Secured Lending Guidelines & Strategies In The Current Crisis
In the midst of the unfolding COVID-19 pandemic, much like during the financial crisis, the banking laws and regulations are being changed as fast as they can be written. There are orders and new programs seemingly daily. At the same time, Lenders are facing pressure internally and from their Borrowers (including and especially Borrowers that have been reliable and compliant in the past) to modify, extend or defer payments. The pace and uncertainty of the orders, well-meaning though they may be, suggests that decision makers must proceed with extreme caution. What is permissible today may be strictly prohibited tomorrow. There can be little doubt that attorneys general and regulators will be looking to make examples of non-compliant businesses.
In just the past few days we have seen executive orders and court orders that have:
- Temporarily prohibited evictions both residential and commercial
- Temporarily prohibited foreclosures
- Unilaterally and universally extended statutes of limitation (at the state level)
- Prohibited default judgements and extended deadlines effectively indefinitely
These types of restrictions are forcing Lenders to adapt quickly to accommodate their Borrower and address internal concerns about the Lender’s own balance sheet. Lenders scrambling to grant short term relief should be mindful of the following:
- As always, any modification should be documented in a writing acknowledged by the Borrower and any guarantors.
- Always ensure that all discussions with Borrowers are with authorized representatives of the Lender and subject to written reservation of rights so that any terms are not binding on the Lender until definitive documentation is signed by both the Borrower and Lender.
- Modifications should be as narrowly focused as possible so as to avoid open ended relief. They should also make clear that separate defaults will result in termination of such relief.
- Consider whether the nature of the Borrower’s problem is tied directly to the pandemic or is symptomatic of a deeper problem that merits a more traditional approach to a troubled loan. Struggling Borrowers make look to take advantage of the situation to avoid facing the realities of underlying problems. In such cases, a more robust forbearance agreement may be appropriate with added covenants, releases and conditions.
- Loans that are in need of temporary relief tied directly to the COVID-19 virus will be treated differently by the bank regulators than loans that would be highly risk rated outside the current climate. In fact, FDIC guidance has indicated that short term relief afforded to Borrowers that are current on existing loans, either individually or as part of a program for creditworthy Borrowers who are experiencing short-term financial or operational problems as a result of COVID-19, generally would not be considered troubled debt restructurings (TDRs).
- An example of how a lender’s reaction to this uncertainty can lead to litigation, is a case filed in the Southern District of New York on March 25th entitled AG MIT CMO LLC et al. v. RBC (Barbados) Trading Corporation and Royal Bank of Canada, No. 20-cv-2547 (S.D.N.Y. Mar. 25, 2020). This case was filed as a result of RBC exercising its rights under Master Repurchase Agreements (“MRAs”) to sell at auction commercial mortgage-backed securities (“CMBS”) financed by AG through the MRAs. RBC had taken the position that AG was in default of the MRAs as a result of a margin call by RBC due to RBCs determination that the CMBS had precipitously dropped in value due to the effective freezing of the markets for CMBS. AG‘s Complaint alleges, among other things, that RBC’s low valuation of the assets was both a breach of the MRAs and in bad faith, and that RBC’s declaration of the default and auction sale of the assets was in violation of several of the executive orders and other regulations of which we have written. AG sought a temporary restraining order preventing RBC from conducting any further sales. However, that application was denied as moot as RBC agreed to suspend further sales pending a conference with the Court scheduled for April 2nd. This case is in its earliest stages and, if it goes forward, it may provide some guidance on how Courts will interpret the various executive orders, statues and regulation being issued daily.
In addition, the federal government adopted the CARES Act (about which this firm has written extensively). Among the many programs in the act is a temporary but vast expansion of SBA programs that will be administered in part and put a heavy burden on existing SBA Lenders. There is no doubt Lenders will be inundated with applications for the program. The criteria for eligibility is fairly open, however, there are still a variety of underwriting concerns both direct and indirect.
- SBA Participant Lenders will have to review and process the applications and screen the eligibility criteria. If the underwriting review is inadequate and the payroll protection loan defaults or is not forgiven, the underwriting Lender may be exposed.
- Lenders will have to consider how the SBA payroll protection loans and disaster loans dovetail with existing credit facilities.
- Lenders will have o determine if these loans result in covenant breaches regarding additional indebtedness and should they be carved out given the generous terms and potential forgiveness.
- Existing Lenders holding existing debt may need to consent to such loans, although they will be unlikely to refuse to consent, Lenders should consider:
- How the loan proceeds are going to be used and over what period of time in order to know how much debt will be remaining after its Borrower applies for forgiveness of the loan.
- The existing Lender may condition any on compliance with the requirements in the statute to obtain forgiveness of the payroll protection loan.
- Lender needs to take into account whether the amount of the loan will be limited to the forgivable costs for the eight (8) week period covered by the statute, or if the loan is greater than such amount, how the Borrower will repay the balance.
- Requiring the company provide the records required to be submitted for loan forgiveness and provide regular reporting of the same to the Lender.
- Require the Borrower to actually and promptly submit its application for loan forgiveness.
We are closely monitoring these continually developing events and will endeavor to keep you updated as matters progress. We encourage our clients to reach out to us, with any questions that they may have regarding these unfolding events.