Loan Modifications Have Been Key to Keeping Deals Going, Mortgage Bankers Say
Like the rest of the working world, commercial real estate lenders, intermediaries and borrowers have developed new ways of doing business over the last year. They recognize that mutual flexibility is crucial to keeping deals from falling through.
At the most fundamental level, the pandemic has forced providers and arrangers of debt and equity to elevate their due diligence processes, to scrutinize terms of underwriting even more closely based on a variety of factors. Lenders have found themselves reckoning with political dynamics, revising loan terms for commercial properties based on the severity of COVID-19 infection rates and shelter-in-place orders in a given region.
The nuts and bolts of dealing with elevated requests for loan modifications were central topics at the “Commercial Mortgage Stress in the Age of COVID-19” panel at the annual Mortgage Bankers Association (MBA) CREF 2021 event. The event was conducted in a virtual format this year. Mark Weibel, partner and chair of real estate capital markets practice group at law firm Thompson & Knight LLP, moderated this panel.
The pandemic has produced clear winners and losers in terms of asset classes, forcing lenders to be more selective with their deals.
In many cases, this selectivity has led to lower overall loan production and decreased allocations for certain property types within lenders’ portfolios. Factors that have long carried weight in shaping loan terms — borrower credit, tenant rent roll, market growth expectations — have become even more important.
The capital markets for U.S. commercial real estate assets, which had been defined by record-setting levels of liquidity prior to the pandemic, have prioritized quality over quantity in terms of deals. In doing so, they’ve often had to make adjustments to existing loans.
According to MBA’s data, total commercial and multifamily loan originations declined by 30 percent from 2019 to 2020 as the pandemic drastically disrupted the economy. However, the organization reported that loan volumes across all property types increased by 76 percent from the third to fourth quarters of 2020, indicating a higher degree of confidence in the marketplace.
In addition, MBA projects a total annual increase of 11 percent between 2020 and 2021, with loan volumes expected to grow from $440 billion to $486 billion during that 12-month stretch. Prior to COVID-19, the organization had projected an aggregate loan volume of $683 billion.
“There are still a lot of good deals out there, but it’s all about the deal making sense when you examine it and the market closely,” said panelist Amy Frazey, assistant vice president at Oregon-based StanCorp Mortgage Investors. “While we definitely want to get the capital out there, we’ve had to really up our due diligence on how
COVID-19 was impacting the market, borrower and tenant. And we’re not going to push a deal that doesn’t make sense.”
Frazey said that one of the first steps her firm undertook last spring was to adjust its profitability index — a metric used to project a property’s future cash flows — for many deals in response to pandemic-related factors. Taking that step involved going back to underwriters and uncovering more information on the property, its locale and comparable deals based on that region’s bureaucratic response to COVID-19. Borrowers were typically understanding of this requirement, even if it translated to lower valuations, Frazey said.
Another mechanism that her firm implemented early in the pandemic involved offering borrowers three to four months of interest-only payments on their loans. Doing so enabled many borrowers to free up cash flows at a time in which shelter-in-place restrictions were hitting their tenants’ businesses particularly harshly and abruptly.
With less stress on the debt attached to their properties, borrowers could more easily tap into the equity side of the capital markets, which as Frazey noted, had ballooned in volume in the years leading up to the pandemic.
“The majority of the forbearance that we issued was interest-only, and most of our borrowers, when they emerged from that several months later, did not ask for loan extensions,” she said. “So taking that step really helped borrowers get their properties set up with the infrastructure that tenants needed to open their businesses back up when [stay-at-home] orders began to be lifted.”
The level of requests for forbearance was a factor of geography, with borrowers in states with harsher restrictions typically needing more relief, Frazey added.
Panelist Brian Hanson, managing director at Washington, D.C.-based special servicer CW Capital Management, said that the business of updating and modifying loans in response to the pandemic has kept mortgage bankers busy. As a special servicer, CW Capital’s client list includes a number of institutional investors with highly specific, customized finance needs.
In order to keep pace with these types of requests from borrowers, his company had to invest more in data analytics to really understand what’s happening with given properties and markets.
“As a special servicer, we’ve plowed a tremendous amount of money and resources into technology just to be able to absorb the mountain of data that’s coming out and to meet our clients’ expectations of having real-time analysis of that data,” he stated. “So some of our ‘COVID fatigue’ stems from doing this preliminary, surveillance-type of work and not necessarily dealing directly with loans that had issues.”
Hanson noted that in addition to spending more time on data analysis, his firm has also been fielding new inquiries from borrowers needing to finance properties, with agency-driven multifamily transactions accounting for much of the new deal volume.
In responding to these inquiries, CW Capital has leveraged its longstanding relationships with mass servicers, in the process developing new protocols to “triage” borrowers’ requests. By working with mass servicers, the firm has been able to better identify which loans are most in need of immediate relief and modifications.
The development of new business is one of the key takeaways in which this economic downturn has differed from that of 2008-2009, when transaction activity essentially shut down across the board, Hanson said. While acquisitions essentially ground to a halt at the onset of the pandemic, many lenders stayed busy with requests from borrowers to refinance their properties. In most major markets, sales activity began to rebound over the summer.
“During the last recession, there was hardly any takeout [of loans]; it was difficult to dispose of assets, and we simply had to ride them out,” Hanson said. “The difference in 2020 was that capital is available and eager to provide financing for mezzanine loans, preferred equity — essentially rescue capital for distressed borrowers. In addition, there has also been healthy capital available for new acquisitions this time.”
Another way in which the two downturns have differed for mortgage bankers involves default rates, which were significantly higher in 2008-2009 than in 2020, Hanson added.
Moderator Weibel then asked Hanson about the extent to which he expected loan modifications to persist in 2021, noting that his law firm was doing a lot of “surgery” on various loans for properties that were expected to weather the downturn.
“There’s bound to be some loans that need surgery in 2021, because there are so many external factors — vaccines, the stimulus package, the lifting of the eviction moratorium — we just don’t know what the impacts of these forces will be,” Hanson replied. “Depending on what happens in the next few months with those factors, the number of loans that will need modification could go way up or down.”
Panelist Richard Tsui, senior director and head of strategy and surveillance of global investment management firm Nuveen Real Estate, said that his firm was equally proactive in its efforts to get ahead of the deluge of requests for loan modifications that came down in the pandemic’s early days.
“In March, we implemented incident monitoring protocols and immediately reached out to all our borrowers and inquired about their financial well being and the status and impact to their properties,” he said. “We started these dialogues early and stayed connected with the industry. We talked to our servicers about all aspects of operation, including collections, covenants, trigger tracking — things like that.”
Tsui also says this firm monitored new legislation, particularly that which is tied to the National Association of Insurance Commissioners (NAIC), which oversees life companies. Nuveen also put together a special team to handle the rapid and drastic increase in phone calls and emails that started coming in from borrowers who requested or proposed alterations to their loans.
Later, Tsui addressed the resilience of the apartment sector throughout the pandemic, drawing careful distinctions about which multifamily product sub-types had been most vulnerable.
“Multifamily isn’t a complete failsafe, and assets that offered high-end amenities or were still in lease-up are probably feeling some pain,” he said.
According to the MBA’s data, the annual volume of loan originations for multifamily assets fell by 8 percent from 2019 to 2020. However, thanks to agency-backed financing, these properties still accounted for healthiest levels of production among commercial asset classes last year.
In the fourth quarter of 2020, multifamily loan originations rose by 14 percent relative to that period in 2019, MBA reports. In addition, the organization projects that annual multifamily loan production will rise from approximately $302 billion in 2020 to $323 billion in 2021, an increase of 7 percent. ν