Pandemic Highlights Benefits of Relationship Lending

This article appeared in the August 2020 issue of the Colorado Real Estate Journal's Retail Properties Quarterly  https://crej.com/current-issues-and-archives/

As the coronavirus pandemic enters its sixth month and with no signs of abating, retail property owners are facing unprecedented challenges on multiple levels. For those retail owners unable to pay their existing commercial mortgages or those that are facing an upcoming loan maturity, these challenges are especially acute. While the pandemic and its associated government and public health response has dramatically changed consumer behaviors, what hasn’t changed is the importance of strong lender relationships and their ability to solve the biggest problems retail property owners have faced in recent memory.  Strengthening existing lender relationships and forming new ones will arguably be the most important factor in determining which property owners will make it through the pandemic intact. 

Two recent reports, one from Trepp [1] and one from the NAIC [2] highlight the breadth of the challenges retail property owners are facing: The total volume of CMBS loans collateralized by retail properties was about $122.5 billion as of YE 2019.  Of that, 18.07% (about $22 billion) were more than 30 days delinquent as of June, which was an increase of 793 basis points from May. In addition, 14.3% of all retail CMBS loans ($17.5 billion) have been assigned to the special servicer, suggesting foreclosure is imminent.  Both statistics will likely get worse before they get better, as the quick, v-shaped economic recovery many expected has failed to materialize.     

Delinquency data for retail loans held by life insurance companies and banks are more difficult to find, but a few data points are available.  Essex Financial Services (an affiliate of Essex Financial Group) currently services a portfolio of over 200 life insurance company loans originated by Essex Financial Group, with a total unpaid balance of $1.8 billion across all asset types.  Retail loans account for approximately 26% of the total portfolio, spread over 62 individual loans. Since the start of the pandemic in March, only one loan showed a missed payment, and that has since been made current. 

Before one can draw any conclusion between these statistics, it is important to remember that life company and CMBS loans differ in significant ways. Compared to CMBS loans, life company and bank loans are typically more conservative, with lower loan-to-value ratios, less interest only periods, and lower interest rates. In addition, both banks and life insurance companies are less likely to lend on power centers, malls, and other properties with large, non-grocery tenants.  These factors make missing a payment on life company and bank loans less likely than with CMBS loans.   

The stark difference between CMBS delinquencies and life company delinquencies – albeit in a very limited sample size – illustrates how valuable relationship lending can be for retail borrowers.  At the start of pandemic the majority of life insurance companies were proactive in granting their borrowers’ requests for several months of interest-only payments, with the option to extend those benefits at the lenders’ discretion. Borrowers were also given short-term variances from the lease approval and modification provisions outlined in loan documents, allowing borrowers to grant their tenants rent deferrals or abatements without lender or servicer approval. 

Banks were even more aggressive when granting their borrowers relief, as they offered complete debt service forbearance for several months, and in some cases the offer of relief was unprompted by the property owner. Banks provided the added benefit of being able to work directly with property owners to process requests for government relief such as PPP loans or SBA EIDL grants. 

When working with either life companies or banks, communication between borrowers and lenders was direct, straightforward, and efficient. In the event borrowers needed help providing documentation or supporting info when making their loan modification request, their mortgage banker or servicing contact was available to assist them.  In almost all cases, relief was granted within days. 

Contrast this experience with that of a CMBS borrower facing difficulties paying their debt service. Unlike life company and bank loans, CMBS loans are not serviced by the lender that originated the loan, and there are often multiple loan servicing companies that are assigned to a particular loan, which makes identifying and communicating with the appropriate person difficult.  Further complicating matters, a loan servicer’s responsibility is more aligned with the investors of the CMBS bonds and not the property owner, as special servicers often have a right to acquire a foreclosed property at a discount on behalf of the investors.  CMBS loan modification requests require several layers of approval, and the interests of all parties are not always aligned.

The economic impacts of the pandemic were felt by retail property owners almost immediately.  But when quick and decisive action is not made available by lenders, rising delinquencies and foreclosures are the result. 

With relatively healthy retail loan portfolios, both life insurance companies and banks still have a strong demand for commercial mortgages and are actively lending on retail assets, albeit with more conservative underwriting and loan terms than at the start of the year. Funding a retail loan in this environment is also likely to require more structure, and this can take form of funded debt service reserves, free rent holdbacks, and short interest only periods in the first months of the loan term. Grocery-anchored centers, free standing retail, child-care facilities, and automotive repair centers are still attractive property types for lenders.  Unanchored strip centers are also being considered at the right leverage for borrowers with existing lender relationships. 

For any property owner facing an upcoming refinance or capital event, it is imperative to be proactive and begin communicating with lenders early in the process. Banks and life companies will need to understand the occupancy and payment history for each tenant, any free or deferred rent offered to tenants, and any existing loan modifications that have been made in the past few months. Keeping detailed cash flow records and documenting all agreements with tenants are good practices to implement. Lenders know that the impacts from pandemic are out of most property owners’ control, so they will not think negatively of borrowers who have offered or accepted relief as long as they are able to demonstrate that it was necessary and in the best interests of the property. 

For those property owners that do not have strong lending relationships, or are looking to develop new relationships, tapping into their network of real estate professionals will likely yield positive results.  Mortgage brokers have spent years developing strong relationships with both life insurance companies and banks and will be able to help you identify, analyze, and execute on the loan that best fits your business plan. Asset and property managers have experience communicating and working with the servicing departments of a variety of lenders and will be able to offer good feedback on the benefits and drawbacks of each. Investment sales brokers will be able to make recommendations on which mortgage brokers and lenders are the best at delivering their quoted terms and executing on time.

The coronavirus pandemic has taught us all many lessons, but for retail property owners, it’s clear that those with strong lender relationships have been better able to diagnose and work through problems quickly and efficiently allowing them to stay current with their existing mortgages and to hopefully emerge from the pandemic in good financial condition.