In each issue of The RMA Journal, veteran workout leader Jason Alpert gives tips on thorny workout challenges.
Question: My bank has a $2.6 million real estate loan secured by a Class B office building in a mid-size city. We originated the loan four years ago at a 75% loan-to-value (the valuation was $4 million) and our sponsorship is a well-known real estate developer who is exposed with other similar properties in the market. We have a fixed rate loan, but the maturity goes out another six years. My credit team is worried about the state of the office market and the performance of this loan with all the issues we read about in the office sector. Any advice?
Jason: Office CRE loans are certainly an area of heightened risk as remote work remains common post-COVID and companies downsize their space in response. (Bankrupt WeWork’s struggles, which are adding vacancies in some markets, aren’t helping either.) Values will decline in this sector for the foreseeable future—until the market stabilizes or companies (tenants) decide to take on more space.
The main question is: What is the customer’s financial status and the property’s operating performance? Assuming that the financial monitoring and covenants on your loan are not robust, to properly assess the risk, you should request financials as soon as possible. Most bank documents usually contain catch-all language that would require the borrower to provide statements as reasonably required. Put your request for information (rent roll, operating statements, tax returns, personal financial statements, and a contingent debt schedule) in writing and require the borrower to remit back to you in 30 days. If they don’t, you may have a default on your hands. But first consult with your internal legal partners. Additionally, you may determine that ordering a new appraisal is warranted (and perhaps allowed under your loan documents, with the borrower to reimburse the bank for the appraisal’s cost).
Even with a new appraisal that shows that the property’s value has declined, assuming the loan payments are made as agreed, you may not have any defaults (unless there is language covering a re-margin default in your loan documents). If the property is struggling under a 1x debt service coverage and the personal guarantor is not able to demonstrate continued support, you may have a criticized asset that should be transferred to your workout team for further servicing. Note: Based on the fact pattern of the question, there are no financial covenants, so even if the property shows below 1x it is not an event of default under the loan documents.
Revolving Line of Credit Concerns
Question: I am handling a $1.25 million revolving line of credit with $600,000 that is outstanding. The borrower is in the consumer disposable goods industry and our line is unmonitored. The line matures in four months, but we have not received any updated financials from the customer, who has become unresponsive. Bank management is concerned that the borrower may draw the remaining availability. Can we limit the borrower’s drawing under the line so we aren’t more exposed?
Jason: Absent a default, there is little you can do to stop the borrower from advancing on this facility prior to maturity. You certainly do not want to freeze their ability to draw without a declared default because that will create a “lender liability” issue that will most likely result in more time, costs, and potential litigation for the bank. I would recommend that you thoroughly review the loan documentation and engage your internal legal partners and workout team to determine whether anything proactive can be done that could limit the exposure. For example, there might be an opportunity for the bank to address the borrower’s failure to provide financials (including aging schedules), failure to rest the line, or other defaults.
If no defaults exist, and given the customer is unresponsive to your requests, perhaps the best course to reestablish communications is to send a formal information request. It could cite the pending maturity as the pretext for the letter and state that without transparency and information you will not be able to entertain the renewal. Give 30 days to reply. If there is no response, then strongly consider a notice of non-renewal. (You are giving the borrower 90 days’ notice, which should be reasonable time to replace the line at another lender.) Sure, this might run the risk that the borrower panics and draws the remaining portion of the line, but assuming they don’t fraudulently transfer the assets out of the entity, the company will have that cash available to pay down the line as a condition of any short-term renewal. (Which, I’d imagine, would be the case given they aren’t behaving like a responsible long-term customer.)
Handling a Habitually Late Borrower
Question: If a loan is 60 days past due (covering two missed monthly payments), do we have to send it to workout? This borrower eventually pays, but I have to physically drive out to their business and meet with them to stress the importance of the payment—which usually comes in right before it gets to 75 days past due. I’m starting to get tired of this conversation with the borrower (and having to explain the situation to my manager).
Jason: You have a major early warning sign, if not a straight up non-performing loan, given the customer is habitually past due and it takes a special effort on your part to have them to come up with funds to pay. The borrower is demonstrating a severe cash flow issue. You should immediately work with your management, credit team, and legal/workout partners on transferring this asset to workout. There is a high risk that this customer is distressed and you have a criticized asset on your hands that needs immediate intervention by your professional workout team. Finally, the opportunity cost of you continuing to spend your time begging and pleading with this customer would be better spent focusing on new prospects and current customers that need your financial expertise and new products. Good luck!
Have a question for The Workout Window? Email Jason at firstname.lastname@example.org or reach out to him at 813-293-5766.
Disclaimer: The Workout Window is not intended nor is it to be considered legal advice. As The Workout Window stresses, consult with legal counsel and your institution’s management to be sure you are acting within the parameters of your institution’s policies and banking law.