We started seeing "COVID-19" provisions written into loan documents around June 2020. It began with modifications for our clients who own hotel and retail assets, and it has since expanded into Agency deals with Freddie Mac and Fannie Mae. It's not axis-tilting changes by any means, but we think it's interesting. Let's talk about what the new language is and what it means.
We were not surprised when loan amendments started pouring in for the assets that surely struggled when the pandemic hit, and we still see ongoing requests to log modifications to the history of a deal. And we get it; there were some big language changes and additions.
Borrower has notified Agent that, in response to the unprecedented market disruption and negative impacts to the hospitality industry and Premises caused by the COVID-19 pandemic ("Public Health Event") and the Legal Requirements promulgated by the Governmental Authorities in connection therewith, Operating Lessee has temporarily closed the Premises... Lenders, Agent, Loan Parties, and Guarantor desire to amend certain provisions of the Existing Loan Agreement and Existing Loan Documents.
1. Definition Amendments. The definitions for things such as "Gross Revenue" and "NOI" set forth in the Loan Agreement have been amended in this new language. The definition for "Gross Revenue" has now been replaced to include stimulus payments, while "NOI" has been amended to explicitly dis-include stimulus. Additionally, "Legal Requirements" now includes requirements to be in compliance with the CARES Act (more towards the bottom on what this means).
2. Definition Additions. We now see brand new definitions added into loan amendments. For instance, "Stimulus Payments" is added to address the gross revenue received from the government for monthly payments. "Reopening Date" is added to address that premises have been closed to the public. And other new definitions include: "Cares Act", "COVID-19 Government Loan", "COVID-19 Period Budget", "COVID-19 Provisions End Date", and many others of this nature.
3. Interest Payments. Unsurprisingly, in the 2020 environment, many borrowers were left to handle suddenly hard-pressed budgets and searched for relief where they could find it. Some lenders allowed borrowers to defer interest in response. However, the language built in some requirements. The deferred interest amount could not exceed a certain limit - one loan document used $1mm for this - and the amount would accrue additional interest compounded monthly. Basically, a bit of relief now for increased payment later, and further changes were required surrounding this allowance.
3a. Cash Management. To further outline the logistics of the deferred interest allowance, some additional steps were added to the Cash Management Arrangements, including payment of COVID-19 Period Approved Operating Expenses and repayment of any outstanding COVID-19 Government Loans.
3b. Financial Reporting. Some additional reporting requirements have also been instated by some lenders; one doc calls for two more documents on top of other monthly reports. If the borrower defers any amount of interest, they would be required to provide a statement identifying Operating Expenses paid and a certificate certifying the Gross Revenues have not been used to make any distributions to members of the loan parties.
3c. Prohibition of Distributions. Expanding on the above, the document further clarified prohibitions that the borrower must not make any dividends, payments, or distributions to any direct or indirect owner or affiliate, until the deferred and accrued interest has been paid (and when any use of FF&E funds has been replenished).
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4. COVID-19 Government Loans and Stimulus Payments. One amendment allowed for the borrower to additionally have a government loan, though not in excess of $1.2mm and not secured. Of course, this loan would be required to be disclosed in full to the lender and would fall under CARES Act requirements, and the government loan must not become ineligible for forgiveness.
Rider to Multifamily Loan and Security Agreement
The Multifamily Rider incorporating the COVID-19 Debt Service Reserve was intended as a protection mechanism for both the lender and the borrower, and we are sure many borrowers are aware of the escrow-like budgeting requirement they face. But the Rider itself incorporates some interesting and notable language, and we have been intrigued to see that the highest closing cost by far for recent HUD, Fannie, and Freddie loans have been payments into a COVID Reserve.
Due to the global pandemic of COVID-19, commonly referred to as the coronavirus, as a condition to making the Loan, Lender has required the Borrower to establish the COVID-19 Debt Service Reserve to ensure adequate funds are available for, among other things, payment of any deficit during the COVID-19 Debt Service Reserve Period.
1. Required Documentation. Payments into the reserve operate like a typical and familiar escrow, so we noted the language surrounding the use of the Reserve. It is only when the borrower does not meet their monthly rent collection requirements that they may document a request to the lender to accept use of the Reserve. If the borrower provides the lender-required documentation and they are not at risk of default, the lender will collect funds from the reserve equal to only the shortfall in the principal and interest payment.
2. Recourse. Also incorporated in the Rider is an addition to guarantor liability. The guarantor is personally liable for any misrepresentation in the Borrower Certification of Rental Collections required by the lender for a Reserve disbursement. As this would constitute fraud, this is in the same vein as your typical bad boy carveouts.
3. Borrower's Personal Funds. If the Reserves do not cover the shortfall in the monthly payment, the borrower must pay from personal funds. This would, in practicality, act like a normal payment default in a situation where the Reserve has been entirely depleted from several months of covering P&I shortfalls.
4. No Forbearance. While the Reserve has any amount of funds, the borrower cannot claim hardship in any way related to the pandemic to qualify for forbearance.
5. CARES. The Borrower is now required to be in compliance with the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Meaning:
- Any loan proceeds must solely be used for purposes permitted under the Act.
- Proper records must be kept detailing the usage of the proceeds.
- The borrower must be in compliance with Cares Act covenants.
We think everyone can relate to that one Chinese curse, "May you live in interesting times" - and we surely do. But we hope you enjoyed catching up on how lenders have adapted post-March 2020!
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