During the early 2000’s, hotel owners, like the owners of virtually all property types, turned increasingly to Wall Street to finance and refinance their properties, attracted by the higher leverage and lower rates offered in comparison to more conventional lenders. These loans were packaged with a wide variety of other loans and turned into securities, known as commercial mortgage-backed securities.
|
|
Scott A. Weinberg |
Jerry H. Herman |
Since 2004, about US$100 billion of hotel CMBS loans have been issued across all hotel sectors and markets. They range in size from US$5 million to US$1.4 billion, including more than 30 single or portfolio CMBS loans each in excess of US$200 million, according to Realpoint. Surprisingly, many of the post-2005 CMBS loans have been made on midscale hotels in amounts averaging US$15 million-US$20 million. Nearly 1,000 CMBS hotel loans are maturing within the next two years. Such a huge volume of maturing loans involving a debt class that has not yet gone through a serious hotel industry downturn is even more sobering when looking at the explosion of CMBS hotel delinquencies during the past 12 months. Said delinquency rate has jumped from less than 0.5 percent in the fall of 2008 to 6-8 percent with predictions that the delinquency rate will exceed 10 percent in the months ahead, according to Realpoint.
What will be the result of such large upcoming maturities and increasing delinquencies on CMBS hotel lenders and borrowers in such a severe industry downturn? While politicians may trumpet the end of the “Great Recession,” current hotel performance trends, combined with an almost total absence of new CMBS issuances and a lack of lending capacity from more traditional lenders, would seem to point to a large number of defaults in the CMBS hotel arena during the next few years. More specifically, with the industry’s revenue per available room projected to decline 17 percent to 18 percent in 2009 and an additional 1 percent to 5 percent in 2010, hotel owners and lenders cannot rely on an improving economy to bail out distressed loans.
Because of such an unprecedented decline in industry revenue fundamentals, hotels’ average net operating income and asset values have declined 35 percent to 40 percent, according to Realpoint, which in turn has caused or will cause many owners to lose their equity investment and, in many instances, the cash to meet ongoing debt service payments or covenants.
Finally, the growing loan refinance and balloon default risk facing many hotels, when combined with the lack of financing and very stringent loan underwriting standards, even places hotel owners with performing assets at great risk should they have debt maturing in the next one to two years.
While such problems are not unique to CMBS-financed hotel properties, the complexities of pursuing and securing a restructuring with CMBS debt often are far greater than hotels with other forms of financing. To understand why CMBS loan restructurings are likely to be more challenging even to hotel owners with previous downturn experience, this article will answer common questions regarding the structure of typical CMBS loans and highlight some of the issues unique to CMBS loans that hotel owners likely will confront when dealing with a workout.
1. How are CMBS loans typically structured and what are the main governing documents?
One of the main differences between CMBS loans and conventional loans is that CMBS loans are transferred by the originating lender into a trust together with many other loans, with the original lender having no ongoing relationship with the borrower. The document governing this pool of loans is called the Pooling and Servicing Agreement, or PSA. Though this agreement can be the single most important document governing the workout, the borrower is not a party and is generally not even entitled to see a copy.
Another basic difference is that CMBS loans often are tranched into multiple classes, both within the mortgage and sometimes also including one or more classes of mezzanine loans. An example of such a multitranche structure is shown in chart form. The relationships among these various classes of lenders are set forth in Participation Agreements and Intercreditor Agreements. This multiplicity of players, each with a differing interest, can result in a much more contentious workout than borrowers might expect, with the disagreements among lenders being greater than those with borrowers.
2. Because there are so many players, with whom will the borrower deal?
While the loans technically are held by a trustee, the PSA appoints a loan servicer, usually called the master servicer, to act on behalf of the trust and administer the loans on a day-to-day basis, including collecting and applying debt-service payments. The PSA also typically appoints another party, called the special servicer, to deal with situations outside the ordinary course. In most securitizations, only the special servicer has the right to waive defaults or modify the loan, so that is the party the borrower almost certainly will deal with in any workout situation.
3. What standards do the servicers apply in administering the loans?
The servicers must act in accordance with accepted servicing practices and administer the loans “giving due consideration to the customary and usual standards of practice of prudent institutional commercial mortgage lenders servicing and administering mortgage loans for third parties.” In the context of a workout, the servicer usually is charged with “maximization of recovery to the [H]olders as a collective whole, taking into account their relative priority.”
This means the servicer must consider the interests of the holders of subordinate tranches outside the trust (though not separate mezzanine loans) in addition to acting for the trust itself, which becomes interesting in light of the fact that the special servicer typically is appointed by one of such subordinate holders and may have an economic interest in the pool of loans being serviced. Furthermore, the special servicer is required to undertake on each CMBS loan an analysis of the net present value, or NPV, of projected income/sale proceeds less costs of pursuing certain business and legal restructuring options; i.e., the special servicer is charged with analyzing whether the projected NPV of pursuing a loan forbearance/modification will yield a higher NPV than a real-estate owned sale.
4. How does a loan get transferred into special servicing?
The rules governing a transfer to special servicing are contained in the PSA. The typical conditions for transfer include such objective items as loan maturity or a payment or other event of default which has continued for a certain period of time, as well the more subjective standard that the master servicer believes there is “an imminent risk of an event of default.”
A borrower cannot simply request a transfer into special servicing, which has been a great source of frustration to many borrowers since, as stated above, only the special servicer has the authority to enter into loan amendments. This has led some borrowers to intentionally default to precipitate a transfer, which generally speaking is a bad idea. The better course, if possible, is to try and convince the master servicer that a default is imminent, but that also entails a certain degree of risk to the borrower, including a potential risk of triggering recourse in certain instances.
Part 2 will examine the remaining four questions, examining the dynamics of working with a special servicer to unwind and workout CMBS hotel loans. The article will be posted to HotelNewsNow.com Wednesday, 13 January.
Scott A. Weinberg, partner, DLA Piper LLP (US) – New York City Office, concentrates on real-estate finance matters, including securitizations (scott.weinberg@dlapiper.com).
Jerry H. Herman, of counsel, DLA Piper LLP (US) – Washington, D.C., office, specializes in hospitality and real-estate transactions (jerry.herman@dlapiper.com).
The opinions expressed in this column do not necessarily reflect the opinions of HotelNewsNow.com or its parent company, Smith Travel Research and its affiliated companies. Columnists published on this site are given the freedom to express views that may be controversial, but our goal is to provoke thought and constructive discussion within our reader community. Please feel free to comment or contact an editor with any questions or concerns.