Hospitality Companies and Their Lenders: Preparing for Difficult Conversations
In a sudden reversal of generally expansionary trends, the hospitality business has been among the most immediate and badly hit economic sectors as a result of the COVID-19 pandemic, and the resulting stay-at-home and shelter in place orders.
Most regions of the country are only beginning to emerge from the most stringent phase of social distancing. However, even when current health orders are lifted or loosened, increased sanitation and social distancing costs and fragile consumer confidence can be expected to continue the pressure on lodging operations. As a result, we are only in the early stages of what is likely to be a prolonged period of uncertainty. And when that uncertainty collides with the leveraged nature of most hospitality businesses, difficult conversations with lenders are sure to follow.
Whether these conversations lead to a positive outcome for the borrower depends on how well that borrower demonstrates that it knows its business, understands the current situation, and has a well-thought-out plan to come out on the other side.
Hoteliers are heavily invested in very expensive fixed assets which require relatively frequent and expensive renewal and repositioning to maintain market position. They almost universally rely on construction and term loans and lines of credit to acquire, improve, maintain, and operate them. Lenders typically rely on steady asset values and predictable cash flows in the industry to service that financing. With both leisure and business travel drastically curtailed, and hotel revenues greatly reduced as a result, many hotel owners will be looking at breaches of financial covenants and debt service and loan repayment challenges.
On the other side of the coin, lenders are confronting a situation where the entire hotel sector is facing extreme uncertainty and is under financial duress, making it unproductive to reflexively declare defaults and exercise remedies. With both hoteliers and lenders subject to the downturn from the pandemic, we anticipate that many well-positioned hospitality businesses will be in serious workout discussions with their lenders in the near future, if they are not already.
We expect that some lenders will be more receptive to reasonable workout adjustments than others. Those lenders that are amenable to such restructurings will be engaging in triage and presumably will be focused on the same factors that they typically assess in determining whether a borrower is likely to succeed if given some breathing space. Here are questions lenders are likely to ask and that borrowers need to answer well if the lender is to see them as “likely to recover with care,” rather than “let’s see how they do on their own,” or, worse, “hopeless.”
- What is the borrower’s performance history? Do the borrower’s operational and financial troubles predate the current situation?
- What was the property’s competitive position before March? How urgent are upgrades?
- How strong is the business’s management team? Do they consistently deliver on commitments? Is their reporting reliable?
- Is the borrower realistic about its situation and about its plans for overcoming its challenges, or does it seem to be in denial?
- Is management knowledgeable regarding, and have they appropriately explored potential opportunities in, the recent government stimulus bills, including forgivable loans?
- How well is the borrower doing in managing its costs?
- Does the borrower have a realistic staffing plan in place and the knowledge to execute upon it?
The lender’s position in the industry is also very important. Lenders that have an extensive exposure to the hospitality industry and value their reputation for reliability will be most willing to work with their borrowers. On the other hand, CMBS holders are often slow to respond and lack the flexibility of balance sheet lenders.
In any event, there are two things borrowers should be prepared for:
First, even successful workouts will not be without cost. Lenders will be looking for compensation for taking these unexpected, if unavoidable, risks, whether in the form of interest rate increases or additional fees, not to mention recovery of out-of-pocket expenses. If borrowers are unable to pay these costs upfront, they may be able to negotiate paying them sometime before exiting the loan.
Second, time is typically not a borrower’s friend, as denial and delay will continue to erode prospects for restructuring debt. Borrowers are usually well-advised to reach out to their lenders as soon as they have some insight into their situation, and to let the lender know what to expect and the company’s plan for dealing with that situation. Knowing their business, objectively analyzing the current challenges, and having a realistic plan to deal with those challenges will help lenders see borrowers as the key to overcoming them. In addition, transparency is key. Lenders are generally far more willing to work with borrowers they feel are giving them all the relevant information, rather than only a part of the real story.