Your loan is coming due: What now?
By Tony Petosa and Nick Bertino
As the credit crunch continues, lending options for
commercial real estate, including manufactured home communities, have become
increasingly scarce. Conduit loans are still not being originated, life
companies are lending on a highly selective basis, traditional banks are
experiencing financial challenges causing them to pursue new loans only at
lower leverage levels, if at all, and the agencies (Fannie Mae and Freddie
Mac) have become more selective. Adding to this problem of lack of
available capital is one sobering fact: a lot of commercial real estate
loans will be maturing in the coming years.
Over the past decade commercial real estate owners
enjoyed some of the most favorable lending programs ever experienced.
Aggressive underwriting parameters, low interest rates, and a bounty of
lenders hungry for volume all factored in to borrowers being able to obtain
attractive loans on their properties. In today's credit market, many of
these lenders and loan structures simply don't exist, and many borrowers
will face difficulties in refinancing their properties in the coming years.
Examples of properties that will face financing challenges include
properties located in secondary and tertiary markets; properties that have
experienced flat or declining occupancy and cash flow streams in recent
years; and properties financed at high leverage levels with minimal
amortization and loan terms of 5 years or less. Properties that will mirror
the problems suffered by the local and regional economies present
corresponding problems for refinancing. Does your property fit any of the
characteristics described above? The answer may bring you to another
question: "What happens if I can't refinance or pay off my loan when it
comes due?"
Even if you are current on your loan payments, you will
be in "monetary default" if you cannot pay off your loan balance when the
loan matures. As a first step, we recommend that you dust off and review
the loan documents (particularly the promissory note, deed of trust/mortgage
and guaranty) from your current loan. At the outset, you should at a
minimum have a clear understanding of the following topics:
-
Is Your Loan a Conduit Loan? This is a vital
fact that must be determined at the outset. Conduit loans have typical
features, and are much more difficult to modify. Balance sheet
(non-conduit) loans potentially present greater flexibility as
your loan approaches maturity.
-
Maturity and Default. Do you have a specific
"balloon" maturity date versus a fully amortizing loan term that may
have periodic interest rate adjustments? If your loan was a conduit
loan, it is possible that it has "hyperamortizing" features that
essentially provide an automatic "workout" once the "anticipated
repayment date" (essentially what would have been the maturity date if
this feature was not added) has passed. However, in any event, if your
loan has matured, it is likely to be accelerated unless you can work
something out with your lender.
-
What is Your "Default Interest Rate"? Most
commonly, when a loan goes into default, the current interest rate will
adjust to the "default" interest rate. This is typically the lesser of
the current interest rate plus an additional margin (often 4%-5%)
or the maximum interest rate allowable by law. The bottom line is that
the interest rate you will be charged when your loan is in default will
be substantially higher than what your rate had been throughout the loan
term. To put this in perspective, imagine that five years ago you
obtained a $5 million conduit loan at 80% loan-to-value amortized over
30 years with a 6% fixed interest rate. During those five years, the
cash flow of your property was flat. You try to refinance your property
at loan maturity, but because underwriting parameters are now more
conservative and because your property has not increased in value, you
are unable to obtain a new loan for your property, and the loan goes
into monetary default. Your interest rate would then adjust to 11%. If
the lender doesn't accelerate the loan balance, and you are permitted to
continue monthly payments, in this particular circumstance the default
rate alone would increase your monthly loan payment by more than
$17,000. As you can see, the purpose of implementing the default
interest rate is to motivate the property owner to refinance or pay off
the loan.
-
Personal Liability. This issue may strongly
shape your course of action. Was your loan made on a recourse or
non-recourse basis? Are you a carveout guarantor or fully or partially
responsible for repayment of the loan indebtedness? These are extremely
important facts to ascertain. Recourse loans (for which the guarantors
are fully liable for repayment of the entire loan) are typically
non-conduit and made by banks when the loan is to be held on its balance
sheet. Nonrecourse loans are made with limited and specific "carveouts",
and virtually all conduit loans follow this pattern. For a nonrecourse
loan, the lender agrees to look only to your property for repayment,
except: (i) for losses it may sustain for
certain "bad boy" acts, such as fraud, diversion of rents or insurance
proceeds, waste and environmental conditions; and (ii) for your
full liability for the entire loan in the event of bankruptcy,
an unpermitted transfer of the property or equity interests in the
borrower, or violations of loan covenants that assure the lender that
your borrowing entity will remain a "single purpose, bankruptcy remote
entity". If you are only a "carveout" guarantor on a nonrecourse loan,
be absolutely certain that you don't do anything (unless you determine
that to be the best course of action, on balance) that will trigger that
full (springing) personal liability and be aware of what the scope of
your "carveout" liability will be for losses and damages as well.
-
Is There a Prepayment Penalty/Premium?
Payment of your loan prior to maturity almost always carries with it a
prepayment penalty or premium (there is no practical difference in the
term used). For conduit loans, this typically takes the form of
"defeasance" or "yield maintenance." Defeasance is a complicated and
costly process that involves assembly of a basket of U.S. Treasury
securities to replace your property as security, and for which you will
require an expert to put the pieces together. Yield maintenance
premiums (measuring the loss of yield over a U.S. Treasury security, as
if your prepayment proceeds were to only be invested in such a security,
but typically never less than 1% of your prepayment) are determined by
your lender, are far less complicated, and don't require outside experts
and their related fees. Other loans (most often bank balance sheet
loans) may require a "stepped prepayment premium" or a fixed percentage
of the prepaid amount. In short, know what is required, and determine
the impact against your available capital and refinancing proceeds.
-
Is There an Open Prepayment Window? If you do
decide you are going to pay your existing loan off prior to its
maturity, check your loan documents in further detail to determine
whether there is an open prepay window, as well as whether there are any
restrictions pertaining to what day of the month you will need to pay
off your loan. For conduit loans, as well as many bank balance sheet
loans, the "window" is the last 3 months (some longer, some shorter)
prior to maturity when the loan can be prepaid without a prepayment
penalty. In additional, some loan documents may require that the loan
be paid off on the first or last day of the month, or you will be
charged the full month of interest for the month in which the loan is
paid off. If you are processing a new loan, you will want your new
lender to be aware of this so that you avoid paying double interest
during that month. Additionally, your existing loan documents may
require that you give the existing lender written notice of at least
30-60 days prior to paying off you loan. Again, this is a point you
should be aware of if you are processing a new loan.
Even if your existing loan does not mature for another
12-24 months, it is only prudent, and strongly recommended, to start
exploring your options for refinancing now. Remember, lenders hate
surprises, so you should manage the expectations of your current lender. If
your loan is a balance sheet (not a conduit) loan, you may have greater
flexibility in working directly with that lender to extend the term of your
loan prior to hitting the wall at maturity, although this will most likely
require full personal liability if that is not already the case. If you
have a conduit loan, be aware that loan modifications cannot typically be
made unless the loan is in default. This presents material issues to
working something out and virtually assures that you'll have to be on the
"brink" in order to do so. Thus, for a conduit loan in this environment,
you cannot begin looking too soon for refinancing alternatives and setting
realistic goals in that regard.
If an extension is offered to your loan, request a
written outline of any additional items the lender may require to grant the
loan extension. You may find, for example, that the lender will require a
partial pay down, shorter amortization, full recourse, an extension fee
and/or re-setting of the interest rate as part of the loan extension.
In this economic environment it is critical to understand
your specific loan terms and any default risks they may pose so you can plan
accordingly. The "friendly banker" you knew five years ago may not be the
one you will be dealing with tomorrow. Please feel free to give us a call
to discuss your particular situation.
Tony Petosa is Senior Vice President and Nick Bertino
is Vice President of Wells Fargo Commercial Mortgage. They specialize in
arranging financing on manufactured home communities, offering both direct
and correspondent lending programs. If you would like to receive future
newsletters from Petosa and Bertino, or would like to receive a copy of
their Manufactured Home Community Financing Handbook, they can be reached at
760/438-2153; 760/438-8710 fax; and via email:
tpetosa@wellsfargo.com and
nick.bertino@wellsfargo.com. You can also visit their website at
www.wellsfargo.com/mhc. Special thanks to Jim Simpson, Principal with
the law firm of Miller Canfield, for his contribution to this article.
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