Dawn is breaking on a new reality for lenders and borrowers. While the ramifications of higher debt costs and lower capital values for the refinancing of existing loans have been discussed in recent months, light is beginning to be shed on how market participants are dealing with these testing circumstances.
As Real Estate Capital Europe went to press, two of the biggest names in private real estate were engaged in talks with their lenders about loans that have come due. In the US, Canadian manager Brookfield defaulted on two Los Angeles loans backed by well-known office skyscrapers. But at the time of writing, the lenders involved had not foreclosed. In Europe, US manager Blackstone was working out next steps with the servicer of a securitised loan held against property from its Finnish Sponda platform, after noteholders denied it a one-year extension.
These are not the only examples of debt maturity-related problems being addressed. But they are the highest profile. How the conclusions are reached will be watched with interest.
What is already clear is that a repeat of ‘extend and pretend’, as seen after the global financial crisis, will not be lenders’ go-to solution. Then, lenders were as keen as borrowers to live with loan-to-value covenant breaches and stave off maturities in the hope of better times ahead. This time, higher financing costs are straining interest coverage ratios, creating more immediate concerns for debt providers.
All this means lenders can be expected to be proactive. But equally true is that they will not want to be handed keys in a market of falling values, or be forced to manage property on an ongoing basis. With the added threat of borrowers doing a ‘strategic default’ – where they step away from debt obligations when the collateral has dropped in value – lenders are likely to show some flexibility to reach mutually acceptable conclusions.
Within those two extremes sits a fresh reality. Since the GFC, lenders and borrowers are better at working collaboratively. As the market transitions to a higher-rate environment, such collaboration will be crucial. To that end, sources tell us loan extensions are being granted in some cases, but with conditions attached – no matter the borrower’s calibre. Some expect to see short-term ‘bridging’ extensions of mere months, while others report 12-24-month extensions being granted.
Rather than extend-and-pretend, lenders are more likely to aim to extend-and-resolve – in other words, give sponsors breathing room to undertake near-term business plans.
The conditions could include borrowers providing additional equity into a deal, with market sources saying contributions of up to 10 percent of the value of the property are being required. To tackle tightening ICRs, lenders are also likely to ask borrowers to put extra money into cash reserve accounts, which typically have deposits of around 12 months’ worth of finance payments. Also, banks in particular cannot tolerate unhedged facilities, meaning borrowers may be required to put new hedging in place if a loan is to be extended.
Cash traps are also crucial. These operate as ring-fenced funds taken from surplus cash generated by the borrower’s underlying asset that can be used to meet interest payment shortfalls.
And of course, there will be margin increases. Thus far, sources have seen these in a range, depending on the sponsor, from 25 basis points and up to 225bps.
As increasing numbers of sponsors come up against loan maturities in the coming weeks more will become clear. Whatever the new dawn brings, one thing is for sure: lenders will be motivated to reach near-term solutions to debt problems, and they are far more likely to work with their borrowers to that end.