Your Borrower, The Market, and Collateral before a CRE Work-out
By Joseph Patterson, ECL
“Houston, we’ve had a
problem here” may have as much meaning to the nation’s commercial real
estate loans as it did for Apollo 13. With any problem, understanding it is the
first step to solving it. So with commercial real estate, knowing your borrower,
market and collateral, becomes mission critical in any type of workout. Whereas,
at Mission Control, the goal was saving the crew, the ultimate goal here is to
maximize the recovery of the debt.
The purpose of this article
is to provide some of the questions that need to be answered about the default
circumstances, before and/or during a workout strategy. In the end, the decision
comes down to what the outstanding balance is verses foreclosure/collection
values, compared with the current default verses the default of a failed
It is important to understand what factors and circumstances contributed to the
borrower’s financial difficulties. Misuse of funds, gross mismanagement,
fraudulent or illegal activities, will certainly demand immediate acceleration,
as well as preservation or protection of what assets remain.
However, most likely other
circumstances – such as:
Bankruptcy of key tenants
Downsizing or relocation
of tenants and customers,
Rising costs reducing
profits in fixed priced contracts,
Accounts receivable are
increasingly slow pay, and
General adverse effects
of market trends
It is material that a clear and accurate picture of the borrower’s financial
condition and business operations are understood and documented. At a
information regarding the operation and financial condition of the
borrower(s) and co-borrower(s);
The nature and amount of
all outstanding secured and unsecured debt;
Any outstanding or unpaid
taxes or assessments;
obligations or commitments;
An updated title report,
with an evaluation of any junior liens;
A current appraisal;
The status and location
of other personal property, such as accounts receivable, securities and
Any additionally secured
debt, which could be mezzanine or other subordinate debt.
What, Exactly, is in
Carefully review the file and the loan documents to determine the relative
rights of all parties involved. Look for any documentation deficiencies
(you may want to have outside council to help with this).
The review should determine:
If a non-recourse real
estate loan, any “carve outs” to the non-recourse provisions;
The loan documents are
fully and properly executed by all authorized individuals;
The borrowing resolutions
and authority documents are complete and fully executed;
Exhibits, schedules and
appendices referenced in the loan documents are attached and complete;
The mortgage, deed of
trust or other security documents are appropriately recorded and filed, and
Any required post-closing
items have been received, including any title insurance policy and
During this review, exercise
extreme care in all communications. Quick, unintended or informal
“understandings,” or commitments, may be misconstrued or leveraged by the
borrower. This can lead to unwanted repercussions to any successful workout.
Having an independent market
and economic analyses as to the recovery potential for the borrower and the
related industry is very important. This becomes valuable information that will
allow for better negotiations and validation of the borrower’s claims. It
should also answer the following questions.
What are the
Surrounding Property Values?
Not only know the appraised value of the property in question, but also the
values of similar properties in similar geographic locations. Get actual
pictures, prices and statistics. Obtaining any history on these properties will
help to spot trends and test theories.
What are current and
past Lease Rates?
Knowing the current and the past 12- to 24-month trends on lease rates
will substantiate any assumptions on workout plans. However, include a variety
of occupancies, as well as specific occupancies appropriate to the property in
How many Vacancies are
Most reports provide this number as a percentage. Although this is very helpful,
having the actual numbers that calculated these percentages can have more
meaning. In a 10-suite building, one
vacancy would be only 10% vacancy; but if that one suite was 4,000 square feet
of a 10,000 square foot building, that would be a 40% vacancy. Again,
understanding the numbers behind the percentages provides for a realistic
perspective of what truly is happening.
What’s the Current
As mentioned earlier, it is critical to have a current appraisal of all
collateral in question. This is
essential to support any decisions made for the workout.
What are the Current
Leases and Use Agreements?
Obtain copies of all lease agreements, usage agreements, and in the case of
construction loans, prime and sub contracts. Review these agreements for their
statuses, specific terms, obligations, and potential liabilities and effect on
What’s the Current
Condition of the Property?
Inspect the property for the condition of improvements, as well as how the
maintenance has been handled. Look specifically for any deferred maintenance,
any issues concerning environmental contamination or liability.
Having all the facts related
to the borrower(s), market and various circumstances surrounding the property
and its value creates a better position to draw a successful work-out plan.
to October 2009 Lending & Credit Digest>
Patterson, a former project manager in $3 billion REO work-out group, is
chief software architect for ECL Software. He can be reached at email@example.com.