The Importance of Reliable Collateral Data When Resolving Distressed Commercial and Multifamily Mortgages

Deteriorating Commercial and Multifamily Real Estate Credit Quality

In the past year, property owners, developers, and their lenders have faced unexpected challenges in the real estate market, including rapidly rising interest rates and operating expenses, the higher cost of hedging floating rate debt, slower rent growth, and decreased demand for office space.

Lenders are not only concerned about declining collateral values due to higher capitalization rates, but also any deterioration in ongoing property cash flow.

Technical defaults on commercial mortgages have surged due to breached loan covenants, particularly debt service coverage and debt yield, allowing lenders to initiate remedies such as cash sweeps and principal paydowns.

Refinancing loans with higher rates and tighter underwriting standards is increasingly difficult and often requires the borrower to contribute fresh capital. These dynamics have resulted in monetary and maturity defaults and an increasing number of foreclosures.

This new credit environment has led lenders to cut down on new loans and instead focus on the performance of their existing portfolios. Lenders are proactively reaching out to borrowers with upcoming maturity dates and rate cap expirations and keeping a closer eye on loan agreements.  

To achieve this, lenders are gathering data from borrowers, such as rent rolls, property operating statements, and new lease information, to assess the collateral’s continuing ability to service the debt.

How Lenders Can Use Data to Make More Informed Decisions 

Lenders have to make important strategic decisions to preserve their capital, including, whether to grant an extension on the loan, renegotiate its terms, divest the loan, or initiate foreclosure proceedings on the collateral. To make the right decisions, property data provided by borrowers must be complete, timely, and reliable.

Most property is not institutionally owned, and many smaller property companies lack the necessary accounting and control infrastructure to provide accurate monthly reports, like variance-to-budget analyses, to their lenders.

Smaller property owners also often use outdated systems or lack the staff required to review and approve accounting entries, process invoices on a timely basis, or generate auditable financial statements.

Faced with these challenges, real estate lenders need additional support in reviewing the information provided by their borrowers. While many lenders have asset management expertise, few have in-house accounting teams that can dig into the accuracy of financial statements.

Instead, lenders are working with third-party accountants who can support data collection and collateral performance monitoring by:

• Verifying financial data by reviewing monthly accounting (e.g., rent collections and arrearages, accounts payable, journal entries and trial balance), confirming insurance policies are current and premiums are paid, monitoring intercompany payments and receivables, reviewing the accuracy of monthly financial statements, and confirming compliance with all lender requirements. Assessing the borrower’s accounting department staffing, credentials, policies, procedures, control environment, and data governance for reporting capabilities.
• Working with the borrower to establish better controls around data integrity, review and approvals, and cash management.
• Understanding the feasibility of and progress toward the borrower’s value-add business plan, including their strategies for leasing additional space, achieving higher rents, or reducing operating expenses, and conducting reviews of monthly budget variances and capital expenditures outlays against budgets.
• Conducting lock-box monitoring which includes preparing monthly analysis of cash receipts, and confirm required payments to the borrower for operating expenses.
• Monitoring borrower compliance with loan covenants based on monthly review of verified accounting and collateral performance data.
• Establishing regular communications with the lender on the status of collateral performance reporting and provide alerts regarding significant changes or discrepancies in budgeted revenues and expenses and escalate any unresolved issues.

These tasks, along with various other analyses, make sure that the lender has reliable information for its credit reviews and strategic loan decisions.

Getting Started with Collateral Monitoring

With so many new dynamics impacting property performance and the capital required to manage commercial and multifamily mortgage debt, there is a growing dependence on data generated by a borrower’s accounting and financial teams.

Lenders must rely on this information to understand collateral performance trends and, if necessary, develop sustainable workout strategies. Inaccurate data could result in ongoing issues and potentially exacerbate credit losses.

When real estate lenders partner with accountants to verify property financial information and regularly assess a borrower's business plan and compliance with agreements, they gain access to more reliable and actionable data. This enhances their ability to effectively manage their mortgage portfolios and make informed decisions regarding restructuring, loan sales, and foreclosure.