How CMBS Lenders Squeeze Borrowers in Forbearance Deals

The CMBS market could be in for a turbulent year. A new report from Trepp estimates significant losses in the $540 billion of CMBS in the market—losses that will likely extend beyond the B-piece or junk bond class. Under a bearish scenario, up to 64% of the BBB bond market will incur losses.

In 2020, retail and hospitality product drove CMBS default activity. At the peak of delinquency numbers, 26% of hotel properties and 18.3% of retail properties were in special servicing. However, this year, multifamily and office properties are also showing increasing signs of risk for entering default, a trend that is fueling concerns, according to Trepp.

The good news/? Lenders are providing flexibility and forbearance, albeit on a case-by-case basis. The bad news, according to Trepp: lenders are taking this opportunity to tie up borrowers and make any potential future default under the loan painful.

Trepp takes a deep look into two hotel case to illustrate these trends.

Both properties are full-service properties in the Southeast, and both suffered occupancy losses during the pandemic. In the first example, the owner of a Comfort Inn incurred a $2 million operating deficit in 2020. The borrower’s post-COVID plan was $15 million below the loan’s principal balance, leaving no equity in the property. The borrower ultimately decided not to take a forbearance agreement, instead choosing to pursue a potential A/B note. Ultimately, the special servicer and borrower could not come to an agreement because the appraisal revealed that the property value was well below the loan amount. The special servicer has since required that a receiver manage the hotel.

The second case study is a boutique hotel property. The property owner has not made a loan payment until July when the property went into default. Unlike the first property, the appraisal revealed a higher value than the loan balance by 25%. The lender responded with a forbearance proposal that deferred principal and interest payments for six months, converted the loan interest through December 2021 and waived deposits to the property’s FF&E reserve for this year. All deferred payments will be repaid in installments beginning in 2022. Trepp noted in its report that “when the lender received renegotiated terms from the borrower that they didn’t like, the lender flexed its muscle via a legal notice, reiterating all of its rights under the loan documents, instead of picking up the phone to have a discussion. This is how servicers negotiate. Don’t expect a counteroffer.”

The Trepp report advises borrowers to expect lenders to “tighten belt-and-suspenders legal language when a borrower receives a forbearance or a major loan modification.”

It also warned borrowers to “look out for language concepts, including springing recourse, in the event of blocking foreclosure; additional reporting requirements with little, if any, notice; and cure language and attempts to easily assess potential future fees.”

In addition, borrowers will find it challenging to sell assets at appraised values, limiting opportunities to resolve loan issues. If net operating income doesn’t recover quickly, borrowers will find operations challenging this year.

The inner workings of CMBS loans are often a mystery to borrowers, because in a typical market, there is no need to be concerned about the process of special servicing. The special servicer has tremendous authority over the loan and potential deferral plans once the loan falls into default. Often the forbearance plans can vary greatly, and in most cases, all funds will eventually need to be repaid.