By Hugo Dorta, Founder + Principal of Brickell Capital
The COVID19 pandemic has adversely affected almost every aspect of the economy. Undoubtedly, the epidemic's detrimental effects shall have negative consequences on private commercial lenders,banks, and borrowers' ability to make their mortgage payments. For example, with regards to the retail industry, private lenders should anticipate that as retail tenants face the inevitable economic difficulties of the pandemic, a liquidity crisis will jeopardize the landlord's (or borrower's) ability to meet their debt obligations. As housing tenants face a loss of employment and economic hardship, private lenders can reasonably expect rental defaults regarding the multifamily industry. These circumstances will impact a lender's decision regarding loan programs, underwriting, lending guidelines, loan workout alternatives, and resolutions.
During this crisis, the one question that repeatedly surfaces with banks and private commercial real estate lenders is how many loan applications deals are being processing ?… how will the bank (or private lender) assess unknown risks related tocovid-19 ? … how will the bank (or private lender) underwrite new loans under the current crisis ? … and how many loans have been approved to close ? … and whether the bank (or private lender) is obligated to close given the unforeseeable circumstances caused by the covid-19 pandemic.
From a private commercial mortgage lender perspective, a"loan pipeline" includes all loan deals for which a commitment letter(or a letter of intent) has been issued but for which closing conditions and closing date are still pending. Many loans have closing conditions that concern changes in economic conditions, such as the ones we are experiencing today. For example, a closing condition could state that the loan shall only close if the economic viability of a project or the borrower's financial status stays the same as on the date the private lender issued the loan commitment. Given the current uncertain situation and unforeseeable resolution of the crisis, the viability of allprojects, and most borrowers' economic stability are certainly at risk. It is always advisable for all private lenders to seek legal advice regarding their obligation to close and fund loans that were received, underwritten, or approved before the economic downturn.
Regarding the private lender's obligations to fund, the private lender should review the loan term sheet (or loan commitment) issued to the borrower. An analysis of the private lender's documents will determine whether the private lender has the legal obligation to deny the loan application, revise the loan commitment, change any pre-closing conditions, impose additional borrower equity, or refuse to fund and close the loan. Generally, requirements concerning material adverse changes that affect the loan to value, the viability of a project, or increase the private lender's risk of loss shall vary from lender to lender.
A possible alternative in which a private lender can protect themselves is to incorporate pre-closing condition in the loan commitment,which states that the loan is subject to: (i) borrower (or the project) notincurring (or suffering) any material disruption or material adverse change;(ii) the absence of any condition which adversely affects the financial,banking, or capital markets; or (iii) any document that could impair the syndication of the loan materially. The private lender's loan documents could also state that the loan is subject to no market change in the value of the borrower's project or financial status.
As the pandemic continues, it is unlikely that private lenders will be able to properly underwrite a loan (or assess the value of an asset)given the uncertainty of current economic conditions. Given the situation and unforeseen duration,private lenders should exercise greater due diligence. In the same manner, borrowers should be cautious and concerned about their equity investments and any personal guarantees given on any project.
Nevertheless, borrowers may believe that the value of their project will not be affected and still insist that they close the deal. In such cases, we always recommend for a private lender to ask counsel if they are obligated to fund the loan or not ? Generally, most private lenders shall have three options: (i) fund and close the new loan; (2) terminate the loan commitment (or deny the loan application); or (3) invoke the MAC clause or provision, a/k/a "materials adverse change" provision, which protects a bank (or private lender) and allows them to introduce new requirements or terms. Under such circumstances, a bank (or private lender) can require a borrower to pre-fund certain months of interest to ensure full and timely payments, demand additional guaranties, or add cash management features in the loan terms, such as a lockbox for rents.
During the Covid-19 economic downturn, most private lenders should anticipate that borrowers shall be notifying the bank (or private lenders) of their inability to meet their debt obligations. Bank (or private lenders) should require those borrowers affected by the pandemic and looking for relief to request specific and possible modification terms instead of just requesting general relief, such as lowering the interest rate, temporarily require interest-only payments, or reduce, waive or defer payments for a predetermined set period. Generally, when borrowers are experiencing economic hardship and struggling to meet debt payments, the possible solution is an injection of cash from equity investors. Therefore,private lenders may want to relax the guidelines and consent to borrowers adding equity partners to meet payments during this pandemic.
Upon receipt of a borrower's request for relief, the first step is for the private lender to make an initial analysis as to whether the borrower's request is reasonable and viable. If the demand looks reasonable, private lenders should require a pre-negotiation agreement, or PNA, before discussing terms or potential loan modifications.
When considering the approval of a borrower's request for relief, private lenders should also use this opportunity to mitigate any risk associated with the borrower, such as reviewing the credit loan file for deficiencies and mistakes, missing affidavits, unrecorded loan documents, or pending insurance coverage issues and certificates. The private lender should also conduct a due diligence inquiry, such as updating borrowers' financial statements, tax returns, property income, and expense reports, completing a property inspection, reviewing the title, and conducting a lien and judgment search on the borrower.
Before discussing any matters relating to the loan, the private lender should require the borrower and guarantors to execute a pre-negotiation agreement. The pre-negotiation agreement allows borrowers and private lenders to undertake confidential non-binding discussions without either party waiving any rights, which, in turn, facilitates open discussions about potential alternatives to alleviate the borrower's present financial difficulties. A properly drafted pre-negotiation agreement should contain the loan's current status, admissions of defaults and requires that the borrower and guarantors attest to loan documents' authenticity. The pre-negotiation must include that the discussions, negotiations, drafts, and any loan modification proposals undertaken by the private lender and borrower are non-binding until both parties sign and execute a written agreement. The pre-negotiation agreement should also clearly indicate that neither party waives any rights and remedies under the loan documents.Finally, a pre-negotiation agreement should also allow either party to terminate the agreement for any reason whatsoever.
Another loan workout alternative is for the private lender to forbear from exercising its rights in consideration for a borrower making reduced mortgage payments and comply with specific terms and conditions. In a forbearance agreement, the bank (or private lender) temporarily agrees during a set period to forbear from exercising any default remedies, such as foreclosures or personal guarantee lawsuits, to allow the borrower time to get financially stable or seek refinancing while simultaneously giving the economy a chance to turnaround.
A forbearance agreement should reaffirm the validity of the loan documents and the total amount due. Moreover, the agreement should provide for a general release in favor of the private lender.
Finally, a forbearance agreement is also an opportunity for private lenders to mitigate any risk associated with the borrower, such as reviewing the credit loan file for deficiencies and mistakes, missing affidavits,unrecorded loan documents, or pending insurance coverage issues and certificates.
The COVID19 pandemic has increased the risks associated with commercial mortgage loans. Due to the unforeseen consequences and impact of the pandemic, private lenders need to be even more scrupulous when determining whether to approve individual loans in the pipeline and proceed to close the transactions or terminate the loan commitment (or deny the loan application). Regardless, private lenders should be prepared to manage and review an anticipated increase in borrower relief requests that will arise due to the pandemic.
How Covid-19 Recession Will Impact Commercial Real Estate Values
Hugo Dorta, the author of this article, is the Founder and Principal of Brickell Capital.
Brickell Capital is a Florida “private bridge” mortgage lender. We specialize in residential and commercial loans for Self-Employed Borrowers and Foreign Nationals, New Construction Loans for Builders + Developers and Loan Servicing for Performing (and Non-Performing) Loans. Brickell Capital also purchases seasoned performing (and non-performing) first and second mortgage lien loans; sub-performing mortgage loans; mortgages in bankruptcy and foreclosure; investor fallout loans; scratch and dent loans, and aged mortgage loans on warehouse lines.
For the last 3 years, Brickell Capital was voted "Top 20" Commercial Lenders and Brokers by the South Florida Business Journal(South Florida's leading news outlet for residential and commercial real estate, banking, finance and business news).
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