By Andrew Egan

Senior Director, Credit Solutions

Every commercial real estate (CRE) deal is unique. However, using a programmatic approach – a consistent and organized method – in portfolio management of CRE debt is imperative. In recent years, macro volatility and external market events, including higher interest rates, inflation, declining property values, and rising vacancy rates, have increased the challenge for portfolio managers to maximize recoveries.

Considering all of these factors, this narrative discusses recurring themes related to successful loan restructure negotiation outcomes and effective portfolio management strategies.

Negotiating Loan Restructures

In recent years, lender asset management teams managing bridge loans for transitional CRE assets have primarily focused on modifying their existing portfolios. Typically, negotiations with asset owners revolve primarily around equity paydown of debt (or other form of material capital commitment) in exchange for a loan (term) maturity date extension. The majority of CRE bridge loans have five-year total loan terms and are structured with three-year initial terms, followed by two one-year extension options subject to specific credit metric thresholds. Negotiations are most often triggered by an impending loan maturity date that requires the asset to meet specific financial thresholds related to debt yield, debt service coverage ratio (DSCR), and loan-to-value (LTV), to qualify for the extension option.

Owners aim to avoid default and undesirable outcomes, such as foreclosure or selling during a market downturn. By comparison, lenders primarily focus on returning underperforming loans to within refreshed agreed-upon credit metrics and secure a structured loan extension. Additionally, lenders seek to lower their loan basis and make reasonable efforts to keep the owner in place, typically with their “plan a as a structured loan extension, and generally trying to avoid foreclosure and taking full ownership of the asset in real estate owned (REO).

Negotiations can become contentious due to owners’ focus on maximizing their internal rate of return, and multiple on invested capital, by minimizing capital outlays (such as equity loan paydown, carry reserve and tenant improvements/leasing commissions [HL1] reserve replenishments, and costly interest rate caps) while maintaining control of the property with semi-favorable debt terms.

For substantially impaired office assets, sophisticated institutional investors, aware that their equity may be wiped out, often refuse to contribute additional capital. In contrast, long-term generational owners with extended investment horizons, may continue to support the property despite minimal return on investment on the additional capital. Executing revised business plans, especially asset type conversions (most often office to multifamily use), can be extremely time-consuming taking years to accomplish, adversely affecting the lenders’ returns and their ability to recycle capital.

All these factors create a delicate tightrope for both sides. When borrowers begin negotiations with the stance that they are unable or unwilling to make a significant equity contribution towards a paydown or reserve re-balancing, the dynamic shifts to a lender re-underwriting model. This involves assumptions on legal timeline to take the property (via foreclosure or deed-in-lieu), potential value creation through leasing, capex, asset type conversion, opex efficiencies, financing options for their new REO asset, and the ultimate sale price and timing.

Modification Structures / Dual-Tracking

The majority of modifications booked over the past two years have included a lender accommodating with a one-year loan extension of the maturity date with waiver/compromise on the applicable debt yield hurdle, and waiver of an interest rate cap requirement. In exchange for these accommodations, borrowers would replenish the interest carry reserve for a year (so that the loan stays current for the extension term), pay an extension fee, and generally provide additional credit enhancements through recourse, equity pledge, and/or consent to receiver. In some cases, borrowers even need provide a pre-baked deed-in-lieu for additional term, so that the lender could quickly take title to the asset should the loan default again.

In efforts to reaching an agreement on a structure of a loan modification, dual tracking is recommended. This involves taking both an enforcement approach towards notice of defaults, beginning foreclosure actions etc, while also continuing progress on modification from a legal perspective. This generally helps guide borrowers that the modification route is their best and only path to maintain ownership of the asset.

CLO Loans

Managing collateralized loan obligation (CLO) modifications can add another layer of complexity into the dynamic to be navigated, often requiring expertise from special servicers to minimize friction. Administrative modifications offer the simplest path, but more substantial changes – such as criteria-based modifications, or major decision classifications – require higher levels of approval. The special servicer oversees the CLO modification process, following the servicing standard, and aiming to maximize recovery for all bondholders while ensuring client (lender) satisfaction with the outcome.

Programmatic Approach to Maturity Defaults

From an operational perspective, adopting a programmatic approach across the entire portfolio is important for lenders. This refers to a disciplined and consistent framework that guides all decisions within the portfolio management process. Operationally, many private equity debt funds have proactively engaged their origination teams in portfolio re-underwriting. This is particularly efficient during periods of reduced origination volumes and re-balances relatively leaner asset management staffing from previous years of minimal CRE distress.

Establishing structured timelines for borrower communication is essential. The objective is to prevent a rolling maturity default scenario, where owners repeatedly share refinance term sheets or purchase and sale agreements for potential capital events that ultimately do not materialize. This situation is exacerbated by factors such as declining property valuations, rising interest rates, asset deterioration due to office tenant downsizing or vacancies, increased operating expenses (e.g., insurance costs) impacting net operating income, and stricter underwriting criteria for new loans. In these situations, lenders may find themselves facing imminent maturity default events without a genuine restructuring or capital commitment from the borrower. To manage this risk on a portfolio-wide basis, lenders should consider issuing formal notices of default with reservation of rights language across all deals where loans enter maturity default. Additionally, three months before a loan matures, lenders should consider sending borrowers a debt yield calculation and the required paydown amount to extend the loan term, along with a pre-negotiation agreement. Starting negotiations with terms from the original loan agreement, even if adjustments are likely, helps set a clear framework. The loan extension provides borrowers additional time to implement their business plans or arrange for refinancing or property sales. Additional time may also facilitate pushing off a capital event until 2025/2026 when debt and equity capital markets conditions are generally anticipated to improve. Conversely, if the lender believes that the recovery position will deteriorate further (owner not capable of carrying out business plan, substantial deferred maintenance issues, potential fraud or waste etc.) then in many cases it is best for the borrower/lender to push for an asset sale or take title to the asset and market for sale, even if the projected recovery is below the current loan balance.

Conclusion

Proactively managing interest rate cap renewals, reserve replenishments, and other covenants – such as capex completion timelines and springing cash management provisions – is important, fully utilizing the loan structure in place towards maximizing recovery. These measures ensure structured negotiations and align with the original loan agreement, facilitating effective modification discussions – all steps towards the ultimate goal of maximizing recovery.

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Andrew Egan, Senior Director, Credit Solutions at Trimont, has 16 years of commercial real estate experience including the workout of non-performing CRE CLO / Balance Sheet Debt portfolios and CRE Equity (REO) asset management. Mr. Egan has an extensive background across both the Equity and Debt sides of CRE originations / acquisitions, underwriting, asset management, and workout throughout his previous roles.

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If you have questions related to proactive loan management, contact us at info@trimont.com.

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