In times of crisis, people often try to help one another to pull each other through. In the current COVID-19 economy, many people are losing jobs, small businesses are struggling, and many lenders are feeling the fallout from those factors.
Borrower defaults are on the rise, and many are reaching out to their lenders for help during this time of need.
Evaluating the Validity of Borrower Defaults during COVID-19
Parsing through this uptick in borrower defaults or borrower requests for assistance through this time will be time consuming and overwhelming. Lenders will need to evaluate the validity of a borrower’s request when determining how to proceed. For example, if your borrower is a landlord of multifamily property, and comes to you advising that many of his tenants have been laid off and are unable to make their monthly rental payments, working with that borrower is a legitimate concern. Their ability to repay your loan is tied to the rental income flowing through that multifamily property, and if there is a temporary difficulty collecting rents from tenants, it would make sense for lenders to work with that borrower to get through that tough time.
Alternatively, if the borrower is consistently late on or misses payments, or the ability to repay the loan is not tied to residential tenants who may be struggling themselves, it may be an opportunistic play by your borrower to try to defer payments during this time period. Lenders will need to take the time to review each file and request on a case-by-case basis to determine whether it makes sense to work with a particular borrower, or to stay strong and proceed with a remedy to cure the default.
The Importance of a Demand Letter
Traditionally, when a borrower defaults or advises their lender that they will be unable to make payments, a lender’s first step towards approaching the default is to send a demand letter to the borrower, requesting payment or to otherwise cure the outstanding default. This is strongly recommended even when a borrower has waived notice or cure periods in their loan documents – sometimes there is an extenuating circumstance the borrower is going through, and that letter is enough to get them to reach out and get back on track.
Prudent lenders will absolutely take the conservative approach of sending their borrowers a demand letter upon a default while the COVID-19 crisis is ongoing. Similar to the last recession, there will be extensive litigation that flows from today’s situation. Lenders who try to work out loans with their borrowers as much as possible prior to taking action to commence a judicial or non-judicial foreclosure (or other remedy) will be seen in a better light if there is ultimately related litigation.
The demand letter is also helpful to start the conversation with your borrower to see how you can work with them to move forward. The most common request from borrowers during this time will be a temporary deferral of monthly payment obligations until the market normalizes and their income is back on track to pay your loan.
Forbearance Agreements for Short-Term Bridge Loans
For short-term bridge loans, the easiest way to document this would be to enter into a forbearance agreement with your borrower in which you allow the borrower to miss one or two monthly payments, then tack those missed payments on to the loan balance due at the maturity date. Lenders can build an automatic extension of continued deferred payments into the forbearance agreement, which is based entirely upon the lender’s discretion. If the time of hardship continues, it is easy for the lender to fall back upon this agreement to help their borrowers through.
Foreclosing during the COVID-19 Outbreak
If the demand letter and forbearance don’t end up working for a particular situation, whether because the borrower is unresponsive or the request for assistance is determined to be opportunistic, lenders always have the option to commence a foreclosure action. Currently, the federal government has placed a moratorium on certain federally backed mortgages, and has requested that business purpose lenders avoid foreclosure, but has not mandated it. Lenders should look to the states in which the properties securing their loans are located to determine whether those states have imposed restrictions on business purpose foreclosures.
In many midwestern and northeastern states, there has been a requirement to halt foreclosures placed on all lenders, including business purpose lenders, if the property securing the loan is residential. In other states, like California, there has been a request to halt foreclosures, but no actual restriction in place from the government. If the property is located in a judicial foreclosure state, it may be extremely difficult to start a foreclosure even if they have not been banned, due to availability of the courts to start proceedings during this time. Even for non-judicial foreclosures, while it may be possible to start a foreclosure action, it may be difficult to complete it due to the fact that the public sales are not taking place.
If the property is located in a non-judicial foreclosure state and there is no restriction on commencing a foreclosure, lenders may consider starting the foreclosure process now, even if they cannot complete the sale at this time. For example, there is typically a 4-5 month notice period prior to an actual sale date occurring, so lenders can get the clock started now so they are able to jump to sale once public sales are taking place again.
In some situations, the nature of the default may be so extreme that it warrants emergency court action on behalf of the lender in order to avoid a serious hardship to the lender down the line. It may be difficult to obtain temporary restraining orders or receiverships during this time period, so it is strongly recommended that lenders only pursue this route if other attempts to work with the borrower have been unsuccessful and there is a serious harm occurring at the property.
Borrower defaults will absolutely be on the rise as COVID-19 panics the nation. Lenders should be prepared to manage requests from borrowers to work with them as they manage this stressful time. There are many options available to lenders to manage defaulted or soon-to-be-defaulted loans, and being prepared to choose the best option will be crucial to managing loan portfolios during this time.