Commercial Real Estate Debt Restructuring

Since the financial crisis, banks had been extending many loans with the hope that asset values would recover rather than pushing for repayment and risk having to classify loans as non-performing. However, with ultra-low interest rates and lack of pressure by regulators to clear weak loans from balance sheets, banks have used this time to build loan loss reserves. With stronger balance sheets and greater regulatory scrutiny, banks can no longer continue to carry those kinds of loans on their books.

With underwater loans coming due, debtors risk not only losing their assets through foreclosure, they also jeopardize other collateral, including personal assets, when loans include cross-collateralization or personal guarantees. In these cases, banks are much more aggressive in demanding full repayment and pursuing borrowers for deficiencies when foreclosure and subsequent asset sales fail to fully cover loan balances.

Helping with the Debt

There is no single best way to assist those in distress with commercial real estate debt. Bankruptcy attorneys, together with financial restructuring advisers, have developed a comprehensive set of best practices that achieve objectives such as:

• Comprehensive analysis and strategic planning, taking into consideration the client's entire portfolio and the net benefits of every possible alternative;
• Multidisciplinary team negotiation with creditors, which in itself creates a position of strength;
• Strategies to protect the debtor's core business liabilities and minimize risk for other stakeholders;
• Reduction or elimination of personal guarantees;
• Restructuring the balance sheet to restore liquidity, positioning clients to return to financial stability;
• Debt reduction;
• Discounted payoffs; and
• Recapitalization funding to implement negotiated solutions.

In essence, best practices combine the legal expertise of bankruptcy attorneys with the financial expertise and business strategy of the financial restructuring advisers. Because of the nuances specific to each bank and loan, the partnership between a financial restructuring firm and experienced bankruptcy legal counsel is critical to maximizing the outcome for the client to achieve the highest level of financial analysis, assessment of all strategic alternatives and the most aggressive and experienced negotiation with creditors.

What the Restructuring Professional Does

The financial restructuring professional works side by side with the clients' bankruptcy attorney for interpretation of federal and state regulations, legal procedures, and the developing case law relevant in each situation. In addition, there is often the need to use legal remedies, ranging from injunctions to lawsuits. When assessing plans for Chapter 11 proceedings, the bankruptcy attorney plays a crucial role in helping to develop a plan with the highest probability of confirmation by the court. The financial restructuring adviser complements his or her legal expertise with a complete working knowledge of all proposals' non-legal components, including financial and operational aspects.

Best practices utilize a three-step approach.

The first is to understand the debtor's specific situation and overall business prospects at a granular level. To accomplish this step, the financial restructuring professional analyzes the entire portfolio of the debtor's assets and operations, not just real estate. A detailed restructuring plan is then created, encompassing the complete set of alternative scenarios that can play out in the restructuring process. The plan takes into account each reaction and counter movement of all the stakeholders. In addition, a granular understanding of the impact of each scenario on the entire client portfolio is necessary. Every scenario must be realistic and accurate. This part of the process demands the fused knowledge of a CFO-level professional working closely with legal counsel. If the business or asset can be presented as a going concern, the debtor is more likely to come out of the restructuring in better condition.

The second step entails insight into the changing dynamics of capital markets and investor behavior on a national and local level for each asset class. This level of knowledge is a prerequisite for preparing lender proposals that have a realistic chance of success while at the same time garnering the maximum benefit for the client. The more market awareness, especially about emerging trends, the more persuasive the team can be in negotiations.

The third step is the bankruptcy legal analysis including review of critical decisions ranging from regulations to filing lawsuits. The laws of one district related to commercial real estate may differ significantly from those of another having a drastic effect on the strategy. For example, the team must proceed much more quickly in a state that allows non-judicial foreclosure than one where only judicial foreclosure is permitted.

Another one of the many considerations are the federal and state taxes related to restructured debt. An example of the benefits of a comprehensive team of finance, business, and legal experts is the ability to configure the situation in a way that allows the debtor to benefit from tax law and reduce the tax cost associated with the workout.

After completing this three-part process, the debtor is ready to consider one or more of several options, including:

• Discounted payoff;
• Bridging the equity gap;
• Loan modification; or
• Foreclosure or deed-in-lieu of foreclosure.

While many borrowers and virtually all bankruptcy attorneys have experience with these options, the complexity in practice and uniqueness of each borrower's portfolio and situation demand a highly specific expertise. The most common mistake made by overleveraged borrowers: trying to perform a restructuring by themselves with their bank and then bringing in legal counsel later in the process.

Like a chess game, the restructuring process is highly complex and technical. The further along in the game, the fewer alternatives that remain for the borrower. Often, a financial restructuring specialist is brought late into a situation when the borrower has already painted itself into a corner, resulting in a diminished range of alternatives and limited potential benefits.

It is critical for borrowers and bankruptcy attorneys alike to realize that the professionals inside a bank's workout group are highly specialized. They are much different from the loan officers who originated the loans. These workout specialists are much more aggressive and technically astute with respect to non-performing loans and ways to maximize the bank's recovery at the expense of the borrower and, they must presume, other lenders who may also have underwater loans with the borrower. As a result, the borrower is “playing chess” with a professional who rarely loses to a less experienced opponent.

In today's environment, to maximize the outcome for distressed debt restructuring, the owner needs to assemble the best team of experts. Seasoned, successful bankruptcy attorneys and financial restructuring advisers will bring crucial components to complement the team. The right restructuring team will have the experience to know what each lender will and won't do in various situations. The key differentiation of this experience is not only realizing that each lender differs, but knowing how they differ ' that's one critical qualification to consider in selecting a restructuring firm.

Another key element is in the quality of the financial analysis and planning, taking into account the bank's perspective. The team needs a depth of background on the banking as well as the borrower's side, which is essential in bringing an understanding of the lender's needs to the strategic planning and negotiating process. This provides clients with a competitive advantage in attaining a success outcome with their lenders.

Steve Huntley is a founding principal and Mark Richardson is a principal of Huntley, Mullaney, Spargo & Sullivan, Inc., a financial restructuring firm. They may be reached at [email protected] or 925-831-3233; and [email protected]'or 415-677-9627, respectively.

For real estate bankruptcy law practices, there is significant opportunity in distressed real estate. Actually, the opportunity is enormous: At the end of 2012, U.S. commercial real estate debt was estimated to have reached $3.6 trillion. Approximately 10% of the total will mature each year for the next five years. Most of the $350 billion in debt coming due annually to 2017 originated in the early part of the decade. And much of that debt will not be able to be refinanced, causing a maturity default. To restructure loans experiencing maturity defaults effectively, the business, finance, and legal sectors must collaborate in a field that is as much art as it is science.

Real Estate Restructuring Teams

As law firms experiment with new approaches to improving performance for clients, they are focusing increasingly on partnering with financial restructuring experts. In our view, this increases the probability and magnitude of success for the client.

Since the financial crisis, banks had been extending many loans with the hope that asset values would recover rather than pushing for repayment and risk having to classify loans as non-performing. However, with ultra-low interest rates and lack of pressure by regulators to clear weak loans from balance sheets, banks have used this time to build loan loss reserves. With stronger balance sheets and greater regulatory scrutiny, banks can no longer continue to carry those kinds of loans on their books.

With underwater loans coming due, debtors risk not only losing their assets through foreclosure, they also jeopardize other collateral, including personal assets, when loans include cross-collateralization or personal guarantees. In these cases, banks are much more aggressive in demanding full repayment and pursuing borrowers for deficiencies when foreclosure and subsequent asset sales fail to fully cover loan balances.

Helping with the Debt

There is no single best way to assist those in distress with commercial real estate debt. Bankruptcy attorneys, together with financial restructuring advisers, have developed a comprehensive set of best practices that achieve objectives such as:

• Comprehensive analysis and strategic planning, taking into consideration the client's entire portfolio and the net benefits of every possible alternative;
• Multidisciplinary team negotiation with creditors, which in itself creates a position of strength;
• Strategies to protect the debtor's core business liabilities and minimize risk for other stakeholders;
• Reduction or elimination of personal guarantees;
• Restructuring the balance sheet to restore liquidity, positioning clients to return to financial stability;
• Debt reduction;
• Discounted payoffs; and
• Recapitalization funding to implement negotiated solutions.

In essence, best practices combine the legal expertise of bankruptcy attorneys with the financial expertise and business strategy of the financial restructuring advisers. Because of the nuances specific to each bank and loan, the partnership between a financial restructuring firm and experienced bankruptcy legal counsel is critical to maximizing the outcome for the client to achieve the highest level of financial analysis, assessment of all strategic alternatives and the most aggressive and experienced negotiation with creditors.

What the Restructuring Professional Does

The financial restructuring professional works side by side with the clients' bankruptcy attorney for interpretation of federal and state regulations, legal procedures, and the developing case law relevant in each situation. In addition, there is often the need to use legal remedies, ranging from injunctions to lawsuits. When assessing plans for Chapter 11 proceedings, the bankruptcy attorney plays a crucial role in helping to develop a plan with the highest probability of confirmation by the court. The financial restructuring adviser complements his or her legal expertise with a complete working knowledge of all proposals' non-legal components, including financial and operational aspects.

Best practices utilize a three-step approach.

The first is to understand the debtor's specific situation and overall business prospects at a granular level. To accomplish this step, the financial restructuring professional analyzes the entire portfolio of the debtor's assets and operations, not just real estate. A detailed restructuring plan is then created, encompassing the complete set of alternative scenarios that can play out in the restructuring process. The plan takes into account each reaction and counter movement of all the stakeholders. In addition, a granular understanding of the impact of each scenario on the entire client portfolio is necessary. Every scenario must be realistic and accurate. This part of the process demands the fused knowledge of a CFO-level professional working closely with legal counsel. If the business or asset can be presented as a going concern, the debtor is more likely to come out of the restructuring in better condition.

The second step entails insight into the changing dynamics of capital markets and investor behavior on a national and local level for each asset class. This level of knowledge is a prerequisite for preparing lender proposals that have a realistic chance of success while at the same time garnering the maximum benefit for the client. The more market awareness, especially about emerging trends, the more persuasive the team can be in negotiations.

The third step is the bankruptcy legal analysis including review of critical decisions ranging from regulations to filing lawsuits. The laws of one district related to commercial real estate may differ significantly from those of another having a drastic effect on the strategy. For example, the team must proceed much more quickly in a state that allows non-judicial foreclosure than one where only judicial foreclosure is permitted.

Another one of the many considerations are the federal and state taxes related to restructured debt. An example of the benefits of a comprehensive team of finance, business, and legal experts is the ability to configure the situation in a way that allows the debtor to benefit from tax law and reduce the tax cost associated with the workout.

After completing this three-part process, the debtor is ready to consider one or more of several options, including:

• Discounted payoff;
• Bridging the equity gap;
• Loan modification; or
• Foreclosure or deed-in-lieu of foreclosure.

While many borrowers and virtually all bankruptcy attorneys have experience with these options, the complexity in practice and uniqueness of each borrower's portfolio and situation demand a highly specific expertise. The most common mistake made by overleveraged borrowers: trying to perform a restructuring by themselves with their bank and then bringing in legal counsel later in the process.

Like a chess game, the restructuring process is highly complex and technical. The further along in the game, the fewer alternatives that remain for the borrower. Often, a financial restructuring specialist is brought late into a situation when the borrower has already painted itself into a corner, resulting in a diminished range of alternatives and limited potential benefits.

It is critical for borrowers and bankruptcy attorneys alike to realize that the professionals inside a bank's workout group are highly specialized. They are much different from the loan officers who originated the loans. These workout specialists are much more aggressive and technically astute with respect to non-performing loans and ways to maximize the bank's recovery at the expense of the borrower and, they must presume, other lenders who may also have underwater loans with the borrower. As a result, the borrower is “playing chess” with a professional who rarely loses to a less experienced opponent.

In today's environment, to maximize the outcome for distressed debt restructuring, the owner needs to assemble the best team of experts. Seasoned, successful bankruptcy attorneys and financial restructuring advisers will bring crucial components to complement the team. The right restructuring team will have the experience to know what each lender will and won't do in various situations. The key differentiation of this experience is not only realizing that each lender differs, but knowing how they differ ' that's one critical qualification to consider in selecting a restructuring firm.

Another key element is in the quality of the financial analysis and planning, taking into account the bank's perspective. The team needs a depth of background on the banking as well as the borrower's side, which is essential in bringing an understanding of the lender's needs to the strategic planning and negotiating process. This provides clients with a competitive advantage in attaining a success outcome with their lenders.

Steve Huntley is a founding principal and Mark Richardson is a principal of Huntley, Mullaney, Spargo & Sullivan, Inc., a financial restructuring firm. They may be reached at [email protected] or 925-831-3233; and [email protected]'or 415-677-9627, respectively.