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Receiverships, Restructures and Turnarounds: What You Need to Know During the Coronavirus Crisis
This article written based on a conversation with attorney Richard Ormond that you can listen to here.
The Coronavirus crisis has created uncertainty in the commercial real estate industry. Transactions have ground to a halt. An estimated 30% of tenants failed to pay rent on April 1st, a situation that is expected to become exacerbated come May 1st. As the number of distressed situations continues to rise, there’s growing talk of receiverships, restructures and turnarounds.
Receiverships, restructures and turnarounds – what do these terms actually mean? We look at each of the terms below, including what we’re starting to see in the marketplace already.
What is Receivership?
The concept of receivership is as old as time, dating back at least until British common law more than a thousand years ago. Back then, it was a mechanism for the court to be able to manage real estate and prevent feuding landlords from having the land lay fallow. Essentially, receivership is a process by which the property is turned over to an officer of the court until the dispute is resolved.
In recent days, there’s been growing talk of receivership in the wake of the Coronavirus crisis. The economy has stopped dead in its tracks, and as a result, many businesses have been forced to close. Tens of thousands of Americans are out of work. Collectively, this has caused many tenants – residential and commercial alike – to miss their rent payments. Some landlords, particularly those who are over-levered, are at high risk of defaulting on their mortgages unless rent payments start coming in again. Right now, it’s anyone’s guess when that might realistically happen.
The CARES Act, the federal stimulus package intended to bolster economic activity, enacted several tenant protections. Landlords cannot evict people from residential properties (which carries over into the multifamily commercial segment) during the coronavirus pandemic. Meanwhile, banks are barred from beginning foreclosure proceedings for some time. Some cities and states have enacted even stricter regulations to that end.
That’s why receivership is back on the table.
What many people don’t realize is that most lenders don’t actually want to take ownership of commercial real estate. Banks are in the business of lending money—not managing and maintaining properties. Most lenders would rather place a property into receivership, thereby putting the operational onus on a third party, while the foreclosure proceedings, sale or other arrangement is worked out. Receivers are then responsible for all day-to-day management of the property, including securing the property (if vacant), lease management, rent collection, property maintenance and more. In some cases, receivers even have the authority to sell the property upon consent from the court.
Lenders typically prefer receivership sales to sales via foreclosures. Receivership sales tend to be faster, less expensive and result in higher sales prices (given the ongoing maintenance), which allows the lender to get the distressed loan off its books sooner.
Receiverships: What’s on the Horizon
There has been an uptick in people interested in receiverships over the past two weeks. There are two groups showing interest in receiverships already. The first group includes those experiencing financial distress with their borrowers, and who are interested in placing a property or business into receivership in lieu of foreclosure.
It remains to be seen how many borrowers will actually default, but lenders are clearly preparing for this possibility. While the CARES Act prevents some foreclosure proceedings for now, there are also conflicting regulations in place – those enacted post-Great Recession in 2008-09 – that obligate banks to take certain steps to move distressed real estate off their books. Even if lenders cannot act today, they’re preparing for this reality by setting up the infrastructure needed to support receivership when that time comes.
The second group inquiring about receiverships are opportunistic investors looking for distressed properties. Properties sold through receivership are usually more expensive than those sold via foreclosure but are still available at a discount relative to what they could be sold for on the open market. What we’re seeing so far is that there remains a group of investors who’ve been sitting on the sidelines, keeping their powder dry, just waiting for an opportunity like this to capitalize.
Notes: An Alternative to Receivership?
Lenders may also consider simply selling distressed notes to investors. Rather than going through the lengthy process of either receivership or foreclosures, banks may instead sell the paper associated with loan defaults to investors willing to pay 60 to 80 cents on the dollar. The buyers of those notes may choose to hold the asset, or alternatively, might pursue receivership or foreclosure on their own dime. But in either case, selling the notes at a discount is one way we might see lenders trying to move distressed property off their books quickly. At time of writing we aren’t at this point yet, but it could certainly be on the horizon.
What is Restructuring?
Restructuring is an interim step that some lenders will take in advance of receivership or foreclosure. Restructuring, as the name implies, is the restructuring of a loan to make it more advantageous to the borrower. This could include lowering the interest rate or lengthening the amortization period to make the total monthly payments more affordable to the borrower.
It could include an interest-only period, which would allow the borrower to defer paying principle for a set period of time. Six-month interest only periods are not uncommon, particularly when a lender has confidence in the underlying asset. Some lenders may even restructure loans in way that effectively “pauses” all loan payments for 3+ months, with those payments simply added to the principal.
Let’s use the example of a hotel. The travel industry has been pummeled in recent weeks. Many hoteliers have been forced to go dark. Yet their business, prior to COVID-19, was sound—often, highly profitable. A hotelier may discuss restructuring with their lender to bridge the gap during this crisis, paying interest only, for example, until travel restrictions have been lifted and people are booking hotel reservations again.
Restructures: What’s on the Horizon
We are likely to see lenders pressured to restructure as many loans as possible. After all, COVID-19 is an invisible threat that affects everyone equally—there’s no finger pointing or bogeyman to blame, unlike other economic downturns. The federal government will increasingly ask lenders to restructure loans to prevent widespread defaults which would otherwise result in a prolonged recession.
The extent to which a lender is able to do so really depends on the borrower’s financial situation, and the health of the underlying business. A lender will want to see what cash flow looked like prior to the COVID crisis vs. what it looks like today and projections for the future. They’ll want to take a detailed look at the borrower’s balance sheet to understand whether the loan can realistically be right-sized in the short-term, or whether default seems likely regardless.
Demand for “Chief Restructuring Officers” Expected to Rise
There’s going to be increased demand for professionals who are specifically trained to deal with loan restructuring. These professionals, most often bank employees, were in high demand back in 2008-2012, but many have since moved on into different roles or professions as the economy improved. Lenders are already starting to enlist the support of a “chief restructuring officer” or similar professional who can oversee short-term modifications made on a good faith basis in response to COVID-19. These restructuring officers will have special training in managing distressed assets. Most, for example, will have the skills needed to use a carrot/stick approach to maximize cash flow and improve a distressed situation before a property falls into foreclosure, or business into complete insolvency.
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What are Turnarounds?
Coronavirus has pushed some businesses to the brink of insolvency. To avoid this worst-case-scenario, businesses are already looking at various turnaround programs. A turnaround can be handled in many ways. It could include renegotiating obligations with creditors, such as asking them to lower payments. It may include Chapter 11 bankruptcy, where the business formally restructures its debt as proscribed by a court officer. A combination of both legal and practical tools can be used in a turnaround program depending on a business’s individual needs.
Deloitte has outlined a helpful, four-step turnaround program for those facing insolvency due to COVID-19. The four-step process includes:
1. Stop the bleeding
The insurance company has the burden to prove that there is no coverage under the policy and is obligated to investigate all relevant facts and circumstances surrounding a claim.
2. Analyze the business
There may be governmental intervention or court decisions that compel insurers to pay losses as a result of COVID-19, in which case it will be important that owners have already filed a claim. There are ongoing legislative discussions in multiple states on this topic (including in Massachusetts, New Jersey and Louisiana).
3. Develop a restructuring plan
That prioritizes opportunities, such as new capital arrangements or M&A opportunities, that will protect the business.
The final step is to implement the restructuring plan. Successful implementation will track progress by monitoring KPIs such as certain cash achievements.
As Deloitte notes, stakeholder communication and crisis governance will be critical throughout the duration of any successful turnaround program.
Turnarounds: What’s on the Horizon
The COVID crisis continues to evolve rapidly. We’re still in the beginning phase of this recession, where the need for turnarounds hasn’t become prominent just yet. The first round of debt payments was due on April 1st. Some borrowers missed their payments; others had enough cash on hand to manage through for now. May 1st will be very telling.
At this point, many businesses will have been closed for a month or more. Revenues will have plunged, and it will become clear who has enough liquidity to weather the storm for a bit longer. By the time we hit June 1st, or later, July 1st, we’ll have a more comprehensive picture of the extent to which turnarounds will be needed to protect businesses from insolvency. It’s a situation that investors, lenders and other stakeholders continue to monitor closely.
Receiverships, restructures and turnarounds are not new. They’ve certainly slowed down in recent years, compared to the frequency with which they happened during the Great Recession. But there have always been distressed situations for lenders to work through with their borrowers. How quickly and with what intensity we see an uptick in receiverships, restructures and turnarounds as a result of COVID remains to be seen.
One of the reasons for this uncertainty is that every downturn is different. This recession will look different than the last and will look different than the one before that. Some suspect banks will be able to move faster this time around, moving distressed loans off their books more efficiently than in years past. Conversely, there are likely to be more distressed situations hitting at once (vs. the gradual buildup of distressed loans during the Great Recession), which could result in capacity issues, particularly amongst lenders who are not yet ramping up to adequately address the influx of distressed cases.
This is where we’ll see the greatest opportunity for investors. Now is a time for investors to line up capital for opportunities that arise out of these distressed situations.
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