April Fool’s Day 2020: No Jokes For Borrowers, Loan Officers

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Debra Morgan, Founder and Managing Partner of BlackEagle Real Estate Partners, and Paul Fiorilla, Research Director, Yardi Matrix

April 1 is traditionally a day of lightness, as millions of Americans indulge in April Fool’s Day drifts. This year, April 1 is important to the commercial real estate industry for decidedly no fun reasons.

On that date, the first commercial mortgage payments will be due since the COVID-19 pandemic overtook the United States. have a profound impact on the market.


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About half of the country lives in areas with mandatory quarantine of businesses, retailers, schools, transportation and more, and some 3.3 million workers have filed for unemployment insurance. The coronavirus and the shutdown have severely disrupted the ability of commercial tenants to operate their businesses and pay their rent. This, in turn, makes it difficult, if not impossible, for property owners, especially housing and retail businesses, to make loan repayments, wages and construction expenses.

“The hosting industry will not be able to cover operating costs for many months, and it is predicted that it will take four to five years to return to the level of value it was at the end. January 2020 “, said Keith Thompson, director of Avison Young.

Refrain or transfer

What happens on April 1 if the mortgage payments are not paid? For the estimated $ 600 billion in loans held in securitized debt vehicles (CMBS and CRE CLO), missed payments trigger actions that are defined in service agreements. These 400-page contracts outline the processes, procedures and reporting requirements to ensure compliance and impartial loan management for the benefit of investors, whether the securities are AAA rated bonds or junk rated B-piece bonds.

When loans from securitized commercial mortgage pools become overdue, the manager should contact the borrower to assess the likelihood that the depreciation will be temporary and that the loan will return to income within a reasonable timeframe. This analysis supports a short-term forbearance agreement and gives the borrower some leeway to recover. Otherwise, the loan should be transferred to the special duty officer for training. The typical protocol – unless the special department declares the loan in imminent default and “give up”In their shop, is that the loan must be in arrears for 30 or 60 days before a transfer and a constructive dialogue with the borrower.

The growth in delinquent loans means that departments will be tasked with quickly determining market knowledge, understanding the impact of any federal, state or local orders, and engaging with thousands of borrowers over the coming months. Repairers will be responsible for making recommendations based on market fundamentals, such as reopening businesses, generating enough cash flow to cover operations, and the ability to service debt.

Another problem is that due to the temporary and unprecedented nature of the decline in operations and cash flow, there may be social and political pressure on service providers to grant forbearance. An automatic abstention policy that is not carefully documented can call into question the language of service agreements. It also raises questions about the service standard (service officers must handle each loan independently and with the utmost care) in the event that a loan is ultimately restructured while comparable loans are foreclosed with losses, losses. significant fees and costs.

“The agreements that repairers must follow require decisions to be made about each mortgage loan,” said Brian Olasov, executive director of law firm Carlton Fields. “The serving agent should apply reasonable business judgment to maximize recoveries and minimize losses to bondholders. It can be argued that the aggregate responses across disparate loans do not conform to this requirement, even though the final decision is the same.

Default scenarios are sure to increase in the coming months. Typical remedies used to cover operations and cash shortages, such as cash management, stunts, and the use of cash reserves, are likely to be strained. And only the best capitalized and the most experienced borrowers are likely to have the means and the sponsors willing to honor a call for capital. It will be difficult to get a call for capital from pools of small investors (i.e. crowdfunding, high net worth individuals) or even institutional partners in this market.

Maintenance challenges

Ironically, the strong performance of the $ 3.6 trillion commercial mortgage industry could make it more difficult to respond to defaults that may be caused by the COVID-19 quarantine. The default rate has steadily declined since the all-time high of 10.3% in July 2012, according to Trepp. In the fourth quarter of 2019, less than 1.0% of CMBS guarantees that were issued after the financial crisis were 60 days or more past due, according to Moody’s.

Loans issued after the Great Recession have been underwritten more conservatively, and the market for most, if not all, real estate asset classes has improved since 2012; as a result, default rates are significantly lower on post-Great Recession securitizations compared to pre-Great Recession securitizations, according to Morningstar | DBRS.

The decline in defaults and the growth of commercial real estate markets have led to another trend: talent in the industry has tended to pursue careers in investment banking or loan issuance rather than in the loan department. This trend will reverse and professionals in the loan origination, underwriting or other specialties team will move to the loan restructuring or special situation groups of their business.

A typical distress situation involves the management of legal parties and third parties; appeals to investors; inspect real estate and understand the market; review financial statements and business plans; and meeting with the borrower. Meanwhile, the industry is currently subject to work-from-home and social distancing guidelines.

Ironically, maintenance pay has declined since the Great Recession even as maintenance responsibilities have increased. The loan service is not very profitable and the economics of compensation are not transparent. Businesses typically receive a nominal fee based on the loans under management and a success fee (also known as liquidation or reorganization fees) on resolved loans or the proceeds from the sale of foreclosed property. And repairers are no longer allowed to use affiliates for services that would typically generate additional revenue for the business.

Patience is the key to recovery

Homeowners face an unprecedented challenge. The largest retail REITs have been forced to temporarily close their shopping centers. Accommodation companies, including Marriott International Inc., Hilton Worldwide Holdings Inc. and Hyatt Hotels Corp. have put thousands of employees on leave. Office buildings, most retail businesses and government offices have closed and residential evictions have been suspended.

The situation is full of unknowns, including how much government intervention will help. Property income could be boosted by the government’s $ 2 trillion aid package, which includes business and consumer support and the Federal Reserve’s promise to buy multi-family mortgage-backed bonds . Freddie Mac and Fannie Mae have issued forbearance recommendations, and regulators are warning banks that until the end of 2020, they will not have to immediately classify loans with missed payments as past due.

While April 1 is a monumental date, the impact of the pandemic on the mortgage industry is only just beginning. It will take patience and collaboration on the part of all parties to manage the pandemic and focus on real estate that remains degraded until the fall.

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