Financial Resource

What is a commercial loan modification?

It has been said that there is nothing new under the Sun and as far as Commercial Loan Modifications go that is true. For years, since the invention of Commercial Mortgages, there have been Commercial Loan Modifications. In the excellent old days “modifications” were known as workouts and addressed the exact same issues that a modification does.

Commercial loan modifications can be crafted in a number of guises and could consist of a reduction of the face rate of the mortgage, it could consist of changing the index, fixing the rate, or changing the margin used in the loan.

A commercial modification could also consist of a change in the term of the loan more specifically the amortization period of the loan. Lenders learned a valuable and costly lesson in the 1970’s and early 1980’s about long term lending specifically occasionally it doesn’t work. In the 1960’s and 1970’s lenders were given to lending on a long term basis typically for 30 years. The issue that arose is if you have money out at say 5% for 30 years and the interest rate environment changes to 21% the Lender is upside down.

In that scenario the Lender is borrowing cash at 105, 15% or even as high as 20% but collecting at 5% that creates a issue. Banks are in the company of borrowing cash (via CD’s, Annuities, and Savings Accounts) and lending it a profit. That profit is the “margin” or the spread between what they pay on the CD’s and what they can charge the consumer of capital (Borrower).

In the 1970’s the banks got caught with lengthy term low interest loans in a rapidly rising interest rate environment turning every of those long term loans into a losing proposition for the Lender. Enter the “Balloon Mortgage” it’s the greatest of both worlds, lower payments based on long term amortization with a Balloon payment due in 5, 7, or 10 years usually.

The issue today is that there is no capital market for commercial loans. Anybody with a Balloon coming due in the near future will have an very challenging time refinancing. The reality that there is small in the way of lending going on, and a nearly 40% decline in values because 2007 Lenders have drastically lowered their LTV’s and the issue becomes evident.

Another possibility is to lengthen the term of the loan, making the amortization period longer thereby lower the payment granting some relief to the borrower. In some cases loans that were cast using a 20 year amortization are being modified to a 25, 30 or in some cases 42 year amortization schedules.

This may reduce the payment just enough to make it manageable for the borrower and to return the loan to a performing status.

Often, lenders are given to charging fees for late payments, events of default, impounds, force placed insurance, and Lender ordered appraisals and more. Think of the wisdom in that practice, the Borrower, already cash strapped is struggling to make his or her payment they may even be severely in arrears. The Lender compounds the situation by adding additional “junk” fees that constitute extra profit to the Lender but increase the quantity of the default and could raise the debt service substantially.

These are Borrowers who are having difficulty sufficient meeting the monthly obligation so the Lender makes a bad situation worse.

Here is a “dirty small secret” the Lenders don’t want anybody to know, they might be illegally (fraudulently) charging those fees when not legally entitled to them. There are instances, particularly here in Florida, where the Servicer isn’t even empowered to collect the payments let alone additional fees.

An extra step in modification procedure could involve some level of “Forbearance” where the principal and interest payments are halted for a period of time this is generally tied to a specific event like reaching a certain number of tenants or a particular income objective. In this scenario the unpaid payments could be forgiven but will most likely be “tacked” onto the back of the loan.

In the course of the period of typical forbearance the Borrower is generally plowing all the money flow back into the property in the form of tenant improvements or lease concessions. The concept being once the property performance improves the Borrower will resume making some level of payments.

The Lender and Borrower could also agree to an interest only payment in which the Borrower pays a minimum payment based on a stipulated interest rate and the principal balance remains unchanged. The Borrower once more gets the benefit of a lower payment which could make all the difference between hangings on or a messy foreclosure.

In closing the Borrower and the Lender could agree to just about anything from forbearance to a participation mortgage from a principal reduction to a recasting of the whole loan. The bottom line is that any change of the terms of the original note and mortgage is a “modification”.

Why now?

There is an enormous crisis brewing in America and the World in the Commercial Mortgage company, this crisis is twice the size of the United States’ annual Federal Budget, four times the size of the Residential crisis. According to a recent Company Week article total outstanding debt totals .4 TRILLION that’s ,333.33 for each and every man, woman, and child in the United States of American.

By most estimates the Commercial Investment Market has lost 40% of its overall value because the peak in 2007. That loss is an average and is an “across the board” number. Because real estate is a local phenomenon that loss can be and is higher in some areas of the country and much less in other people. Some property types have been hit hardest although others have escaped unscathed.

The challenge for Borrowers and Lenders alike is establishing a value for a certain piece of property in the context of today’s marketplace. There are many factors to be considered such as income occupancy, expenses, location, future prospects, employment, and the overall economy.

There are key differences between the values of an office building in the Washington DC region versus an office building located in Detroit Michigan. Apartment values in New York and Manhattan have not suffered as a lot as Miami Beach Florida.

Add to that the fact that between 2010 and 2012 there are estimated to be .4 Trillion dollars worth of Commercial Mortgages scheduled to Balloon, in a market that has seen the biggest retreat in capital in the history of the country. Put merely lenders aren’t willing to lend, and if they are it is at levels and costs that make no sense in the face of the capital requirements of most Borrowers.

As an example a Borrower bought a ,000,000 office building, put ,500,000 down and mortgaged the balance of ,500,000. The building has because lost 40% of its original value so it’s worth about ,000,000 the original Lender is owed ,500,000. The Borrower tries to discover a replacement Lender and the only provides they can get are at a 50% LTV based on today’s value or roughly ,000,000 with personal guarantees and hefty fees and costs.

There is more news according to the Urban Land Institute’s Emerging Trends Report for 2010 the markets aren’t expected to recover until 2020. That means that prices, capital, and property will all converge nearly 10 years from right now. That’s fairly a while for a recovery no matter how you view it.

The Federal Government recognizes there is a crisis looming in the Commercial Mortgage Market in reality there is no paucity of Politico’s willing to weigh in on the subject. In reality it’s most likely less difficult to name who has not weighed in on it Christopher Dodd, Sheila Bair, Ben Bernanke, our president most of the cabinet, congress, and senate have all opined on the state of the commercial mortgage and real estate markets.

The FED has stated that most likely the only way to stabilize the market is to engage in some form of modifications and workouts. The FDIC even issued a white paper that set forth at least 12 distinct scenarios under which a bank could modify a loan and still has it pass the Examiners intent gaze.

The consensus across the board is “Extend and Pretend” maintain the loans in place, in the field, and off the Lenders books. Bear in mind to the Lenders, especially Banks a foreclosure and possession is a liability and not an asset. Banks have to “reserve” cash for an anticipated loss as a result of taking back a property. If a bank takes sufficient properties back the bank itself becomes illiquid and is subject to seizure by the FDIC and liquidation.

Advantages to the borrower.

Obviously, the Buyer would love to stay in possession of the property and continue to own and operate the building. The Buyer/Borrower has spent great time, cash, energy, and effort to manage and maintain the property the and last thing they want is to be dispossessed.

Because the loan modification procedure takes place outside the court system there are no Judgments or Law Suits filed. The modification procedure is a procedure of offer and compromise by and between the Borrower and the Lender generally with a facilitator (consultant) acting as a neutral third party whose task it is to bridge the gap between the two. The Consultants job is to care…but not that a lot about the outcome so as to stay neutral and objective.

The Borrower remains in possession and gets to appreciate the benefit of continued money flow, albeit at a reduced rate. This is especially crucial to a Borrower who derives the majority of their personal income from the operations of the property.

If a Borrower uses the property as his or

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