SBA-Best Practices in Debtor Workouts and Note Sales

Steve Katz:                   Hello again, and welcome to the Hillco Global Smarter Perspective podcast series. I’m your host, Steve Katz. Today, we’re pleased to have Hollis Carter with us again.

Hollis, as you may remember, is a 23 year veteran with the SBA and a Hillco Strategic Alliance partner. And our discussion today is going to focus on debtor workouts and note sales. So as part of that, we’re going to discuss what a debtor workout is. The advantages of debtor workouts versus foreclosures, the major impediments to debtor workouts, and lastly situations where a note sale is the most appropriate collection strategy.

So quite a bit to cover again today, but we’ll keep it moving and we’ll keep it informative. So some quick background, as we always provide Hillco real estate as a unit of Hillco global and provide strategic advisory and transactional services to minimize costs and maximize the value of real estate assets for both healthy companies and companies in transition. Hillco has been involved in repositioning more than 35,000 leases and in the disposition of over 200 million square feet of retail, industrial and office properties since it was founded over 25 years ago. With that said, Hollis, I’m really pleased to welcome you back to the podcast.

Hollis Carter:                Thanks, Dave. I really appreciate you having me again.

Steve Katz:                   Well great. Hollis let’s start off today if you would. Can you explain what a debtor workout is?

Hollis Carter:                Sure. Steve, actually, the short answer is a debtor workout is simply a process of a lender and a borrower working together to explore alternatives to foreclosure or bankruptcy after a long default.

So this may involve the lender receive additional collateral, lengthening, the term of the loan, writing down part of the principal balance, providing minor additional lending to make repairs necessary to sell the property in order to get the best price, voluntary sale of all, or a portion of the collateral or any number of negotiated terms and conditions.

But the main thing to remember is that no lender wants to foreclose on property. They realize they are not in the real estate business. That’s not what they do. They don’t want to have to pay for insurance, maintenance, taxes on the property. All this adds up so that they really want to dispose of it as quickly as they can, where they don’t have to keep possession of the property for very long. So foreclosure is definitely a last resort. The debt workout process is unique to the specifics of each transaction. So every case is going to be a little different.

The most important point to remember along these lines is that it does work involves a series of increasingly severe actions by lenders’ bottom line to protect their own financial interest. Debtor workouts, of course, can be unpleasant. They can be uncomfortable for all parties involved and the risk of financial loss oftentimes heightens the emotions surrounding one of these deals.

Steve Katz:                   Okay, great. That’s a helpful overview Hollis. So next I think it would be helpful if you could break down a bit further, the moving parts of a voluntary sale of collateral.

Hollis Carter:                Of course, first thing, timing is critical. If a workout is feasible, negotiation should begin immediately and a final workout plan should be put into effect within a reasonable period of time. That’s usually going to be within 60 calendar days.

The most common mistakes that I find borrow making in default situations are, first, a refusal to communicate with the lender, thereby forcing lenders to take alternative action. Second, the borrower may communicate with the lender, but they don’t provide accurate information. So if the borrower won’t communicate or provide accurate information, a successful workout really is not going to be possible. Those two conditions must exist.

If the workout can’t be accomplished within a reasonable period of time, the next step towards enforced debt collection should be taken by a lender. 504 debtor workout can take many forms. It can involve forbearance, reinstatement of maturity dates, deferment, modification of note terms that is an extension of maturity, payment reductions, interest rate reductions, et cetera. It could be an assumption subordination to a working capital loan, relief on a secured senior loan, and finally the voluntary sale of collateral. Or in other words, a short sale in many cases, or a sale for payment in full.

SBA requires complete current financial information on all obligors to consider any workout plan, except in some cases where the borrower is selling collateral voluntarily. During this session, we’re going to focus on voluntary sales basically for the rest of our time today. If the borrower is nonviable and can’t continue, a voluntary sale may be the optimal liquidation strategy.

A key point here is that a voluntary sale can only be executed, as I said earlier if the borrower is cooperative, and also the collateral must be relatively free of junior liens. That is other junior mortgages, tax liens, judgments, et cetera. If the property is heavily encumbered by other junior liens, foreclosure very well may be the only alternative. So a voluntary sale by the borrower is usually the best liquidation alternative. Since it isn’t usually perceived as a force or distressed sale to property. On the other hand, if the lender takes possession of a 504 project real estate, it’s almost always going to be perceived as a distressed sale situation and clearly does not result in the best recovery for the lender or the borrower. So in short, the owner is in the best position to help the lender and help the seller maximize value and maximize recovery from the sale.

Steve Katz:                   Okay. So with all of that in mind, I’m wondering for a lender to agree to a voluntary sale. Are there certain conditions that need to be, or that should be met?

Speaker 4:                   Great question, Steve. Absolutely. There are conditions that must be met for a voluntary sale to go forward. First, and obviously, the borrower must have possession of the collateral. The sale is going to have to or should maximize the SBAs recovery. Number three, the ultimate sale price must be supported by a current appraisal or broke opinion known as a BPO or the sale must pay off the 504 loans.

So in other words, the sales price has got to be supported by some outside documentation, unless it pays the loan in full. All lean holders must provide consent, cost of the sale must be reasonable. Consideration or payment to the lender should at least approximate the net recoverable value of the collateral. Consideration must be paid to the lender immediately and prior to the release of the lien. And finally, all net proceeds must be applied to the lender’s loan unless the loan is to be paid in full. And if the loan is not paid in full by the voluntary sale, then the transaction is actually a short sale.

Steve Katz:                   Okay, got it. And maybe you could talk for a couple of minutes also about what the specific advantages of a voluntary sale are.

Hollis Carter:                Well the greatest advantage of a voluntary sale is that it serves the best interest of both the lender and the borrower. That’s key because they’re not many things, usually, the lender in many cases, default situation, the interest do not align that way. So the voluntary sale should maximize the sales price and ultimately SBAs recovery. And as I mentioned a few minutes ago, this is largely because the voluntary sale isn’t necessarily perceived as a distress situation. Whereas foreclosure followed by lender sale, again is always perceived as a distressed sale. So a voluntary sale also requires the borrower’s cooperation, of course, which would include maintaining the property and assisting in promoting the sale. So bottom line, the lender’s best recovery is likely to come from a voluntary sale.

Steve Katz:                   So what are some of the impediments to a voluntary sale?

Hollis Carter:                The most common impediment is that the borrower simply waits too late in recognizing the severity of their problems and making the decision to move forward with the sale of the property. In many of these cases, the TPL has run out of patience by this time and possibly even initiated foreclosure. So for this reason, it’s crew critical that the CDCs effectively monitor their problem loans. So these situations are identified as early as possible and key while the borrower still has options. The other impediments are, of course we’ve discussed it previously, uncooperative borrowers, uncooperative TPL, or in some cases, the original TPL may have sold its note to a hard money lender that is simply unwilling to cooperate. So a key takeaway here is when the borrower is unable or unwilling to recognize the severity of their problems or communicate with the CDC, a voluntary sale is very unlikely.

Steve Katz:                   Very interesting. I’m also thinking, in the past, we’ve talked a little bit about a short sale. So as it pertains to what you’re discussing here, how do short sales fit into all of this and what are the requirements for a short sale?

Hollis Carter:                Well, first short sales are quite common in the 504 programs and can lead to significant recovery for SBA. Given that they’re almost always going to be in a junior lien position. A short sale by definition is the sale of real property by the owner where the sale’s proceeds are inadequate to pay off all debt secured by the property and the owner doesn’t have the ability to pay off the remaining balance of the secured debt. For a short sale to occur the junior secured creditor or creditors must agree to release their liens on property for less than the amount required to pay off their loans. SBAs got a number of requirements for short sales, and they’re basically the same as for a voluntary sale, but there are several other additional requirements that apply with short sales.

First, the sale must maximize SBAs recovery. A transaction must be orange linked, that is no relationship between the buyer and seller. No sales proceeds can go to the seller or the borrower in a short sales situation, no subordinate amounts, subordinate amounts may be paid to the third party lender prohibited by the third-party lender agreement they’ve signed with the SBA. No sales proceeds to junior lien holders, unsecured creditors, or others unless prior approved by SBA. And in some cases, SBA will have to approve that in order to forward with the sale. There can be no credits to the buyer. The borrower should make arrangements for payment of any loan deficiency.

That’s prob a topic for another one of these webinars. We could spend a good bit of time talking about that. The CDC may use the protected bid analysis to support the short sale request. If the borrower insists on being released as a condition of the short sale, the CDCs proposal must include a convincing argument or support and evidence complete with current tax returns, financials, etcetera. That all that has to be included with the request so that SBA can make a decision since the release of the obligor on a short sale would be an exception to SBAs normal policy.

Steve Katz:                   Okay and to close out our time today, because believe it or not, we’re running out of time already. Can you talk a little bit about how SBA notes sales fit into all of this?

Hollis Carter:                Sure and I can do this very quickly. SBA will consider the sale of its note only if that liquidation method will maximize recovery on the loan. The SBA has done this from time to time, but the requirements for considering a note sale are basically the same as those for a short sale. However, since the sale of the note means SBA can no longer pursue recovery on the loan with the obligors that is they can’t sue the obligors. They can’t refer them to treasury simply because if the note’s gone, then the guarantees, et cetera, go with the note and SBA will lose all of that. So bottom line, the CDC must carefully analyze all obligors’ financial condition and future earnings potential in making their recommendation for a note sale.

Steve Katz:                   All right, well Hollis, thanks again for taking time to visit with us here on the podcast. It’s always great when you share your knowledge on this topic. And I look forward to having you come back again soon. Maybe we can even get you on in the fall again, to discuss other aspects of the SBA CDC relationship. If that sounds good to you.

Hollis Carter:                I really look forward to it, Steve, and thanks for having me on the podcast again. I hope this was informative for your listeners and I welcome any questions that your listeners might have.

Steve Katz:                   Well, it was our pleasure and I’m sure you will be getting some questions. Just to clarify and drill into some of the topics you covered here today.

So thanks again for certified development professionals. For those from the SBA and others who joined us today, if you’d like to learn more about best practices for problem loan management during these challenging times, Hollis has asked that you reach out first to James Keith here at Hillco real estate. He and the teamwork closely with Hollis on these matters. So James’s email is JKeith@hillcoglobal.com. That’s J-K-E-I-T-H@hillcoglobal.com. And with that said, we hope that today’s Hillco global smarter perspective podcast provided you with at least one key takeaway that you can put to good use in your business or share with a colleague or client to help make them that much more successful moving forward. Until next time for Hillco global, I’m Steve Katz.