As Industry Metrics Improve, Lenders Will Be More Rigid With Underperforming Hotels

Hotel News Now – Federal Relief, Lessons from Past Downturns Increased Lender Patience.

Hotel owners in the U.S. benefited from federal relief programs, higher-than-expected leisure demand and lenders willing and able to be flexible on their loans through the coronavirus pandemic.

Now that the industry is on its way to recovery and the federal aid programs have generally done as intended, it’s only a matter of time until those otherwise flexible lenders will require borrowers to start making their regular payments, sources said.

Experts in the hotel lending space said that time isn’t now, but as momentum for the recovery builds, borrowers will need to make some decisions on how they handle their debt.

Looking Back

Flexibility has been the enduring characteristic of the crisis, said Kevin Davis, senior managing director, capital markets, at JLL. Since the early days of the pandemic, lenders generally have been willing to work with borrowers dealing with issues stemming from COVID-19. Practically every hotel loan that lenders had on their books was presenting challenges, so it made more sense to work with borrowers facing distress.

“As a practical matter, you couldn’t take aggressive action on your entire hotel book,” he said.

That meant loan modifications involving covenant waivers, extensions of maturity dates, removal of London Interbank Offered Rate floors, deferral of interest payments and more. For the most part, lenders were not offering reductions in outstanding principal balances and held firm on that.

“It’s been a pretty expansive suite of things that they’ve been willing to offer,” he said.

One of the reasons there haven’t been as many distressed loans during the pandemic is better leverage, Davis said. Looking back to the years leading up to the Great Recession, there was significantly more leverage in the system. Leading up to 2009, hotel loans were as much as 75% or 80% leverage on pro forma underwriting while leverage in 2018 and 2019 was topping out mostly around 65% with some getting up to 70%.

The fallout in the Great Recession was much worse than it has been now because the underwriting was worse, he said. The pandemic has been a much more acute crisis, but it’s having a quicker bounce back.

“Lenders felt much more confident that even though values were down, they were still in the money, and therefore there was no pressure for them to move quickly to try to sell the loan,” he said.

Current Environment

Hospitality private lender Stonehill provided a lot of relief last year, typically about six months’ worth, said Mathew Crosswy, president at Stonehill Strategic Capital. By January, about 80% of the portfolio was paying back their relief.

“Everybody is paying some form of payment starting at the beginning of the year,” he said. “Today, we even have some borrowers that have been able to catch up on the interest that we deferred.”

Because of the transient demand and returning corporate travel, many submarkets are showing figures at, if not more than, 2019 levels, he said. This shows recovery within the markets, and it also shows lenders which assets are performing — and which ones aren’t.

“You’re going to start to really have more visibility into your portfolio of what your real troubled assets are,” he said. “That’s where you’re probably not [going] to see the same relief that you saw previously, and lenders are going to have to start really focusing on if they haven’t already.”

As more liquidity has returned to the hotel lending space, lenders have started to selectively get more aggressive in leverage and in pricing, Davis said. Lenders are aware borrowers have more options available to them now.

“Many have taken a more aggressive approach where they decided not to be as flexible as today as they once were under the theory that there’s a high probability that the borrower will be able to refinance out the existing debt,” he said, adding that is not always the case, though.

Some borrowers are going to see better performance as conditions improve, but some hotel loans may lag, he said. As a result, hotel lenders will start to choose winners and losers. In that context, lenders are starting to be less permissive on loans.

“It doesn’t mean that just because one loan is performing and one loan isn’t that they’ll drop the proverbial hammer on the loan that’s not performing, but certainly I think lenders will feel like they have more options to force the borrower to refinance them out,” he said.

At the same time, because performance is improving, some lenders are still willing to be flexible with their borrowers through the recovery, said Peter Berk, president at PMZ Realty Capital. Many are waiting to see what happens over the next several months to see how performance continues and whether corporate travel and group demand comes back as much as expected in the fourth quarter.

“Lenders are still being patient, because the last thing a lender wants to do is foreclose on a hotel,” he said. “They’ll do it if they have to, but the best person to own a hotel is that local guy who knows the market and has all the contacts rather than the lender who is not in the hotel business.”

Everything is so encouraging now that Berk doesn’t believe most lenders are going to move too harshly on borrowers. In cases where lenders do get more aggressive, it will likely be for borrowers who took relief and now have to pay it back on top of their regular debt service. However, that hasn’t happened yet.

Pressure Down the Line

The need to spend capital to renovate and improve assets will become a bigger issue with the passage of time, Davis said. Brands will continue to be flexible, particularly for properties that are not changing management and or ownership. He believes brands and owners will have to strike a finely tuned balance that will allow owners to adhere to brand standards in a way that is still economically viable.

“The owners themselves are in the process of recapitalizing their assets and have had to invest a lot of capital carrying the assets,” he said. “I do think that’s something that the brands are generally aware of and appreciative of.”

Owners will find themselves under pressure trying to replenish the furniture, fixtures, and equipment reserves they tapped into during the pandemic to stay afloat, Crosswy said. With property improvement plans deferred and their FF&E reserves spent, they’re now having to raise the cash on lower revenue, prolonging the distress. Generally, though, he believes it should be manageable.

Owners who will have a tougher time will be those with full-service properties in city centers that require larger and more expensive renovations, he said. Properties like that could be a distressed trade as a opposed to hotels that went through about nine months of pain but have been able to replenish reserves thanks to leisure demand.

Brands will want to maintain their standards because of guest expectations, so while they are aware of owners’ challenges, that could be a tough conversation in the future, he said.

If these pressures build up for troubled loans, lenders and borrowers have some options available to them, Crosswy said. Hotel owners would have the option to sell, an option many expected owners to take during the pandemic but haven’t seen to any large degree thanks to federal aid and lender flexibility. The lender could possibly sell the troubled loan.

If the borrower and lender have a good relationship and there’s a path forward to turn the asset around, they could restructure the loan under the existing lender, he said. The borrower might also be able refinance the loan through a debt fund and pay a higher rate than at a traditional bank because of the additional risk.