As if the economy and the tight credit markets were not enough, real estate developers are faced with a new challenge. Banks are informing real estate developers at loan maturity that their cash-flowing, debt-servicing property is now considered substandard because of the value of the collateral produced by the Bank’s latest appraisal.

The key to a successful resolution of a loan that has matured or needs to be restructured is bridging both the credibility and expectation gap between the borrower and lender. 

The issue in any successful negotiation is to understand what both parties need.  Litigation and bankruptcies are evidence of failed negotiations.  This article will not address all of the ingredients for a successful negotiation, but I will discuss some of the more prevalent issues.

Pricing
Clearly pricing has dramatically changed in terms of spreads over LIBOR or Prime.  The highest cost of capital is not having it.  With the demands on liquidity in today’s market, new or maturing cash has a higher price because it is scarce. 

Developers consistently state that “my property is not cash flowing like it used to and the Bank wants more.”  The key to establishing more reasonable pricing involves a series of metrics that involve paydowns, shorter maturities or credit enhancements (more collateral or guarantees). 

If the maturity is shorter and the property can be positioned for a liquidity event (sale) then optimum pricing may be achieved.  The Bank either wants a liquidity event or a performing loan.  Both situations require something of the borrower.  If the borrower is constrained or unmotivated to provide the necessary optics for the Bank, then the developer will sacrifice either time (length of maturity) or pricing.

Loan to Value
Most development loans were underwritten with 70% to 80% loan to values.  If the loans were more aggressively underwritten they often had curtailment payments or financial benchmarks.  The issue today is valuation.  Appraisers are taking ultra conservative positions to the detriment of both the Bank and developer in the restructure process. 

As a developer, you can fight about valuation, but it is hard to argue that value hasn’t dropped at some level.  I have yet to see a developer litigate over value with a Bank as a defense to collection litigation.  Many banks lately have been more reasonable if they can at least get a right sizing to a 95% loan to value. 

Conforming Loans
If as a developer, you have a property that is clearly underwater, I find the A/B structure of loan workouts is feasible.  The A piece is conforming in terms of LTV and pricing. It looks like a standard performing loan that requires no loan loss reserves by the Bank. 

The B piece is the “air ball” or exposed piece representing the potential loss.  The B piece is often reserved, based on the strength of the guarantor and other credit enhancements.  This structure works best when the B piece gets a new borrower that may be affiliated or related in some way to the A piece borrower.  The strategy for the Bank is to not have the whole relationship fully reserved.  There is an art to this structure that is difficult to express in this article, but I mention it as a tool in the restructure process.

Deficiencies and Deficiency Notes
I know of almost no developer that wants to be obligated to pay for a loss in today’s market.  Essentially, the deficiency note is a “game over” instrument that realizes there is a remote likelihood of a favorable outcome in terms of equity preservation. 

The deficiency note is a type of settlement that often involves a distressed sale or a deed given to the Bank in lieu of foreclosure. 

A careful assessment by the developer of his bigger financial picture is required to determine whether this is an attractive alternative.  The stigma of bankruptcy or judgments can be averted.  The developer can live to fight another day and go about his business with more attractive opportunities rather than consuming energy and financial resources to engage in a fight where the only conceivable outcome is the delay of the eventual loss.

Conclusion
Loan restructuring is an art.  It requires detailed analysis, an assessment of your best alternative to a negotiated agreement and an objective education of what motivates each party in the transaction in light of their economic alternatives.  This process can best be handled by professionals who bring an experienced, unemotional review of the likely outcomes and motivations.