The Hospitality Borrowers' Approach to the CMBS Work-out Dilemma
By Marc Stephen Shuster, Partner, Berger Singerman
Co-authored with Brian Rich, Partner, Berger Singerman, LLP
Many hotel owners and developers of multi-family projects are starting to see the value of their assets start to increase. Many of these owners have been hanging on for the past several years, managing the operations, and diligently working to enhance the value of the property and net-operating income. Just as values may be turning the corner, however, many developers who financed their projects through Commercial Mortgage-Backed Security ("CMBS") loans are likely going to be faced with a significant dilemma as their loans mature in the near future.
CMBS loans are a common form of commercial loan often utilized by developers of hospitality projects. The mortgages that were originated to finance these projects are sold to entities that package the loans into a security which is then sold to investors. CMBS loans account for approximately 25% of the total commercial real estate debt market. Numerous reports and studies indicate that there will be a wave of CMBS loan maturities in the next 2 to 5 years. Many of these loans were originated prior to the real-estate bubble bursting and, accordingly, many of these loans will not qualify for refinancing absent a significant capital contribution from the borrowers. The primary hurdle for a refinance is the decline in the value of the collateral securing the loan. Thus, the loan-to-value ratio that existed when the loan was originated is radically different in today's environment, even with values starting to increase.
Thus, the developer that has successfully completed the project, and has worked to weather the economic storm that many believe has now passed, may still be at risk of losing the project. This may seem counterintuitive at time when many borrowers are seeing numerous CMBS loan opportunities for new projects, particularly in the hospitality sector, but there remains a significant distinction between the underwriting requirements for loans that are being originated now versus loans that were originated in 2007. Additionally, the proposition that a significant number of these maturing CMBS loans, in the hotel space, will fail to be refinanced is a notion that is not met with universal agreement. Robert Barron, former Chairman of the Board of the Greater Fort Lauderdale Chamber of Commerce, and a partner at Berger Singerman, says, "On one hand, we're experiencing a hospitality boom. On the other hand, there will always be a measure of unpredictability with any sector that has a tendency to rise and fall along with the economy. With nearly $115 billion in CMBS loans coming due in 2016, a prudent borrower should at least consider the worst case scenario, evaluate its alternatives, and plan accordingly." Regrettably, when a borrower is facing the imminent maturity of its CMBS loan, the options presented to that borrower can be rather daunting.
Obviously, the best option would be to satisfy the loan at maturity. This option, however, in most instances, is not a viable alternative for the borrower. Either the borrower does not have sufficient capital to satisfy the loan, or a sale transaction that will satisfy the loan is not viable due to the decline in the value of the collateral. The next best alternative would be a refinance, especially considering today's favorable interest rate environment. But, once again, with property values and more stringent underwriting requirements, a refinance will typically require a significant cash infusion from a borrower - one that may not have the necessary financial capacity to provide such cash infusion. If either of these two alternatives does not exist, what options remain to assist a borrower facing the maturity of its CMBS loan?
In many instances, the borrower can seek to negotiate a forbearance agreement with the lender which will modify or extend the term of the loan. This option may provide the best alternative for the lender and the borrower. As set forth above, collateral values appear to be on the rise and additional time may allow for a traditional refinance or sale of the property on more favorable terms. The difficulty with respect to this type of work-out with a CMBS lender is that the securitization agreements may not allow for the extension of the term of the loan.
If the lender is unwilling or unable to modify the terms of the loan through a forbearance agreement, the borrower may seek to negotiate a deed-in-lieu of foreclosure. This option would allow the lender to obtain its collateral, and if the loan was a "non-recourse" loan, then the borrower would have no further liability on it. This option, while allowing a borrower to walk away from the transaction, does not allow the borrower the opportunity to reap the benefits from its investment of both time and money. Additionally, as values are increasing, a borrower may not wish to walk away from the project that is on the cusp of being profitable. Finally, if the loan is a recourse loan, this option may result in a deficiency for the borrower and any guarantors.
Another option available to the borrower and the lender is a "short-sale" or discounted payoff ("DPO"). Under these scenarios, the borrower, with the lender's approval, can sell the collateral or pay the lender an amount less than the debt, in exchange for a release. Once again, whether or not the loan is recourse or non-recourse will have an impact on the viability of these alternatives. Additionally, the traditional CMBS loans may not allow for a short-sale or DPO as the impact on the underlying investors is usually detrimental.
If the loan matures and it remains unsatisfied or if the borrower defaults, the lender may seek to enforce its remedies through traditional litigation and foreclosure processes. In this instance, depending on the laws of the state where the collateral resides, the process could move very quickly, or it could stall in the court system for months or years. If a borrower has certain defenses that it could assert, the litigation delay could be longer. The expense associated with litigation will need to be considered, as will the time that may be afforded to a borrower to seek other refinance or sale strategies during the pendency of the litigation. There is also the risk that the lender could seek to appoint a receiver and displace the owner from its management role.
Finally, Chapter 11 can provide the borrower with the ability to restructure the loan in a court-supervised environment. Through a chapter 11 plan, a borrower can seek to restructure the term and interest rate of the loan. This process could allow for a three-to-seven year term at favorable interest rates. Chapter 11 is not without risk and expense, however. Traditional Chapter 11 restructuring cases have been on the decline for many reasons; including the cost and risk associated with the process. Many non-recourse CMBS loans also contain "bad-boy" carve-outs, which impose personal liability on the guarantors in the event of a Chapter 11 filing. The contents of these guaranties have migrated over the years to include both "true bad actions" and other items of liability that are not triggered by a bad action by the borrower or the guarantor; they are simply risk allocations to the guarantor (i.e. non-payment of insurance premiums or ad valorem taxes). All of these factors need to be considered when determining if Chapter 11 is a viable option for a borrower.
[As an aside, it has now become more prevalent than ever for the principal of the sponsor for the borrower to be required to provide a "bad boy" carve-out guaranty in connection with a CMBS loan. Guarantors of CMBS loans must carefully review the terms of the guaranty to understand the implications of any action or inaction that may occur in connection with the loan that is in default. Finally, the borrower should be aware that the interests of the borrower, the limited partners, and the CMBS guarantors usually present serious conflict issues and liability risks among those three parties.]
Some percentage of hotel and multi-family project owners, in the coming years, will find themselves unable to pay back or refinance maturing CMBS loans that were originated prior to the real estate bubble bursting. Each of the five principal options we detail above has its pluses and minuses, and not every option is applicable to every deal. Only by weighing the pros and cons of each of their available alternatives, will hotel owners ensure that they are taking the most promising, and least painful, route for their particular circumstances. Cyrus Sharp, Senior Managing Director with GlassRatner Advisory & Capital Group LLC, recommends that owners come up with an action plan and begin to evaluate options sooner, rather than later, as "So many borrowers wait until the last minute, and often it is too late."
The flip side is for owners to view this as a cautionary tale, and not find themselves in the same position in 2019 or 2024. This scenario should guide the evaluation of the fine print of new CMBS loans into which they are entering, and the negotiation of the most favorable terms, should history repeat itself in five or ten years.
Brian Rich is resident in Berger Singerman's Tallahassee office. His practice includes representation of debtors, creditors' committees, bankruptcy trustees and secured creditors. Mr. Rich has been the firm's primary bankruptcy counsel in numerous complex Chapter 11 cases. He has represented such companies as AT&T Latin America, Aloha Airlines, and Pharmed Group as debtor counsel. Mr. Rich has focused on hospitality matters throughout his career and has represented numerous hotels and restaurants in work-outs and Chapter 11 cases, throughout Florida and around the country. Specifically, Mr. Rich was lead counsel representing the Roney Palace Hotel and condominium on Miami Beach. In that case, the historic property was sold for approximately $154 million. Mr. Rich was the lead bankruptcy attorney for the Berger Singerman team that represented Pittsburgh Grand LLC, one of the largest unsecured creditors of the former Pittsburgh Hilton Hotel. The Berger Singerman team defeated attempts by the senior secured lender to gain control of the property, obtained the equity in the Hotel, and eventually confirmed a Plan of Reorganization to restructure the Hotel's debt in a hotly contested bankruptcy transaction and case with over $60 million in debt. Mr. Rich has represented numerous hotel owners, ranging from independent operators to nationally flagged owners, in real estate "work-outs," out-of-court restructurings, and healthy sale transactions. He has also represented bankruptcy trustees in numerous fraud-related cases seeking recovery for victims of "ponzi schemes" and real estate fraud. Mr. Rich is listed in Chambers & Partners USA, America's Leading Business Lawyers in Bankruptcy/Restructuring and in Florida's Super Lawyers. Mr. Rich is a member of the Board of Directors, Immediate Past President, of the Northern District of Florida Bankruptcy Bar Association and the American Bankruptcy Institute. Mr. Rich received his law degree from University of Miami School of Law and his undergraduate degree from Temple University. Mr. Rich can be reached at Brich@bergersingerman.com or 850- 521-6725.
Marc Stephen Shuster is a partner in the Miami office of Berger Singerman, Florida’s business law firm. Mr. Shuster is a business attorney with extensive experience in commercial real estate transactions, both healthy and distressed, and corporate M&A deal work, with an emphasis on the hotel and hospitality industry. He advises both traditional hospitality conglomerates and Internet advertising sites serving the industry. Mr. Shuster he has served as counsel to a Florida-based emergency management/services conglomerate in negotiating for disaster relief work throughout the Caribbean. Mr. Shuster speaks and writes on novel issues affecting the hotel and hospitality space, serves on various community boards, and has been recognized with numerous awards and accolades. Mr. Shuster can be contacted at 305-982-4080 or firstname.lastname@example.org Extended Bio...
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