Commercial Real Estate Loan Commercial Real Estate Loan Workouts and - - PowerPoint PPT Presentation

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Commercial Real Estate Loan Commercial Real Estate Loan Workouts and Modifications

Strategies for Developers, Owners and Lenders Restructuring Underperforming Loans

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific WEDNES DAY, AUGUS T 24, 2011

Today’s faculty features: David A. Barksdale, Partner, Ballard Spahr, Los Angeles Ren R. Hayhurst, Partner, Bryan Cave, Irvine, Calif.

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4

Real Estate Loans in Trouble: Understanding Securitized Lending Lending

Ren Hayhurst (Irvine,CA) 949-223-7125; rrhayhurst@bryancave.com

Differences in CMBS Lending vs. Portfolio or Balance Sheet Lending g

• Basic Differences from Balance Sheet Lending
• Significance/Impact on Commercial Real Estate

Finance

• Structure
• Structure
• Parties and Relationships/Roles and Motivations
• Special Servicer

p

6

Overview of Securitized Loan Originations g

• Making the Loan

– Originator Underwrites and Closes Loan in Own Name – Loan Usually “Table Funded” By Warehouse Lender

• Warehouse Lender and “B” Piece Buyers Play Key Roles In

Underwriting

• Immediate Loan Sale

– Along with Closing Documents, The Loan is Assigned to the Along with Closing Documents, The Loan is Assigned to the Warehouse Lender – Importance of Representations and Warranties Relating to Standardized Documents Standardized Documents

7

Overview of Securitization Process

• Key Players

– Securitization Trust Securitization Trust – Investors

• Tranche Investors – “A” Piece and “B” Piece Investors

Servicers Master and Special Servicers – Servicers – Master and Special Servicers

• “B” Piece Investor Often in Role as Special Servicer
• Purpose of Trust Structure

– Use of REMIC Trust Structure for Tax Benefits – Legal Limitations of REMIC Structure for Individual Loans

8

Role of Servicers

• Pooling and Servicing Agreement (PSA)

– Sets the Operational and Control Issues Controls the Actions of the Investors and the Servicers – Controls the Actions of the Investors and the Servicers

• Master Servicer

– Manages Basic Loan Administration

• Limited Authority to Make Decisions
• “B” Piece Owner is “controlling investor”
• Special Servicer

– Manages Unique Decisions and Default Situations

• More Authority than Master Servicer, But Still Limited By PSA

Terms and REMIC laws

• “A” Piece Owner is “controlling investor”
• A Piece Owner is controlling investor

9

Master vs. Special Servicers

• Role of Master Servicers

– Oversees Loan Payments, Application of Reserves, Basic Lease Approvals Within Terms of the Loan Documents Lease Approvals Within Terms of the Loan Documents

• Not Authorized to Make Major Lease Decisions or Changes in

Reserve Provisions

• Not Authorized to Work Through Default Situations
• Role of Special Servicers

– Review Loan Modifications, Post Default Issues, Post Maturity Problems – Role of the Controlling Investor Class (Usually “A” Piece Owner)

• Tension between investor classes in default situation

10

Commercial Real Estate Loan Workouts and Loan Workouts and Modifications

Loan Defaults and Loan Modifications/Restructuring

D id A B k d l

Strafford Webinars & Teleconferences Wednesday, August 24, 2011

David A. Barksdale Ballard Spahr LLP 2029 Century Park East, Suite 800 Los Angeles, California 90067 424 204 4322 Direct 424.204.4322 Direct 866.254.2297 Facsimile barksdaled@ballardspahr.com | www.ballardspahr.com

Loan Defaults

• Types of Loan Defaults

yp

• Payment Default
• A CMBS loan will be transferred from the
• A CMBS loan will be transferred from the

master servicer to the special servicer if the loan is 60-days past-due

• Maturity Default
• With respect to CMBS loans, the master

servicer may delay the transfer of the loan to the special servicer if the borrower provides an acceptable refinancing commitment

12

p g

Loan Defaults

• Types of Loan Defaults (continued)

yp ( )

• Covenant Default
• Typical violations relate to SPE provisions, subordinate

Typical violations relate to SPE provisions, subordinate financing, financial performance covenants, etc.

• May not be discovered until after monetary defaults

arise arise

• A CMBS loan may be transferred from the master

servicer to the special servicer upon the occurrence of a t d f lt if th d f lt ill t i ll d l covenant default if the default will materially adversely affect the certificate holders and is not remedied within the applicable cure period set forth in the loan documents

13

documents

Loan Defaults

• Evaluation and Analysis – Lender v. Borrower

y

• Identifying the Cause of the Default
• The borrower must acknowledge the default

g

• The borrower and the lender must agree on the

underlying causes

• Outside or within the borrower’s control
• If outside, it may be worthwhile for the lender to

work with the borrower work with the borrower

• If within, an arrangement leaving the borrower in

control of the project is probably not an option

14

Loan Defaults

• Evaluation and Analysis – Lender v. Borrower

y (continued)

• What is the relationship between the borrower and

p the lender?

• Does the lender trust the borrower?
• How has the borrower addressed the problems

to date?

• d e?
• Does the borrower have the experience and

ability to solve the existing problems?

15

ab ty to so ve t e e st g p ob e s?

Loan Defaults

• Evaluation and Analysis – Lender v. Borrower

y (continued)

• Lender evaluation of the borrower
• Evaluation and analysis of the borrower’s

credibility and ability for future performance y y p

• Pre-default v. post-default conduct

Q ti

• Questions:
• Who, what, when, why and how

16

Loan Defaults

• Pre-Negotiation Agreements

g g

• A Pre-Negotiation Agreement (PNA) is designed

to:

• Protect the lender and its representatives

M th b ’ t ti t th t t

• Manage the borrower’s expectations at the start
• f discussions concerning the modification or

extension of a loan e e s o o

• 17

Loan Defaults

• Pre-Negotiation Agreements (continued)

g g ( )

• There are five basic provisions that the PNA should address:
• No final agreement until reduced to a final, signed agreement
• All discussions and writings are confidential and inadmissible
• The borrower and all guarantors affirm the loan documents and

acknowledge that the lender is not waiving any of its rights under acknowledge that the lender is not waiving any of its rights under the loan documents

• Current borrower representatives should be identified and the PNA

should be signed by the borrower and all guarantors should be signed by the borrower and all guarantors

• Costs to be borne by the borrower

18

Loan Defaults

• Pre-Negotiation Agreements (continued)

g g ( )

• Additional PNA terms:
• Other terms may be included such as
• Other terms may be included, such as
• releases

t i t ti d ti

• certain representations and warranties
• interim forbearance terms
• But only if they can be obtained without lengthy

discussions

19

Loan Default

• Default Letter
• Identify the default with clarity and brevity

Li it t l t d f lt

• Limit to clear payment defaults
• Avoid non-monetary defaults to the extent

ibl possible

• Set forth a limited amount of time (7-10) days for

th b t th d f lt the borrower to cure the default

• Doing so enhances the lender’s argument that it

t d i bl

20

acted in a reasonable manner

Loan Default

• Default Letter (continued)

( )

• Avoid stating the exact amount owed in the default

Th t h d il d f lt i t t

• Those amounts change daily as default interest

and other charges accrue P id t t i f ti f th l d

• Provide contact information for the lender

and/or lender’s counsel for the borrower to

• btain exact information
• b

e c

• Reserve rights with respect to all other events of

defaults

21

de au ts

Loan Defaults

• Forbearance Agreements

g

• Two alternate and exclusive goals

R i t t t

• Reinstatement
• Bring the loan back to performing status
• Usually accomplished by modification
• Termination of the loan

Termination of the loan

• End the borrower/lender relationship

22

• Takeout financing, DPO or a short sale

Loan Defaults

• Forbearance Agreements (continued)

g ( )

• Benefits to the lender
• Acknowledgement of loan balance

Acknowledgement of loan balance

• Acknowledgement of existing defaults
• Express written forbearance request
• Express, written forbearance request
• Established end date for forbearance period
• Allows time for amendment to loan documents
• Allows time for amendment to loan documents
• Acknowledgement of enforceability/priority

R l f l i / i f d f

23

• Release of claims/waiver of defenses

Loan Defaults

• Forbearance Agreements (continued)

g ( )

• Benefits to the borrower

B thi t bilit t i d bt

• Breathing room to assess ability to service debt
• Limited duration
• May allow continued advances under loan

documents

24

CMBS – Lender Remedies

• Acceleration
• Foreclosure
• Foreclosure
• Receivership
• Bankruptcy

p y

25

Roles of Parties During Foreclosure Foreclosure

• Proper Parties

– Trustee for Trust is the Proper Party in Litigation Because Trustee for Trust is the Proper Party in Litigation Because Trust Holds the Loans – Servicer is Agent Acting for the Trust – Originator Typically is Not a Party in Any Capacity g yp y y y p y

• Obstacles

– Must Locate All Assignments to Trace Ownership of the Loan by the Trust by the Trust – Servicers Bound by PSA, But PSA is Not a Public Document

26

Immediate Actions

• Default/Acceleration Notices

– Use Of Pre-Workout Letters – Establish Basis Of Disputes – Describe Disputes And Defaults – Sets Boundaries For Discussions – No Obligations On Lender, No Waiver Or Estoppel, Confidentiality, Right To Terminate And Pursue Remedies, Ease Path To Remedies - i.e., Receivership

• Enforceability of Pre-Workout Letters

– Extent of Confidentiality/Evidentiary Protections – Specific Remedies/Attorneys’ Fees Provisions Specific Remedies/Attorneys Fees Provisions

27

Note on Immediate Actions

• Practice Tip

– Very little litigation on the enforceability of Pre-Workout L tt Letters – Try to take full advantage of existing state and federal law on settlement discussions – Err on the side of more detail and more explanation of the terms and boundaries

28

Immediate Actions (Part II)

• Obligations of the Property Manager

– Terminate Or Continue – Insider vs. 3rd Party Managers

• Lockboxes

– Change Application Of Funds; Hold Excess Proceeds Change Application Of Funds; Hold Excess Proceeds – Springing Lockboxes; – “ARD” Situations for Securitized Loans

29

Immediate Actions (Part III)

• Staged Response

– First, Default/Notice Letter – this document puts the game in ti d ft i i d i di t d ti i t d l motion and often is required in syndicated or participated loans

• Practice tip: Beware of the need for co-lender approvals

– Next, Pre-Workout Letter – this document sets the ground l d t bli h th t ti f th l d t h rules and establishes the protections for the lender to have

• pen discussions
• These are more negotiable when the lender is not a loan servicer

– Finally, Foreclosure or Workout

• Workout = Forbearance Agreement or Modification Agreement

30

Use of Special Purpose Entities in Foreclosures

• Reasons for Forming SPE in Foreclosure

– Isolate Troubled Asset from the Rest of the Loan Pool

• Who Controls the SPE

– Special Servicer Usually is the Sole Member

• Problems
• Problems

– Transfer of all Tranche Interests into SPE – Partial Note Foreclosure Issues

31

Enforcement Options

• Receivership

– Ex Parte vs. Motion for Appointment – Practical Considerations

• Writs of Attachment

– Tool To Use On Guarantors Tool To Use On Guarantors

• Remedies Against Personal Property Collateral
• Judicial vs. Non-Judicial Foreclosure

– One Action and Anti-Deficiency Considerations – Optional Use of Either Remedy; “Dual Tracking” – Timing Considerations – Timing Considerations

32

Enforcement Options (Part II)

• Bad Boy Carve-Out Guaranties

– Enforced by Courts for Damages or Full Recourse – Not Prohibited as Liquidated Damages or Penalty Provisions – Specificity of Provisions Affects Enforceability

• Springing Recourse Guaranties

Springing Recourse Guaranties

– BK Filing, SPE Violations, Additional Debt and Unpermitted Transfers Can Be Recourse Triggers Practice Tip: Misapplication of Funds Can Apply to Transfers of – Practice Tip: Misapplication of Funds Can Apply to Transfers of Rents, Proceeds, Accounts and Receivables

33

Enforcement Options (Part III)

• Expansion Of Waste Remedies

– Failure to Maintain or Repair Property with Rents or Other Revenues – Failure to Pay Taxes or Insurance Premiums

• Material Adverse Change (or MAC) Provisions

g ( )

– Limited Case Law in the Loan Context (most cases come out of the insurance context) – Subjective vs Objective Standards Subjective vs. Objective Standards

• Practice Tip: Enforceability is often tied to objective criteria for

triggering a MAC provision

– Trigger Default vs Trigger Additional Lender Rights Trigger Default vs. Trigger Additional Lender Rights

34

Alternative Transaction Options

• Alternatives to Foreclosure

– Deed in Lieu of Foreclosure or Note Sale – Title Subject to Competing Liens and Other Defects

• Consensual Foreclosure

– Permits a Lender to “Clean Up” Title And Can Speed Up the Permits a Lender to Clean Up Title, And Can Speed Up the Process – Receiver Sale – Compare with Risks for Non-Consensual Receiver Sales Receiver Sales

• Consensual Bankruptcy

– Risk Of Trustee Or Judicial Interference

35

Pre-Foreclosure Note Sale Issues

• Note Sales

– Previously Limited Market; Uncertain Pricing – More sophisticated investors in the market now, so more note sales at higher prices – Practice Tip – If the borrower is in bankruptcy, then:

• Note sale is possible without court approval
• Property sale requires court approval

– Note that a competing property sale offer can be the basis for a l d ’ ti l d l d t 363 l lender’s competing plan and can lead to a 363 sale

36

Post-Foreclosure REO Sale Issues

• Advantages Over Note Sales

– Servicers Usually Not Authorized to Sell Notes Under PSA – Title is Cleaned Up for Purchaser After Foreclosure – Bankruptcy Risk Eliminated Following Completion of Foreclosure

• Obstacles

– Increasing Reluctance to Take REO on Books Long Delays for Buyers and Sellers of Underlying Property – Long Delays for Buyers and Sellers of Underlying Property Assets

37

Loan Modifications and Restructuring

• Considerations arising from CMBS structure

g

• REMIC regulations
• Modifications must comply with REMIC regulations in
• Modifications must comply with REMIC regulations in

addition to the PSA

• Opinion letter from REMIC counsel

p

• Approval of controlling class/directing certificate

holders

• Application and adherence to the servicing

standard

38

Loan Modifications and Restructuring

• Considerations arising from CMBS structure

( ti d) (continued)

• Common elements of the servicing standard:
• Maximizing recovery for the benefit of all certificate holders
• Maximizing recovery for the benefit of all certificate holders
• The servicer must manage and service loans at the higher of

(a) the standard of care used in the servicing of loans held for its own portfolio and (b) the standard of care it applies to its own portfolio and (b) the standard of care it applies to servicing loans held by third parties

• Ensuring that the loan administration and servicing complies

with all applicable laws, the terms of the subject loan d t d th t f th PSA documents and the terms of the PSA

• The servicer’s actions will be guided by its obligation to all

certificate holders without regard to conflicts

39

Loan Modifications and Restructuring

• Significance of property value

g p p y

• Current value
• Future value
• Future value
• Latitude allowed to special servicer in determining

value

• Use of appraisals
• Use of broker’s opinions of value
• Use of broker s opinions of value
• Cash flow and income analyses

40

Loan Modifications and Restructuring

• Economic viability of the property

y p p y

• A cash infusion is usually required

T f l difi ti d i d t k th

• Terms of loan modification designed to make the

debt serviceable on a current basis R d d i t t t

• Reduced interest rate
• Extended interest-only periods
• Maturity extensions, if allowed

41

Loan Modifications and Restructuring

• Rescue Capital

p

• Funds provided by new investors to help

restructure loan

• Investors usually become equity partners

I i t i t t b

• In some instances, investment may be

characterized as debt L d b illi t t t

• Lenders may be more willing to restructure non-

performing notes with the rescue capital in place

42

Loan Modifications and Restructuring

• A/B note splits

p

• Original note split into an A note and a B note

Th t f th A t di t t d b th d bt

• The terms of the A note are dictated by the debt

that the property’s operations can support Oth difi ti / l ti t t i

• Other modification/resolution strategies
• Principal reduction
• Short sale
• Discounted payoff

43

Discounted payoff