CMBS -- (Cowboys May Be Surprised)

Face it - we all drank the CMBS “kool-aid” in the last 10 years.

CMBS loans offered long terms, favorable rates, interest only
options, high LTV’s, creative underwriting and (best of all) nonrecourse
liability. In fact, many recent deals could not have
been done without readily available Wall Street money.
 
However, many of our clients are now being reminded of the
other side of the CMBS coin: INFLEXIBILITY. CMBS loans
were designed to be static loans with expensive penalties for
prepayment. This inflexibility is never more apparent than when
a property goes into distress. We are at the beginning of the
CMBS default wave right now and the rules are still being written
to some extent. However, our current experience has been
consistent across-the-board. CMBS lenders are not inclined to
be creative work-out artists. To understand why, we would need
10 pages. Suffice it to say, though, that the servicing structure
of CMBS loans does not empower the “lender” to modify the
loan or waive certain loan document requirements.
 
Fortunately (and unfortunately, ironically), we have very creative
clients who have a million ideas of how to rescue a distressed
property. Mezz debt, recapitalizations, lease restructurings,
capital raises, short-sales, roll-ups, etc., etc., etc. The opportunities
for creativity are endless when a project goes into
distress. The worst part of our job these days, though, is
pointing out the many roadblocks imposed by existing CMBS
debt.
 
Rather than go on endlessly about the impediments to a CMBS
work-out, we want to offer a simple piece of real-world advice.
When your CMBS encumbered property experiences distress,
you must start by reading the loan documents. Remember, the
“stick” of inflexibility had the “carrot” of non-recourse hanging
from it. Most clients want to preserve the ability to walk-away if
the work-out ultimately fails. If full or partial recourse enters the
picture, you now have a carrot-less stick and the lender will
certainly use it.
 
The best way to avoid recourse in the CMBS-world is to check
your “cowboy” mentality at the door. Most recourse carve-outs
are directed at prohibiting bad-boy actions during periods of
distress. If your first instinct is to take any and all action in order
to save yesterday’s equity, you are likely to violate the recourse
provisions of your CMBS loan. Simple acts and omissions like
additional debt, lease restructurings (even for a fee) or raising
additional capital, may all have implications in terms of your
recourse liability. Likewise, simple omissions (like letting your
entity fall out of good standing) may have the same effect.
 
Finally, and most importantly, things that make good “business
sense” for an asset may still be prohibited under the loan documents.
Many actions resulting in recourse to a guarantor occur
when a smart client tries to do the right thing for an asset.
Recourse pit-falls are everywhere in CMBS documents. You
must know the recourse ground rules of your loan before taking
steps to reposition a CMBS encumbered asset. The loan documents
provide this framework.
 
Let us be clear, though. We are not suggesting that every
CMBS work-out will end in a give-back of the property to the
lender. CMBS work-out strategies can be implemented at the
right time and in the right way. However, before embarking on
this journey, look at your CMBS loan documents and particularly
the non-recourse carve-outs. Better yet, have someone else
look at them. A fresh set of eyes will give you a better understanding
of the carve-outs in the context of a work-out that no
one saw coming at the time the loan was originated.

© 2009 Levenfeld Pearlstein, LLC