Law360 (June 12, 2020, 8:27 PM EDT) -- Thousands of hotels facing their worst year on record during the COVID-19 pandemic may have to close for good if they can't get debt repayment deals, but the few firms that would be able to help are already overwhelmed with requests for aid.
Hotel occupancy and revenue have slowed to a trickle since March, and millions of employees have lost their jobs in the months since the virus hit U.S. shores, lawyers say. At the same time, hotel owners are struggling to obtain forbearance on loans, with so many facing the risk of foreclosure that lenders and loan servicers cannot keep up with the appeals for deferred payments.
"There are some hotel owners that may not be able to make it through this period, frankly," said Samantha Ahuja, a shareholder at Greenberg Traurig LLP whose practice focuses on hotel acquisitions, operations and finance. "In my experience, many don't have excess liquidity and big credit lines they can draw on. Can they make it for a year at 30% occupancy or less? Probably not."
Cash-Strapped Hotels Struggle To Get Debt Forbearance
by the numbers
of hotel debt borrowers have requested debt forbearance or payment deferral agreement.
of commercial mortgage-backed security debt (CMBS) borrowers have received forbearance.
of bank-approved forbearance or payment deferral requests were for 90 days or fewer.
On June 2, Hilton CEO Christopher Nassetta said during a virtual conference with other major hotel chief executives sponsored by New York University that the hospitality industry is running at 25% to 30% occupancy, up from 13% earlier in the pandemic but far from last year's 75%. And it will be a long time before hotels regain strength.
"Until 90 days ago, the people on this call agreed that this is a golden age of travel," Nassetta said. "We will get back to that, [but] we need testing regimes for antibodies and contact tracing. The basic playbook for all of us is similar: to protect our people — employees and customers — and the business."
AccorHotels SA CEO Sébastien M. Bazin predicted during the NYU conference that 10% to 20% of small mom-and-pop hotels will disappear in the next 12 to 18 months due to mounting financial problems, saying, "I'm not glad about it, but scale matters more than ever."
Collapse Came All at Once
Hotels were doing well in recent years until they got slammed by the coronavirus and suddenly saw room occupancy plummet, said Alan Cohen, co-office managing partner of Akerman LLP's New York office and chair of the firm's real estate finance practice.
Now, Cohen said, the hotel industry through no fault of its own holds a major portion of commercial loans that have gone into default since March, and owners with room occupancy down to as low as single digits are desperate for modifications on debt service.
"Lenders are permitting some hotel borrowers to defer payments for three to six months to try to get past the crisis and generate income to pay debt service," Cohen said. "Some hotels are in a better position than others, depending on their geography, tourist destinations, business travel and whether they're a major flagship hotel with professional management and excess capital. The loan servicers are taking all of that into account as they come up with a long-term plan to give hotels breathing room."
Some owners are taking advantage of the Small Business Administration's $660 billion Paycheck Protection Program, the forgivable loan program introduced in March when Congress passed the coronavirus relief bill. On June 3, the PPP won Senate approval for more flexible terms, and President Donald Trump signed the new measure into law two days later.
Employers now have 24 weeks to spend PPP funds, triple the previous covered period, and they are required to spend only 60% on payroll, down from 75%. The AHLA supports the revised program, saying that while the hospitality and leisure industry has topped all other sectors for virus-related job losses — at about 7.7 million jobs lost in April — hotels also need to cover other costs beyond payroll to keep their doors open.
But even with greater flexibility, PPPs don't necessarily work for hotels, according to hospitality lawyers. As states relax business restrictions, they say, hotel occupancy may slowly rise from single digits to 25% or so, but skeleton staffing is likely to remain in place for months. As a result, businesses that may have hoped for loan forgiveness are unlikely to meet the PPP rules for rehiring employees.
Also, according to Randy Eckers, a real estate finance attorney at Akerman, lenders "almost always" prohibit additional indebtedness when giving loans to hospitality businesses. Now, he said, some hotels are taking the unusual step of asking loan servicers to give them a break by letting them take out PPP loans, including the servicers of collateralized mortgage-backed securities that bundle many loans into a single debt issue.
"Although the loan documents prohibit additional indebtedness, I've seen lenders including CMBS servicers allowing borrowers to obtain PPP loans," Eckers said. "The lenders recognize that the PPP loans are very valuable to certain types of property owners, so they're not standing on the loan documents to negatively impact the borrowers."
Cohen agreed that he is seeing "a ton of those requests" to lenders, saying it would be "a public relations nightmare" if they refused otherwise creditworthy borrowers' requests to use PPP loans. He added that borrowers who do cut a PPP deal with their lenders must make sure the government loans are forgiven or repaid from their own funds and not loan money.
A Look at Lender Relationships
Before the pandemic, hotels typically relied on three types of debt: bank loans, money from debt funds managed by private equity firms, and collateralized mortgage-backed securities.
When relationship-focused bankers make loans, borrowers know whom to call if they get into trouble with loan repayments, lawyers say. And although relationships with debt funds don't run as deep, the funds know the industries they invest in and understand when a borrower might seek forbearance.
Meanwhile, CMBSs are sophisticated capital market instruments backed by a pool of commercial mortgages, and borrowers have relied on them for years because they're a form of low-cost debt. But hotel owners are now finding that if they're on the edge of default, a debt workout for their loans sold into CMBS pools can be extremely hard to get, lawyers say.
When a loan in a CMBS pool goes into default, it gets passed from the "master" servicer and ends up in the hands of "special" servicers — companies that are few in number and employ small staffs. Hotel owners don't have a relationship with special servicers the way they would with a local banker, lawyers say, and those servicers are slammed with requests for aid because just about every hotel in the country is asking for forbearance since the COVID-19 crisis hit.
"When you borrow CMBS debt, the person you hope never to speak to is a special servicer," Ahuja said. "You always hope your loan will be in good shape. It is my experience that most hotels with debt are asking for some type of a modification of their loan at this time, regardless of the type of debt it is. The challenge is that many hotels are closed right now, and we don't know when they will be able to reopen or otherwise generate enough revenue to pay operating expenses and debt service."
Sandra Kellman, a DLA Piper partner and global co-chair of the law firm's hospitality and leisure practice, said it's been so tough for loan borrowers to make contact with special servicers that she's aware of at least one hotel owner who decided not to make a monthly loan payment to force a servicer representative to return the hotel's calls for forbearance.
Special Servicers Also Overwhelmed
"The special servicers are understaffed, which is understandable, but getting them to respond to an email or a phone call is very difficult, and the hotel-owning borrowers have got real problems, not from anything they did," Kellman said.
A special servicer is typically a fee-based company, separate from the master servicer, and its responsibility is to protect CMBS bondholders, Kellman said. Currently, she said, CMBS servicers are preparing default notices for hotel owners who can't make their next payments as the hospitality industry founders.
Overwhelmed special servicers with staff numbering about five to 10 people have received as many as 6,000 requests for forbearance in a single week from hotel owners, according to lawyers.
"What borrowers have done is trade off a lower interest rate for a more difficult lending structure," Kellman said. "After the last recession in 2008, all these borrowers said, 'I'm never doing another CMBS loan, it's too hard to deal with,' but then they forgot. So now where people want some help because they're facing cash flow issues, the master servicer can only do so much."
Special servicers are aware of the industry's debt worries and are doing what they can to work with hotel owners and operators who are in default due to the coronavirus, according to Curt Spaugh, who leads the special servicing practice for SitusAMC, a real estate finance firm that processed about $7 trillion in assets in 2019. SitusAMC has a large special servicing unit that handled about $3.6 billion of distressed loans during the 2009-13 recession, Spaugh said.
"It's not our first rodeo. We've gone through these cycles before," Spaugh said. "In this cycle, we had to ramp up quickly to meet rapidly escalating demand for our services. We reallocated individuals from within our organization and had to do some new hiring."
In this particular cycle, the coronavirus hit the economy with sudden speed, taking companies by surprise. SitusAMC, for example, had to grow its special servicing staff to 15 to 18 employees, according to Spaugh.
The company plans to add more people over the next six months depending on how many special servicing loans come into the shop, he said, adding that SitusAMC in the past couple of months has already hired 10 new asset managers — the people who get assigned to work with at-risk debt holders, including hotel loan borrowers.
"Many of the challenges we are seeing with hospitality loans are COVID-related, and we have to figure out what to do," Spaugh said. "As a special servicer, our job is to determine how to maximize the loan recovery. In our current situation, the typical hotel is asking for a forbearance arrangement on making loan payments because they're closed or their operations are running at a fraction of where they were pre-COVID."
In cases where asset managers feel like they're dealing with a good operator, they will work with the hotel's borrower representative and come to terms on a forbearance agreement, Spaugh said. Typically, SitusAMC permits the borrower to defer monetary payments for a short time and then catch up on the deferred payments, sometimes for up to 12 months, he said.
"We send a hello letter from the asset manager assigned to their loan, and we ask them to sign a pre-negotiation letter. We do not have a deal until we have something executed in writing by both parties," he said. "We are fortunate in that our portfolio tends to focus on larger, more complex loans compared to competitors. While incredibly busy, we have not been overwhelmed like some servicers who tend to deal with a larger volume of smaller loans. We got ahead of the curve on this."
Cohen and Eckers said most hotel owners are seeking a three-month deferment of principal and interest or interest only. If an owner already has sizable financial reserves set aside for a property to cover items such as furniture, fixtures and equipment, the special servicer may allow the owner to use those reserves to cover debt service for a time and then replenish the reserves when revenue starts flowing again, they said. The owner will probably also need permission from brand operators to tap reserves.
The Akerman lawyers added that they're advising owners to reach out to whoever originated the loan. Originators make their money by closing loans and care about repeat business and relationships, so calling them can help borrowers navigate through special servicing, Cohen and Eckers said.
Considering the state of the U.S. economy, the commercial mortgage-backed securities market may need special servicers' help as much as property owners do. According to Mosaic Real Estate Investors executive Ethan Penner, who's widely credited as having founded the CMBS market three decades ago, the pandemic could destroy the sector.
Penner recently told Law360 that while CMBS loans in their early days were closely tied to the underlying properties, they are now much further removed, a fact that could spell disaster in the pandemic. CMBS investors in the early 1990s undertook careful due diligence on the underlying properties, but that level of diligence and knowledge of the properties no longer exists with CMBSs in their current guise, and that's become a hindrance for investors, Penner said.
"This pandemic ... could shake CMBS to its foundation. It's definitely possible. Imagine that a quarter to a half of all loans in CMBS end up in special services," he said. "That would precipitate a situation that one can imagine would be very, very challenging for the CMBS model to survive in its current form."
Arne Sorenson, president and CEO of Marriott International Inc., said at the NYU conference that people in the hotel industry have been experiencing an "emotional roller coaster" during the pandemic, as 90% of their business has disappeared and they wonder how long will it be gone. He urged hotel owners, particularly small business operators, to ask for help.
"There's a sense almost of despair," Sorenson said. "How can we navigate our way through this? Are there tools sufficient to respond to this crisis? We as an industry don't have the tools to carry our community from the date when the crisis began to the unknown date when it will end. We can't be greedy, but we have to ask for what is fair."
--Additional reporting by Andrew Kragie and Andrew McIntyre. Editing by Philip Shea and Brian Baresch.
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