Dealing with default: What’s next?

The recession may be over from an empirical standpoint, but that doesn’t mean lenders have stopped pressuring owners. Now is the time when the aftereffects of the downturn are really taking hold, leaving many owners struggling to hang on by their fingertips.


But there are alternatives to mailing in the keys, according to panelists during a session titled “Hotels In Default: What’s Next?” at the Midwest Lodging Investment Summit this week.


The dominant strategy thus far has been to extend and pretend, when a lender gives temporary financial respite to a borrower. And though the technique doesn’t address the financial hit needed to get back to a healthy state of lending, it does give owners the chance to live to fight another day, said Steve Van, president and CEO of Prism Hotels.

“Why would we quit extending and pretending because no one wants to say, ‘Hey remember that loan we made for (US)$100 million? It’s worth (US)$40 million,’” he said.


The “workout mentality” has begun to take hold for some lenders, however, said Biff Hawkey, senior VP of development for Hostmark Hospitality Group, but the volume of defaulted properties is so great that it’s taking incredibly long to make a dent in the distress.

Van has even gone so far as to tell some clients to avoid engaging lenders altogether despite looming debt payments. Financial institutions often are so backed up that owners might be able to hold out for two or three years—which might be enough time for things to turn around.


Rules of engagement


But not all owners will abide by this wait-and-see approach. For those wishing to engage lenders, they must think of what each party wants, said Rick Takach, Jr., president and CEO of Vesta Hospitality.


If the asset shows promise, the lender and owner are far more willing to restructure the deal than if it were a money pit, for example.


But regardless of what either side wants, owners have to bring their checkbooks—better yet, a new partner’s checkbook—to the table.


“I have found that I cannot get anybody to do anything without putting new cash into the deal,” Takach said.


“From the lender’s perspective, you’re not ready to restructure unless you’re doing something with new capital,” added Scott Steilen, principal with Warnick Company.



Exit strategies


If you’re looking for a Resolution Trust Corporation 2.0 to unclog the transaction markets, don’t get your hopes up, Van said. While the government-run program worked great 20 years ago, the sheer scale of the current conundrum can’t be dealt with in the same way.


“Last time it was a (US)$200-billion problem,” Van explained. “Today it’s a (US)$2-trillion, (US)$3-trillion problem,” adding that if a RTC-like mechanism did force the industry to liquidate its pool of distressed assets, the hit would have sent many into a full-scale depression.

And even if every distressed asset came to market, there’s not enough financing available to purchase them, Steilen said.

“Most of the finance opportunities that exist today are for fairly stable assets, reasonably performing assets, and (loan-to-value) in that 50-65 (percent) range,” he said.

We’re in the ditch, Van said, and we’ll be here for a long time. “We might as well learn to make a living at it.”

The good news is that industry fundamentals have turned the corner. Occupancy is up, and rate soon might follow suit, Hawkey said. That might get us through the necessary five to seven years of market corrections.

Or, if owners preferred, they can sell. Van said now might be the best time for many owners to unload their assets. With a lot of equity chasing a few quality assets, some buyers are even overpaying.

It depends on your asset, of course, Hawkey reminded attendees.

“The truth is there have always been pockets of prosperity in the United States,” he said. “… If you’ve got an asset in one of those cities … you have to give a lot of consideration to it.”

Wait too long, however, and your asset might come to market with a swell of other distressed properties. Despite previously erroneous claims for a flood of buying opportunities, the time is coming—eventually, the panelists agreed.

Many key franchisors have said they have more delinquencies today than ever before, which means more product than ever before will be coming to market, Takach said.