In a nutshell, what this indicates is lenders will readily extend loans to well-capitalized borrowers demonstrating a strong payment history and with the ability to supplement the property cash flow with out-of-pocket funds to service any debt-service shortfall. Earth-shattering news? No. Common sense? Absolutely!
All of this sounds great for storage owners who meet the new guidelines. But what about poorly capitalized borrowers with less than sufficient global cash flow? Well, there’s a structure that might work in these situations as well.
The regulatory guidelines present an “A note/B note” structure allows lenders to keep current the portion of the note whose market interest-rate debt service can be supported by the property’s cash flow (the A note). Additionally, the A note’s principal amount must be within a prudent loan-to-value ratio based on current market conditions.
The lender would classify the B note as non-accrual and structure it with a below-market interest rate and other terms not characteristic of prudent lending practice. This A/B structure allows the borrower to remain in good standing with the lender, and minimizes the lender’s non-performing assets with the potential to recapture part of the write-off (the B note). If lenders did not break the loan into A and B notes, the alternatives of simply reducing the principal amount or adjusting the interest rate to below-market levels would require them to classify the entire loan amount as non-performing.
The guidelines issued in late October clearly demonstrate regulatory support for lenders and borrowers to collaborate on finding solutions to today’s valuation issues. Remember, the above examples may apply to your situation, but each loan will most likely have unique attributes which will need to be negotiated and worked through with the lender. This highlights the need for borrowers to be proactive about approaching their lenders with potential solutions as opposed to waiting for lenders to raise the issue.
There is still tremendous pressure on commercial real estate valuations, inevitably resulting in foreclosure and losses.
Devin Huber is a principal at Chicago-based The BSC Group, where he provides mortgage brokerage and financial consulting to commercial real estate owners nationwide. He can be reached at 312.207.8232. To receive a copy of the Federal Financial Institutions Examination Council policy statement, e-mail firstname.lastname@example.org, or visit www.fdic.gov.
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