Commercial Mortgage Repurchase Agreements: COVID-19 Issues, Temporary Agreements and What’s Next | King and Spalding
The sudden stoppage of commercial activity caused by the novel coronavirus 2019 (“COVID-19”) has had a significant impact on the global economy, and in particular on the commercial real estate market. As a result, the commercial real estate mortgages (“loans”) that fund the commercial real estate market have seen a flurry of amendment, modification, vacation and waiver activity to address the stress placed on home borrowers. business (“borrowers”). by COVID-19. This, in turn, has impacted the funding facilities that fund the loans, including the Commercial Mortgage Repurchase (“Repos”) facilities.
Repos are funding facilities through which banks and financial institutions provide liquidity to the commercial real estate market. Commercial mortgage originators make loans to borrowers and then sell those loans, often through a special purpose subsidiary or “SPV” (the “Seller”), to banks and financial institutions (the “Purchaser”) for a purchase price calculated as a percentage of the outstanding loan balance applicable to obtain financing. The Seller undertakes to repurchase the Loans from the Buyer at a later date.
Repos are an attractive financing arrangement for both buyers and sellers because repos are structured to benefit from several bankruptcy code protections, including automatic stay upon seller’s bankruptcy, which allows the buyer to liquidate, terminate and accelerate loans in accordance with Repo documents without having to go through the bankruptcy process and without having to seek bankruptcy court approval. The availability of these protections decreases the risk to Buyers and, as a consequence of the reduced risk, allows the Buyer to offer the Seller lower interest rates than he could obtain through other types of financing facilities.
Margin mechanisms and call events are other features of repos that help reduce risk to buyers by stabilizing and properly sizing the buyer’s loan exposure. Although triggers for requiring margin payments are contractually negotiated between buyer and seller, margins are generally triggered if the market value of a loan declines (which may be determined by the buyer in accordance with the repo documentation – whether at buyer’s sole discretion, or based on factors such as valuations and default triggers). Upon the occurrence of a margin trigger, the buyer may issue a margin call to the seller requiring the seller to repay the purchase price of the loan to restore the buyer’s advance rate to value revised market of the loan. Sellers often negotiate margin call protections, including minimum margin thresholds or providing that a margin call can only be issued after the occurrence of a specific set of credit events (e.g., borrower default).
In addition to margining mechanisms (which generally facilitate a repayment against a specific loan for less than the total amount outstanding under the repurchase agreement against that loan), documentation of the Repurchase also includes triggers which, if involved, force the full repayment (i.e. repayment) of the amount advanced under the repo in connection with a loan. These events – called “redemption events” – vary from one Repo to another, but often include the occurrence of an event of default with respect to the Borrower under the Loan.
The commercial real estate market disruption caused by COVID-19 has severely affected cash flows for some properties, leading to defaults or early defaults on some loans. This has prompted borrowers to seek waivers, modifications and interest payment holidays. In turn, the sellers made corresponding requests from the buyers for the buyers to cede control of certain changes to the loan documentation that would otherwise require the buyer’s consent, and allow the seller to administer the loan d a way that can prevent this loan from defaulting. These changes often avoid a large margin payment or repurchase event under the Repo.
In some cases, buyers and sellers have entered into agreements (“Temporary Agreements”) regarding repos which (A) allow the seller, among other things, (i) to make changes to the underlying loan documents, ( (ii) to defer interest payments for Borrowers and (iii) to use certain reserves to cover payment obligations, and (B) to allow margin and redemption holidays under the Repo. These temporary agreements often require, as part of their execution, certain payments by the seller to the buyer to reduce the buyer’s exposure to the loans. As the name suggests, these temporary agreements are just that – temporary – and the accommodations given to sellers under them are documented to expire after a certain period of time.
When the temporary agreements expire, depending on how long COVID-19 continues to impact the commercial real estate market, the underlying issues that prompted the need to execute the temporary agreements may still exist and buyers and sellers will need to determine what the next steps will be. to be. There are several possible options that buyers and sellers can consider, including:
- Extend temporary agreements depending on a number of factors, including the relationship between the buyer and the seller’s sponsor, the quality and value of the property securing the loan, the financial strength and willingness of the sponsor of the borrower to bring the loan into compliance and predictability and the timing of the end of loan related issues (eg reopening of malls and hotels).
- Amend the Repo to allow different terms for distressed and defaulted loans in exchange for lower advance rates and/or higher spreads and fees due to increased buyer risk (e.g. add a second facility for “stressed” loans in all four corners of the existing repo transaction for loans that remain under stress, distinct and separate from the standard “performing” loans and less stressed than the initial repo was subscribed to finance).
- If the seller and the buyer cannot agree on the terms for keeping the loan on the repurchase facility, the seller may be forced to repurchase the loan and enter into negotiations with the borrower for a loan restructuring or mortgage foreclosure. Alternatively, the seller may seek to refinance the loan with other buyers who are willing to finance more distressed loans or on other types of financing structures.
It has been said that although the social and economic impact of COVID-19 and the various government responses and preventive measures in March and April 2020 resulted in what have been rightly described as “uncertain times”, may to be as we enter the final days of summer 2020, it is now certain that times will remain uncertain. This remains clearly evident in the commercial real estate market, where we expect buyers and sellers to continue to come up with creative solutions to pension loan funding as markets evolve and stabilize. As practitioners who have practiced in this space for longer than some of us would like to admit, we have been pleasantly surprised by the flexibility shown at all levels – both on the seller’s side and on the buyer – to deal with the events of the past 6 months and with the maturity shown by market participants in addressing issues for which the parties are not responsible. We remain hopeful that the reasonableness and “big picture” thinking we have witnessed will continue.