COVID-19 Challenges: Approaching a Mortgage Lender for Help

Summer 2020 Issue
By: Trey Barrineau
When reworking a loan, it’s important to have a formal, written agreement documenting everything. E-mails won’t do. Getty Images

Important advice for borrowers who own buildings where tenants are in trouble.

The COVID-19 crisis shut down many businesses, reducing cash flows for building owners. That, in turn, is making it difficult for them to pay their mortgages. Mortgage lenders are offering forbearance agreements and other loan modifications to borrowers so they can avoid defaults, but what is involved?

During a recent NAIOP webinar, attorney George Pincus of Stearns Weaver Miller, P.A., outlined strategies that borrowers should follow when engaging with their mortgage lenders.

Pre-Workout Agreements

Most lenders won’t begin talking with a borrower until a pre-workout agreement is in place. Pincus noted that most of the time, lenders will present the borrower with a pre-workout agreement letter that covers these topics. He urged borrowers to review it with their attorneys.

He then described the elements of a pre-workout agreement and how borrowers should best respond to each.

First, lenders want to know if the borrower agrees that the loan documents are in full force and effect. Additionally, don’t label any part of the workout talks a waiver, modification or forbearance.

“This is a significant issue,” Pincus said. “There’s a lot of case law out there that talks about when parties are negotiating certain agreements and one party relies on the other to their detriment. The party that made a representation or a promise that’s not finalized yet could be subject to a waiver claim, modification or forbearance.”

Pincus emphasized that while the pre-workout agreement is critical, the negotiations to reach it can’t be used in any legal proceeding anywhere in the U.S. He said there is a strict rule of evidence in all 50 states and under the federal rules of civil procedure and evidence that settlement negotiations are not admissible in court.

Next, Pincus highlighted the importance of confidentiality in all negotiations.

“You have to take this seriously,” he said. “I’ve been to too many industry events and you’re standing around the coffee stand and people say ‘oh, I got such a great deal from my bank the other day.’ So it’s really important that you as a borrower not tell everyone in your network about the great deal that the lender gave you to work out your loan transaction.”

Pincus then pointed out that if the lender accepts either partial or full debt service payments, it can’t be considered an agreement to the terms of the negotiations. Only a final, definitive agreement will control that.

Borrowers should think carefully about any claims they may have against the lender.

“For example, you have a construction loan, and you’ve been bickering with your lender about the fact that the lender hasn’t fully funded the construction draw,” Pincus said. “But now things have come to a grinding halt, and you’ve got to make a decision as to how important it is to pass up your claim against the lender for the unfunded draw vs. getting to the conversation about a forbearance agreement.”

In the past, Pincus said he’s helped get the lender and the borrower to quantify and describe the basket of issues that they disagree on, put those aside and continue negotiations over the forbearance agreement.

“So if you have any other claims against the lender, you’ve got to balance them against what you’re up against right now if you’re facing a potential payment default on your debt service because you don’t have any tenant revenues coming in,” he said.

It’s vital to have an upfront, detailed conversation with the lender about who will pay for costs and expenses related to a forbearance agreement. Get cost estimates and a budget, then ask for updates as things proceed.

Realistic Objectives

After signing the pre-workout agreement, the borrower has to figure out their goal. According to Pincus, it should be the preservation of the asset above any other considerations.

“Hang on to the property,” he said. “Do what you can to keep it running.”

Obviously, that is difficult when tenants can’t pay rent because the pandemic has shut down their businesses.

“You’re going to have a significant interruption in cash flow that’s going to impair your ability to pay for taxes and insurance and maintenance on the property, pay debt service, make distributions to investors, and get paid on fees and promoter interest,” Pincus said. “In order to preserve your asset, you’re going to have to determine what priorities you have and what you need from the lender to get that done.”

At that point, borrowers have to worry about additional capital contributions. They should expect that the lender will want the borrower to put some money into the deal to fund it. At the same time, it would be a mistake to view that payment as a debt paydown to resolve a breach of the debt service coverage ratio (DSCR), which measures the cash flow available to pay current debt obligations.

If the borrower is in a joint venture structure, this is a good time to pull out the documents and look at the capital call provisions.

“None of you ever thought this was going to happen,” he said. “While you’re looking at the lender, keep your joint venture partners in the back of your head. Think about how you’re going to talk with them and get help from them and deal with their issues.”

Finally, Pincus said it’s important for the borrower to avoid additional personal recourse. If that’s unavoidable, he said a limited-recourse guarantee is better than a full-recourse guarantee.

What is the Borrower Asking for From the Lender?

The right to undertake material lease modifications is the most important thing that borrowers are seeking right now.

“Tenants can’t pay rent,” Pincus said. “You have to evaluate those tenants and either defer rent for a couple of months or extend the lease for a couple of months. I’ve been doing a lot of defer-and-extend amendments.”

Most loan documents require lender consent for material lease amendments, so it’s important to examine the paperwork carefully.

After lease modification, borrowers should ask lenders for temporary payment forbearance. With little or no money coming in, borrowers must prioritize payment for items that will protect the asset. These include taxes, insurance, building maintenance, debt service and running the property.

Forbearance comes in many shapes and sizes. There’s interest-only, principal and interest reductions or forbearance, complete suspension of payments, adding suspended payments to principal, and interest-rate adjustments.

As for financial covenants, borrowers should ask lenders to ease up on them.

“I spend a lot of time negotiating loan documents for clients, and I always try to focus them on DSCR, loan-to-value (LTV) ratios, liquidity covenants, all of that,” Pincus said. “They need to be looked at really carefully, because these are the types of technical defaults that come up a year or two into the loan term.”

A typical remedy for DSCR problems is paying down the loan to bring it back into balance. However, that requires capital, and the borrower may have to pay down the loan out of their own pocket.

Along those lines, it can be really important to have a detailed operating budget for the upcoming months that takes into account the reduced cash flow from tenants who can’t pay rent. That way, the lender sees that whatever money is coming in will go to preserve the asset and the lender’s collateral.

“Make sure that real estate taxes and insurance are at the top of the list,” Pincus said. “If you do have to pay down the loan, and the loan documents impose any prepayment penalty, be sure to ask to be excused from it.”

Because of reduced cash flow, it might be difficult for the borrower to perform maintenance on the property. However, loan documents have covenants that require upkeep or capital improvements to the property.

“You’ve got to look really carefully at it and figure out exactly what it’s going to cost to do the minimum maintenance to the property,” Pincus said.

Finally, prepare a leasing plan for when the coronavirus crisis ends so that any vacant space can be filled.

Documenting the Deal

When it comes to making the deal official, don’t do it by e-mail. Both the lender and the borrower want a formal, written agreement documenting everything.

Pincus warned that the lender may try to include a lot of waiver language in the agreement and set parameters that, if not met, could allow the lender to sue and foreclose on the property. To avoid that, it’s important to stay focused on the deal.

“Get clarity on forbearance,” he said. “How much? How long? How does the amount in abeyance get repaid? What interest is the borrower paying on the amount in abeyance?”

Trey Barrineau is the managing editor of Development magazine.