Sometimes, commercial property owners run into difficulty. When that happens, the lender has a decision to make: Foreclose early – potentially forcing the borrower into bankruptcy – or work with the borrower to get the loan back on track.  

Lenders can’t be pushovers. But there are times when foreclosing outright doesn’t make sense, and the loan will go to the workout desk. This process gives commercial landlords and business owners an alternative to foreclosure, bankruptcy restructuring, or outright liquidation. 

Technical vs. Monetary Defaults

You don’t have to miss a payment to be in default on a commercial loan or mortgage. You can also be in default by failing to meet the conditions or covenants in the loan. These types of defaults are called technical defaults, and they can come in many forms. Here are some of the most common: 

• The borrower fails to maintain adequate liquid reserves
• The borrower takes on additional senior debt without the lender’s approval
• The borrower improperly sells the collateral, or fails to maintain it
• The borrower fails to maintain adequate insurance
• The borrower fails to provide the required financial statements and reporting 
• The borrower fails to clear bankruptcy on schedule (in a debtor-in-possession financing situation) 
• The borrower defaults on another loan

Sometimes there’s nothing for the lender to do but to foreclose – or accept a deed in lieu of foreclosure.

But most often, it’s better for both parties to go through a workout process. The idea is to modify the terms of the loan to recognize the new economic and logistical realities and avoid a foreclosure which nobody wants – while still protecting the lender against taking a major loss on the loan.

Depending on the circumstances, borrowers may negotiate with lenders any of the following measures: 

• A reduction or temporary suspension of payments. This typically involves an extension of the loan term, or a commitment to a higher loan payment later. 
• A delayed maturity date or balloon payment due date
• Waiving the reserve requirement, allowing the borrower to use reserves to make a debt payment
• Waiving other covenants
• A reduced interest rate
• A reduction of principal (sometimes called a cramdown)
• Waiver of lockbox or cash trap requirements
• An extension pending the sale of property in lieu of foreclosure
• An extension pending the acquisition of the owner

Private equity creditors and private lenders tend to have much more flexibility to work with borrowers than traditional bank lenders. Traditional bank lenders must strictly adhere to regulations that restrict their available workout options. 

Know Your Lender

Ultimately, the workout solutions available to you will depend on your lender. Every lender has different ownership expectations, shareholder/bondholder expectations, relationship interests, and regulatory pressures.

If you have multiple business relationships with your lender, and your lender has a reasonable expectation of profitable future engagements with you and your company if they can help you get past some near-term difficulties, and if you’ve been acting in good faith, they will usually be willing to work with you.

Bank Lenders

Normally, bank lenders have very different workout policies than non-bank lenders. Banks are heavily regulated, and they need to adhere to strict capital requirements. However, regulatory agencies have softened their stance pursuant to the COVID-19 pandemic. Federal regulators now view prudent workout arrangements with borrowers affected by the Pandemic as positive actions that can lead to improved loan performance and reduced credit risk.

As of this writing, federal regulators have announced they will not criticize institutions for ‘prudent loan modifications.’ The overall policy goal is to ensure lenders continue to take measures to effectively mitigate or manage adverse impacts on borrowers affected by the COVID pandemic. 

For the time being, bank lenders may be more willing and able to work with you than in past years, prior to the Pandemic. However, this could change as we emerge from the Pandemic and the regulatory environment changes back to one of tighter scrutiny.

If you expect your company to go through difficulties in the coming months, that’s yet another reason to be proactive in seeking a workout arrangement. Regulatory guidance could change, and your banking industry creditors may have less flexibility in the future. 

Non-Bank Lenders

Traditionally, non-bank lenders (private equity firms and commercial mortgage lenders) have had more flexibility when it comes to workout provisions than bank lenders. They aren’t beholden to the same regulators, and have more leeway to work with troubled borrowers. While bank lenders now have more room to work with you than prior to the Pandemic, these non-bank lenders can also potentially modify your loan in a variety of ways to help avoid default, foreclosure, and/or bankruptcy. 

You may get less flexibility from senior debt lenders, private equity mezzanine lenders, and bridge lenders. 

Collateralized mortgage-backed securities (CMBS) lenders tend to be less flexible than any of the above. This is because their critical relationships aren’t with borrowers like you at all, but with their bondholders.

If your loan has been collateralized and sold in a package to CMBS investors, they’ll almost always assign defaults and workouts to a special servicer. CMBS lenders are usually quicker to foreclose. CMBS fund managers don’t have the same relationship interest with you as your hometown bank or your industry-specialist non-bank lender does.

Fees

You can expect to pay extra in fees for special services, especially in the CMBS world.

With CMBS situations, your account will usually get transferred to a special servicer. This usually means higher fees. But they also usually have the authority to provide more substantial relief than the frontline loan servicing people.  

Best Practices

With that in mind, here are our best tips for executives looking to navigate a cash crunch looming ahead: 

• Be proactive. Go to the lender earlier rather than later. You will have more flexibility if you’re current on the loan. 

• Look ahead. Do a detailed cash flow analysis for the next 12-24 months. Look carefully at your debt payment due dates, ordinary seasonality variations, effects of possible recessions, and other likely contingencies. Can you manage? If you think you’ll be in trouble, reach out to your lender now. The worst thing you can do is to blindside your lender with a financial default or bankruptcy filing. 

• Align your interests. Show your lender you have skin in the game. Demonstrate your commitment. Put in your own capital. If you and the other equity owners recently took a dividend or distribution of income, put it back in the company. Lenders will remind you that they aren’t equity partners with you. But they will be more willing to provide relief to borrowers who go to their own capital first, and act with an ownership mentality. 

• Don’t stop paying insurance premiums. Adequate insurance is a typical condition on commercial loans. If you drop your insurance, you could wind up in a technical default. If you breach any guarantees or covenants on the loan, get busy curing them.

• Don’t tap security deposits to pay operating expenses. This is a major red flag for lenders, normally a violation of loan covenants, and possibly illegal. It exposes you to litigation risk, and exposes your lenders to additional risk, too. 

• Know what you need. Crunch your numbers and have a good idea what your shortfall is going to be. You have a better shot at a successful workout if you know what to ask for.

• Be cooperative, rather than adversarial. Keep your relationship at the businessperson level, not the lawyer level. This means communicate early and often with your lender. If you fail to do this, your lender will be much quicker to engage lawyers, who often have recourse to significant actions. For example, if they get wind that you’ve been moving money out of the business even as you file for bankruptcy, they can trigger a lockbox, or they can petition the court and potentially lock down your business bank accounts, so that nothing leaves it without their authorization. 

Don’t Go It Alone. 

It’s important to go through the workout process with experienced professionals in their corner. Many distressed commercial borrowers can spend weeks or months just trying to find out who to talk to in a large lending organization. And then they are completely blind when it comes to ascertaining what workout options are even available. 

Put Experience On Your Side Of The Table

Attorneys are great at crafting and interpreting legal documents. They don’t always have a big Rolodex of workout desk contacts at specific lenders. And unless they have specific lending experience themselves, they aren’t necessarily good at presenting your commercial loan workout request in a form that the lender is likely to approve.

At Reid Lending Partners, we’ve been through it all with our clients. Contact us today to help you negotiate a commercial loan solution with your lenders. Depending on your circumstances, we can also help you with any of the following:

• Pre-default or post-default negotiations;
• Negotiating a commercial debt;
• Refinance at a potentially lower interest rate, longer terms;
• Line up “debtor-in-possession” financing that enables firms going through bankruptcy to stay in operation.
• Unlock liquidity in other forms of possible collateral to help you through a short-term crunch. 

If you’re having difficulties with one or more commercial loan, and expect you’ll need a workout, don’t wait. Contact us today to begin the workout process.