paid.
This type of restructuring is a rare solution but can be possible with the right intermediary. Lenders are willing to take this approach and assume the risk because they have re-valued the asset and believe the amount of the total mortgage is above the asset’s current value. So, if a lender were to foreclose and sell the asset in the market, they would incur this amount of loss anyway. In the majority of successful A- and B-note restructurings, the borrower also must bring additional equity to the table in order to demonstrate his or her commitment to the asset. This type of restructuring also provides the owners with an opportunity for a discounted payoff in the future.
For example, we are working with one of our CMBS clients who owns a suffering resort property in North Carolina that relies predominantly on group business. We’ve signed him up with our newly formed restructuring advisors partnership to divide the existing $23-million loan into an $18-million A-note and a $5-million B-note in the form of preferred equity. The borrower brought in half a million dollars as interest reserve to the service the A-note for the next 12 months. Once successful, this restructuring will allow our client to continue the long-standing tradition of holding this asset in his family trust for the next 10 years as he has for the past 30 years.
Regardless of which form of restructuring may be available to a borrower, research has shown the chances of a successful outcome are improved when hotel owners engage an experienced restructuring advisor who has pre-existing relationships with the Special Servicers.
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.
