lending and why you should do it.

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, because the invention of Commercial Mortgages, there have been Commercial Loan Modifications. In the good old days "modifications" had been 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 employed in the loan.

A commercial modification could also consist of a change in the term of the loan much more specifically the amortization period of the loan. Lenders learned a valuable and expensive 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 normally for 30 years. The problem that arose is if you have cash 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 money at 105, 15% or even as high as 20% but collecting at 5% that creates a dilemma. Banks are in the business 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 long term low interest loans in a rapidly rising interest rate environment turning each of those lengthy term loans into a losing proposition for the Lender. Enter the "Balloon Mortgage" it's the best of both worlds, lower payments based on lengthy term amortization with a Balloon payment due in 5, 7, or 10 years usually.

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

An additional 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 had been cast using a 20 year amortization are being modified to a 25, 30 or in some cases 42 year amortization schedules.

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

Frequently, lenders are given to charging fees for late payments, events of default, impounds, force placed insurance, and Lender ordered appraisals and much more. Believe 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 scenario by adding extra "junk" fees that constitute extra profit to the Lender but improve 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 poor situation worse.

Here is a "dirty little 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, especially here in Florida, where the Servicer isn't even empowered to collect the payments let alone extra fees.

An additional 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 usually tied to a particular 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.

During the period of typical forbearance the Borrower is usually 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 distinction 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 $6.4 TRILLION that's $21,333.33 for each and every man, woman, and child in the United States of American.

By most estimates the Commercial Investment Marketplace has lost 40% of its overall value since the peak in 2007. That loss is an average and is an "across the board" number. Since 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 kinds have been hit hardest whilst others have escaped unscathed.

The challenge for Borrowers and Lenders alike is establishing a value for a particular piece of property in the context of today's marketplace. There are numerous elements to be regarded as such as income occupancy, expenses, location, future prospects, employment, and the overall economy.

There are main 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 much as Miami Beach Florida.

Add to that the reality that between 2010 and 2012 there are estimated to be $1.4 Trillion dollars worth of Commercial Mortgages scheduled to Balloon, in a marketplace that has seen the biggest retreat in capital in the history of the country. Put simply 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 $10,000,000 office building, put $2,500,000 down and mortgaged the balance of $7,500,000. The building has since lost 40% of its original value so it's worth about $6,000,000 the original Lender is owed $7,500,000. The Borrower tries to find a replacement Lender and the only provides they can get are at a 50% LTV based on today's value or roughly $3,000,000 with personal guarantees and hefty fees and costs.

There is much 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 these days. That's very a although for a recovery no matter how you view it.

The Federal Government recognizes there is a crisis looming in the Commercial Mortgage Marketplace in reality there is no paucity of Politico's willing to weigh in on the subject. In truth it's possibly simpler 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 different 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. Keep 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.

Benefits 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 process is a procedure of offer and compromise by and between the Borrower and the Lender typically with a facilitator (consultant) acting as a neutral third party whose job it is to bridge the gap between the two. The Consultants job is to care...but not that significantly about the outcome so as to stay neutral and objective.

The Borrower remains in possession and gets to enjoy the benefit of continued cash flow, albeit at a decreased rate. This is especially essential 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 her primary company address it could be fairly expensive to relocate specifically if the property has been extensively adapted for the Borrowers use. Adding to those costs are the costs associated with moving, relocating machinery, utilities, upgrading fundamental systems (i.e. electric, water, sewer, gas) the removal or installation of docks, roll-up doors not to mention all the downtime associated with the act of moving itself.

There is also the prospect of enterprise interruption and the defection of employees who get wind of the foreclosure or if they object to the move.

Traditionally, real estate markets tend to double in value each and every 7-10 years. If we are not presently at the bottom of a real estate cycle we certain are close that means that ultimately the markets will recover and begin to trend upwards. The ULI report suggested stability in 2020 that means a recovery sometime will begin between now and 2020's stabilized marketplace.

If the Borrower can somehow manage to hold on by means of the current crisis he or she may possibly eventually be made entire. In plain English they may be able to sell for more than they have in the property generating a profit. By staying in title the Borrower can still take benefit of the favorable tax treatment accessible via cost recovery (depreciation) capital gains treatment, and possibly a 1031 Tax Deferred exchange.

The other surprise avoided is the taxation associated with "debt forgiveness" what most people don't understand is when a property is surrendered via a "deed in lieu of foreclosure" that is not the end of the story. Depending on the amount of "forgiveness" there could be drastic, adverse tax consequences. The Borrower ends up owing taxes on funds they never received or benefited from.

An additional problem that is most likely the most problematic is the "Deficiency Judgment". The deficiency judgment arises when the proceeds of the foreclosure sale are not sufficient to liquidate (payoff) all or a portion of the mortgage, fees, penalties, court costs, taxes and any special assessments. The Lender will then seek a deficiency judgment and attempt to enforce those rights by seizing and selling any and all assets of the Borrower they can discover which includes personal property, bank accounts, retirement accounts, and other real estate owned by the Borrower.

Advantages to the Lender.

The Lender can benefit from a modification in a number of ways. 1st, since it is a non-judicial process the Lender does not incur the huge fees associated with a foreclosure. There is no require for discovery, depositions, court reporters, filing fees, and the all important billable hour. Since it is a comparatively simple process the Lender can bring counsel in at the end of the procedure saving time and cash.

Due to the fact a modification is an "supply and compromise" the procedure is not subject to the vagaries of the court system. There is no require to get on the docket since there is no hearing process. The wait to get your "day in court" could be measured in years depending on your jurisdiction whereas a typical proposal is presented within weeks.

Because the procedure is a non-judicial procedure there are no court costs, no waiting to file responses, no complaints, and no lost pleadings the Consultant produces the proposal, gets the Borrowers approval to present it and the Lender is provided a copy.

As mentioned above in the Buyer/Borrower advantages section the Lender could be made entire as well. If the Lender elects to foreclose and sell in today's marketplace they are guaranteed at least a 40% loss. The loss severity discussed earlier coupled with the fact that capital is not accessible means that the Lender is searching for a "cash" buyer, and cash commands a deep discount.

The income will most likely have dropped due to boost vacancy (the dilemma that precipitated the foreclosure and the mass exodus after the tenants become conscious of the suit) a possible rent strike by the tenants that stay, and the want for concessions to attract new tenants. The Lenders loss could substantially higher (60%, 70% or much more).

If the Lender and Borrower can come to some type of agreement and prevent that loss when the market does return to normal the Borrower and Lender could agree to sell and or refinance and both are made entire.

Lenders and Banks are in the company of lending money not managing commercial real estate. They are not equipped to manage real estate and despite the brave face they put on they have to hire local management, usually it's not who they want it's who they can get and of course results vary greatly.

Lenders aren't equipped to make or manage repairs, tenant improvements, or day to day maintenance of a property. These items can be the difference between success and foreclosure sale. In a recent case a Borrower who owns a building directly adjacent to a building that a lender has taken back. The Lender's building is 100% vacant and has been that way for 3 years because the shell was completed. The Lender has instructed its broker to "poach" as several tenants as feasible from the adjacent fully tenanted building as he can.

One reason that hasn't worked is the Lender is unwilling or unable to do the tenant requested develop out. The Lender is also unwilling to sign a lease for longer than one year pending a presumed sale.

By keeping the Borrower in location the Lender has one point of contact to deal with particularly when it comes to collections. Imagine the difficulty of collecting rent from 300 apartment dwellers from across the country.

Keep in mind that as soon as the Tenants turn out to be aware of the foreclosure 50% or more will go on a rent strike further depressing the income stream and causing even higher collection issues.

Examiners like performing loans, whether a bank is Federally Chartered or State Chartered Examiners like to see piles of performing loans. The Examiners don't care at what rate or level just so lengthy as they are performing in some form or fashion.

In that White Paper I mentioned earlier the FDIC offered 12 or so various methods to make a non-performing loan a performing loan. The most creative was to split the loan into two pieces 1 that works and 1 that doesn't the Lender only has to recognize the smaller non-performing portion for regulatory purposes despite the fact it is part of a a lot larger loan, creative eh?

Due to the fact there is no loss the Lender doesn't have to post a Loan Loss reserve thereby preserving the Lenders capital and possibly a few jobs in the bargain. If the Lender has money they remain solvent and as lengthy as they don't reach a level that panics regulators the Lender stays open and everybody keeps their jobs.

By modifying a loan the Lender eliminates the uncertainty associated with a protracted marketing campaign. In today's market how lengthy could it take to identify a prospective buyer or buyers? Then once you have some suspects you want to qualify them to make them prospect. Not everyone will have the cash essential to purchase, and most definitely will not have the credit and credibility.

The prospects will make the usual low-ball offers and it may possibly take months to bridge the gap between the Lenders aspirations and the Buyers expectations. Many transactions will unravel in due diligence and the Lender can anticipate be re-traded at least once or twice. The broker should anticipate a fee haircut. That whole procedure is eliminated by keeping the Borrower in place.

By remaining out of the chain of Title the Lender avoids all the "what if's" associated with ownership. What if we get hit by a Hurricane, earth quake, Tornado, Tsunami? What if the area is down zoned, the main employer closes shop and leaves town (GM). What if the market worsens, changes, or just goes away. What if there is a fire, flood, civil unrest, all of these can and have happened just feel about California, Hawaii or most recently Chile, China, Haiti.

Lenders and Banks are extremely cautious and protective of their image in the community. They don't want to be seen as an evil empire wiping out the little guy. Locally, there is a Lender that made it a point to lend to houses of worship...imagine foreclosing on one of those. Imagine the Ill will that would produce in the community particularly among the members of the congregation.

Bottom line, Lenders don't want the property they want the money the further into this crisis we get the much more reality apparent that will turn out to be.

Commercial Lending