Insight Alert: Crisis-Era Loan Modifications – Part I
As COVID-19 ravages the economy, commercial real estate lenders and borrowers find themselves triaging real estate debt. CGS3 continues to work with our clients in negotiating numerous commercial real estate loan modifications, which gives us invaluable insight into the types of relief various lenders are willing to offer borrowers in these uncertain times.
Loan Workout Strategies
- In formulating a strategy to address loan workouts, it is important to consider the options available to borrowers and lenders, including loan modifications, use of reserve funds, note sales, short sales, discounted payoffs, receiverships, deeds in lieu of foreclosure, and foreclosures.
- At this point in the cycle, we are seeing a dramatic increase in loan modifications while other workout strategies are being shelved. Over the coming months, the CGS3 Distressed Assets Practice Team will provide more specific guidance on these other strategies, but this initial communication focuses on loan modifications.
Loan Modifications Involving Different Types of Loans
With any loan modification, distinguishing between the type of loan and lender involved is key. There are many different types of lenders in the lending market (e.g., life companies, pension funds, regional banks, national banks), but for the purposes of facilitating a loan modification, the industry distinguishes between two types of loans:
- Balance Sheet Loan — Held by the originating lender (or a loan purchaser) on its own balance sheet. Balance sheet loans are easier to modify because the lender itself owns the loan and, therefore, can more easily make decisions about the loan asset.
- Conduit Loan — Packaged with other real estate loans and securitized, with the securities sold on the open market to third-party investors (i.e., it is part of commercial mortgage-backed securities, or “CMBS”, and those loans are owned by investors instead of traditional lenders). Conduit loans are more challenging to modify because the owners of the loan are widely disbursed investors that own a pool of loans, rather than one specific distressed loan that needs to be modified.
How are conduit loans modified if there is no single investor?
- CMBS loans are governed by loan pooling and servicing agreements that rely on the appointment of a “master servicer” (who oversees the general administration of the loans in the pool) and a “special servicer” (who handles more unique situations – such as workouts).
- Master servicers lack authority to approve most all loan modifications; they generally can only approve simple, non-monetary or ministerial modifications (g., lease renewal issues or lockbox changes). Loan pooling and servicing agreements task special servicers with monetary and other complicated loan modifications.
- CMBS borrowers should first contact the master servicer to see if it can handle the relief sought. If not, the borrower will need the master servicer to transfer the loan to the special servicer.
- Such transfers typically occur only upon a loan default: If a default is imminent, the master servicer generally has the discretion to transfer the loan to the special servicer before an actual default.
- Since most borrowers prefer not to default simply to request a loan modification, they must convince the master servicer that a default is “imminent” – but before an actual default event – as a trigger to getting the loan transferred to special servicing.
- Requests to the master servicer for a transfer of an undefaulted loan to a special servicer typically take one of two forms:
- The first form is essentially a plea for help: the borrower suggests a default is imminent, but the borrower has a proposed, mutually beneficial solution that requires a loan modification which only the special servicer can grant.
- The second form is essentially a threat: the borrower demands a transfer to special servicing, or else the borrower will default.
Additional Considerations for Modifications to Conduit Loans
- At this point in the cycle, we generally recommend such requests to master servicers be in the form of a plea emphasizing the unforeseen circumstances surrounding COVID-19.
- Although this cycle feels and may actually be different, historically, a large percentage of borrowers seeking CMBS loan modifications do default on their loans before their loans are transferred to special servicing.
- While special servicers possess more discretion to make grant modifications, CMBS loan modifications are relatively rare, especially without “new money” being invested into the property.
Be sure to read Part II of our Crisis-Era Loan Modification Insight Alert, which discusses best practices for requesting a loan modification for either type of loan.
As always, please contact us should you need assistance navigating a loan workout or loan modification. Our Distressed Assets Practice Team is one of the most seasoned and experienced in Southern California. CGS3 is also one of the most active workout firms in the region, having worked out billions of dollars of commercial real estate debt. Even during the long economic expansion following the Great Recession, borrowers, lenders and special servicers trusted us with their loan workouts.
Additionally, our COVID-19 Legal Task Force – comprised of multi-disciplined attorneys with a wide range of expertise – is ready to assist you in developing a comprehensive and proactive response to these changes and other COVID-19-related issues affecting the commercial real estate industry.
CGS3 Insight Alerts are curated with you in mind. They deliver focused, relevant, and timely information on trending topics to our clients, colleagues, and others in the industry. Please note that they are intended for general informational purposes only, and should not be construed as legal advice for any specific situation. Always remember to contact an attorney to obtain advice with respect to a particular issue or problem