In this video, Dugan Kelley, managing partner of Kelley Clarke Law, emphasizes the importance of having a realistic plan when requesting a loan modification from a lender. Even if you have a great strategy, if your plan is not realistic, the lender may not be receptive to your request. Dugan explains the general process that you will go through with the lender.
The Process of Modifying a Loan
Last time we talked about some of the areas in which you might want to modify your loan, and now we’re going to talk about the mechanisms and the logistics of what you’re going to actually do. Results matter, right? Remember, you might have a beautiful strategy, but if your plan is not realistic, then your lender is most likely not going to be receptive to your ask for a loan modification. So, you need to be really ready for what that plan’s going to be.
Here’s the process, the general process, that you’re going to go through with the lender.
Step one: Pre-negotiation agreement
The first step is going to be a pre-negotiation agreement. Back in the ’90s and early 2000s, we were not doing this with lenders on the acquisition side, on the borrower side when we were modifying loans. But lenders have learned that oral conversations potentially can lead to litigation. So, as a result, don’t be surprised if you’re going to ask for a modification, that your lender is going to want you to sign a pre-negotiation agreement. That’s going to say that you’re releasing the lender presently of any claims that you might have against the lender. Obviously, you need to consult with your attorney prior to entering into any release. But in the event that you don’t have an active claim or the likelihood of a claim against your lender, you should sign these things because the lender, it’s a precursor to actually negotiating with the lender.
So what could you expect in step one of a pre-negotiation letter? We’re modifying the loan; we’re asking the lender to do this. And the lender gives you an agreement, and they say, “Please sign this before we even talk to you about why we might be able to modify your loan.” Well, they’re going to be asking for confidentiality. They’re going to be saying we’re not waiving our rights in connection with the loan documents. There’s not going to be any oral agreement wherein they promise to modify the loan, and then you get to rely upon that oral conversation to your detriment. And then they’re going to most likely be asking you to release any active claims that exist as of the date that you sign that agreement. Remember, releases look back in time, not forward in time. So, if the lender does anything to create a situation where they might—you might have a viable or capable claim against the lender in the future, you’re not waving that right, but you’re more likely than not waiving all rights associated with the lender in the back. So that’s step one. That’s what a pre-negotiation agreement looks at.
Step two: A hardship timeline
Step two, what is your plan? You got to have a plan. You got to be able to lay out your plan and your ask clearly, with clarity and conciseness to the lender so that they can actually evaluate what it is. Remember, what are we going to ask for? Are we going to ask for something in connection with the type of loan, fixed or floating? Are we going to ask for something in connection with the interest rate? Are we going to ask for something with respect to the rate cap? Are we going to ask for something in connection with the reserves or the waiver of current violations potentially that exist at the property, including the DSCR components? Are we going to ask for maturity or amortization issues? All of these are potential. I’m not saying that you should ask for everything. Remember, it needs to be realistic. You need to be realistic with your ask.
Step three: The lender is going to actually do some due diligence at the property
Imagine you’re the lender, and you’re getting this request from your borrower to modify or restructure the loan. Well, you’re going to want to do some due diligence, particularly if you get this plan. You’re going to want to potentially have updated thirds, which is the property condition report, phase one environmental, and appraisal. So, don’t be surprised that the lender actually wants to do some due diligence in connection with the plan that you’ve requested. They might want to do a DSCR analysis. They might want to do an NOI (net operating income) analysis at your property. They might ask for additional due diligence docs from you as the sponsor or the key principles, the guarantors on the loan. They might also do litigation or lien searches, all of which is a predicate between the lender’s review of your plan and then their analysis, their internal analysis, with their team, maybe credit review, and then the possibility of what they’re willing to do.
So be prepared on that step three that the lender is really going to be looking for, digging into diligence on your ask.
Step four: Negotiations
And then step four, you’ve got to roll your sleeves up, and you’re going to be negotiating. And so, this might be you with your counsel and counsel for the lender negotiating. But like I say all the time, it’s so important if you have a personal relationship with the servicer, that you personally are engaging with that servicer in connection with your plan. And you’re asked for modifications. When you lawyer up and your lawyer begins to be your sole or only mouthpiece for your deal, then it can start to be a strain on those relationships. So, while I’m a lawyer, and I enjoy negotiating on my client’s behalf, whether I’m a seller, a buyer, or whether I’m acting as lender counsel, I enjoy that process. But in general, remember, this is a relationship game. Just like investors invested with you because they like you, know you, trust you, well, the lender has loaned you money largely based upon the financial performance of the property and your personal relationship with them. So, get an understanding that you’re going to have to negotiate with that lender. You might have to get a current broker opinion of value or a current appraisal, regardless of what the lender is going to do, to be able to use that as a negotiating tool. Ironically, if you get a broker opinion of value that shows that the value of the property is less than the paper, less than the promissory note, that actually gives you more ammunition, more evidence, more facts to be able to suggest to your lender that they might think about modifying your loan because for them to foreclose on that asset and then sell it on their own balance sheet, they’re likely to take more of a haircut on the value of the property than to allow you to sell that property or for you to recapitalize that property or for them to modify that property.
You need to understand the comps associated with where your property is actually located, and you need to understand your lender’s capital structure. What I mean by that is many lenders sell their loans off in whole or in part to other investors. And so, depending on what your lender’s internal capital structure is, you might not—they may not even have the power necessarily to modify the loan or restructure it, and that will certainly impact the plan that you’re pitching to your lender, the negotiations that are taking place with your lender, and you want to understand all of those things. Then you want to understand market pricing, right? Market pricing is dynamic depending on where you’re at in the country, depending on what market you’re in, depending on what submarket you’re in. It’s super important for you to understand how a lender views this market and submarket for you to be able to take advantage of the negotiations. And then you need to be firm yet flexible. Ironically and sadly, the most leverage that you’re going to have in this negotiation, especially on a qualified non-recourse loan, is to be prepared to walk from the property, be prepared to give the keys to the lender because your business plan didn’t work out or your property is a victim of these rising interest rates or an explosion of rate cap costs or an explosion of utilities or insurance costs. Those costs, as we’ve already talked about, can dynamically change the value of the property and your ability to perform under your business plan.
So, you’ve got to be flexible yet firm with your lender, and that’s step number four.
Step five: Papering up the deal
So, what can you expect on step number five? Well, when we’re doing step number five, that’s really the docs, right? We’re papering this up. So, be prepared. Modification documents will control over any conflict between the loan documents that you originally signed and this modification document. There’s going to be a reaffirmation of the guarantee. So, if you have multiple guarantors on a property, you need to make sure that they’re inside the loop, that you’re not negotiating with their say-so or without their knowledge. It’s certainly going to be important for you to involve them in the conversation. There’s going to be potential other changes. And then just everybody has to be prepared to sign. Now’s not the time to take a vacation. Now’s not the time to not be available to sign documents. You really need to be available to sign whatever documents that you’ve come to terms with in connection with your lender. And that’s step number five.
So remember, aside from all these steps, you’re going to need to keep your investors informed. You don’t want your investors to go off the rails or file a claim or get into a dispute with you if they know that your property is in distress and they know that you’re trying to either sell the asset, refinance the asset, recapitalize the asset, or modify or restructure the loan on the asset in order to help protect their capital. They’re going to be more likely that they’re going to be able to have those conversations. Now, they might vent. They might be angry. They might have a right to be angry with you as the sponsor, operator, manager in connection with these types of changes that have occurred at the property. And you need to have enough grace and tolerance to allow them to vent to you. But you certainly need to keep them informed. You certainly need to be transparent. And then you need to be transparent with your lender, be available and ready to provide info to your lender throughout this entire loan modification process because it can be a daunting process, and it is something that is going to be stressful. There’s no doubt.
There’s going to be stress associated with this, but you can get through this if you really focus with determination, resilience, and you follow the steps and you understand the steps and the reasoning behind the steps. And then you have a plan and you work your plan. And then you’re ultimately available to implement and sign all of the plan.
And then the last thing that I want to leave you with is this concept that fear is sometimes the biggest obstacle for you to be successful in your business plan. Fear is often the biggest obstacle for you to have a successful loan modification or restructuring of your deal. So while your fear might not be my fear, everyone struggles with fear. And so when people procrastinate, even when you know that you need to do something, that is typically a sign that they’re struggling with some form of fear. And I want to encourage you that everyone struggles with that. But in those times, the best thing, in my opinion, is shine a light on that fear, press through that fear because only through pressing through that fear are you actually going to be successful. And our hope and our prayer for you is that you would be able to achieve the types of results and goals that you want, particularly when you’re trying to modify or restructure your loan.
If you want to learn more about us or how we might help you, feel free to give us a call, check us out on LinkedIn, Facebook, Instagram, like or subscribe to our page. And certainly, we’ll be here for you.