By Jeff Lerman
‘Set yourself up to maximize your chance of success’
New accounting standards issued by the Financial Accounting Standards Board will change the way lenders report their troubled debt starting June 15. This significant development creates more uncertainty and concern for commercial property owners obligated on distressed loans.
What impact will these new standards have on your commercial loan workout negotiation? What can you do to optimize your chances for a successful outcome? At the risk of invoking the over-used “perfect storm” analogy, that is exactly what the distressed commercial loan borrower is facing.
- Those new accounting standards are expected to result in a dramatic increase in the percentage of loans banks are required to report as troubled debt restructurings (TDR) and could put a chilling effect on certain lenders’ willingness to add to the TDRs they’re carrying on their books.
- The near-term outlook for commercial loans is dismal. A recent U. S. Congressional Oversight Panel report expressed “deep concern … that commercial loan losses could jeopardize the stability of many banks … and … contribute to prolonged weakness throughout the economy.”
- Between now and 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms. Nearly half are ”underwater.”
- Commercial property values have fallen more than 40 percent since the beginning of 2007.
- The largest commercial real estate loan losses are projected for 2011 and beyond; losses at banks alone could range as high as $200 billion to $300 billion.
- Difficulties in getting new loans create uncertainty for commercial borrowers who need to refinance because their loans are now coming due.
- Many commercial property owners are confronting severe financial challenges due to the lingering recession.
This convergence of risks and challenges makes it crucial that the commercial borrower approach the loan workout negotiation as strategically as possible.
Although every loan workout negotiation is as unique as the real estate and the borrower involved, there is a step-by-step approach that is common to virtually every successful negotiation:
Step 1: Realistically assess your situation.
Impress your lender that you understand your property better than he does. Prepare professional-looking financial statements and current rent roll. Perform a realistic analysis not only of your property but also of the relevant submarket. Get a “broker opinion of value” from a reputable commercial real estate broker. You may be able to get one at no charge (the broker will expect “inside track” consideration when you’re ready to sell). Be familiar with all material terms in your loan documents.
Step 2: Evaluate claims against lender.
The more bargaining chips you have, the better outcome you’ll be able to secure. Consult an experienced lawyer to determine what, if any, legal claims you may have against your lender. You may never want or need to assert them, but that information could have a huge impact on your ultimate outcome.
Step 3: Create a realistic workout proposal and business plan.
To paraphrase Jerry Maguire, help your lender help you. Come up with a realistic workout proposal and business plan that your lender can use to take back to committee and go to bat for you. Consult your CPA to make sure you understand the tax implications of your proposal before presenting it to your lender. Include a hardship letter that fully explains your situation and why you can’t perform without your requested modification.
Step 4: Set yourself up to maximize your chance of success.
Anticipate the biggest objections your lender may have to your proposal and do your best to address those before you meet with the lender. Do you have a weak financial statement? Find a financially strong partner. Does your property suffer from lack of sufficient management expertise? Identify a new management company with better credentials. Does your property require a cash infusion (for principal paydown, tenant improvements, capital improvements)? Offer to come up with more dollars or find an equity partner.
Step 5: Negotiate.
But keep your lawyer in the loop every step of the way. One of the biggest mistakes borrowers make is cutting a deal first, then asking the lawyer to review the deal they made. If the lawyer spots an important issue or deal point you missed, it may be too late. The lender may take the position that you already agreed to all the business points. The stakes in commercial loan workouts are too high not to have your lawyer involved from the beginning of the negotiation.
Many commercial borrowers mistakenly believe attempting a loan workout is a waste of time. Before you give up hope, consult an experienced professional.
Jeffrey H. Lerman’s Lerman Law Partners LLP is in San Rafael and specializes in real estate investment law, estate planning and litigation. He can be reached at 415-454-0455.
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