A maturity default occurs when the borrower under a mortgage loan fails to pay the lender the balloon payment, or principal balance, when due at the maturity of the loan. This term, which has not seen widespread use in recent years, seems to be on everyone’s lips in real estate and banking circles.
While you can have a maturity default on a loan which was already in default for failure to pay debt service or breach of covenant, it is now not uncommon to see loans which were fully performing up to the maturity date, but the borrower is unable to pay off the loan at maturity. This is the type of maturity default addressed in this article.
Few borrowers have the financial resources to pay off a substantial balloon payment on a commercial mortgage with their own funds. The traditional source of repayment is through a refinancing loan, either from the same lender or a new lender. Many borrowers facing maturity are now finding that refinancing loans are unavailable. CMBS is moribund. Large banks and other traditional lenders have no liquidity as a result of the credit freeze. Other lenders are not making loans because of the uncertainty of the value of real estate assets in the current market. There is some mortgage money out there, particularly from regional and local banks, which have lower lending limits. But wherever capital is available, the rules for real estate lending have changed dramatically. The name of the game now is lower leverage and skin in the game. It is not uncommon to see lenders offering terms which include 60% to 65% loan to value; 1.30% to 1.35% debt service coverage; and partial, if not full, recourse. With higher equity requirements and lower real estate values, many borrowers cannot come up with the cash now required to refinance.
Borrowers in these circumstances do have options. The number one option is to negotiate a restructuring and extension of the loan with the existing lender. The lender will not be happy to hear that the borrower is looking to extend the loan. After all, the borrower contracted to pay off the loan at maturity. This will not, however, come as a surprise to the lender, who is now spending most of his time dealing with defaulted loans. A number of factors may cause the lender to favorably consider a restructuring and extension. This has been a fully performing loan, unlike many others, and ideally the property is generating sufficient net operating income to continue to pay debt service as well as leasing costs and capital expenditures. The lender wants to avoid a maturity default, which will require him to take a substantial write-down of the loan. In a real estate market with increasing supply and decreasing demand, the lender doesn’t want the property stigmatized as “in foreclosure” or “REO property”. The number of foreclosures is at an all time high, and in New Jersey an uncontested foreclosure may take 12 – 16 months. The lender really doesn’t want to take the property back. He has lots of other properties he has taken back or will be forced to take back, and there are not a lot of buyers out there. He knows that you can manage your own building better than third party management hired by the lender. Finally, with several trillion dollars of commercial mortgage maturities occurring over the next few years, he knows that things are likely to get worse.
If the lender is inclined to extend the loan, he will squeeze the borrower to put some skin in the game with additional equity to pay down the loan and a partial guarantee. The borrower should count to ten and think carefully before responding. If the original loan was made five years ago at 75% of the then value of the property, current value may not exceed the loan balance. The borrower must understand that, at this point, he has no equity in his building, other than emotional equity. Emotional equity has no value and should not be a factor in what is in reality a new investment decision. The borrower has nothing tangible to lose, but the lender has a lot to lose and knows that he will likely take a substantial haircut if he has to take back the building. The borrower should resist any guarantee, and offer to put up equity so that he does have skin in the game, but insist that the lender forgive some substantial portion of principal. Here is where the negotiation gets interesting. Every deal is different, and not all lenders can or will write down principal as part of a restructuring and extension, but some have and many more will. Other factors to be negotiated include interest rate, amortization, reserves, fees and term. If you are going for the extension, you want five years. Don’t count on the credit markets returning to normal, or real estate values recovering, in a year or two.
Some borrowers are interested in negotiating a payoff of their maturing mortgages at a substantial discount. Many lenders today would be happy to sell defaulted mortgages at a substantial discount, and are doing so. The amount of any discount will depend upon the lender’s perception of the value of the property, NOI, rent roll, condition of the property and other factors. Discounts usually require immediate payment in cash. If the borrower doesn’t have the ready cash, and wants the lender to agree to a discount and then give the borrower time to come up with the money, it is a harder sell but by no means impossible. Many lenders are anxious to be taken out, and will give the borrower a forbearance period during which the lender will agree to accept a specified amount in satisfaction of the mortgage debt.
For the reasons given above, lenders are under siege. This is good news and bad news. The good news is that a borrower may well be able to get relief. The bad news is that it may not be the relief the borrower is looking for. Lenders may be inclined to do the minimum needed to avoid the impending maturity default, and then sweep the problem under the rug. They are likely to offer an extension of six months or so, charge the borrower a fee and increase the interest rate. Remember, things are likely to get worse, and this is only postponing the inevitable. It is in the interests of both parties to deal with reality, and many lenders are beginning to see the light.
What if your mortgage is maturing in a year or two or even three? If you have a performing loan, it is not too early to talk to your lender about extending the loan. Some lenders will understand that this makes sense. Unfortunately, in most circumstances, it may prove difficult to get the lender’s attention.
As always, a borrower should do his homework, understand his options and the lender’s options, and put together the best possible negotiating team.