As the world is dealing with the virus pandemic, the hotel industry is struggling to survive the severe demand disruption. What was, until recently, a manageable debt level for hotels has become an unsustainable debt level. Most hotels in the U.S. are not generating sufficient revenue to pay their debt service, and in fact, many, if not most, are not generating enough revenue to create positive income before debt service. Even if hotels are able to pay their lenders out of operations for now, many hotels will not have generated sufficient cash reserves in their busiest season to support expenses and debt service in their lower occupancy season. Lenders, who have been taking a wait and see approach, will eventually need to act on their nonperforming hotel loans.
Many hotel owners will find themselves in the uncomfortable and unfamiliar position of deciding on a course of action for negotiating with their lender. Some will want to find a way to retain their asset, while others will want to find a way to dispose of their asset because it no longer generates any income.
Below are the six most common mistakes we see borrowers make when facing an inability to pay their lender.
1. Borrowing Money to Make the Payments
Often, clients who are struggling to meet debt service obligations call us looking for additional financing. As we examine their financials, we find that their problem is that they have too much debt, and the solution for too much debt is never more debt. We have seen hotel owners borrow more money (sometimes from their existing lender) so that they can make their debt service payments. We have had clients who have maximized their borrowing capacity from every source, including their family and personal credit cards. Instead of adding debt and hoping that the future will be kinder, hotel owners need to reduce their debt through negotiations with their lenders.
2. Hiding the Problem from Lenders
The instinct of most borrowers is to paint a rosy picture for their lender. After all, that was what was required to get the loan in the first place, and entrepreneurs are, by nature, optimists. They often represent to their lender that the next quarter will be the recovery quarter when the hotel becomes solvent again. The reality is that unrealistic optimism hurts the debt restructure negotiation. Borrowers often represent an unrealistic financial future for their asset to forestall the consequences threatened by their lender and to keep the loan out of the workout department. The reality of successful debt restructure is that it occurs only when the loan is classified as a troubled asset, i.e., it has been transferred to work out and the lender has been forced to put the loan on non-accrual. More about this in a future article, but lenders do not usually restructure loans that are current.
3. Being Less Than Truthful
There is no surer way to fail in a debt restructure negotiation than to cause a breakdown in trust between the borrower and the lender. The lender needs to believe that the borrower’s proposal is in the best interest of the lender. The point at which the lender discovers a misrepresentation is the point at which the lender ceases to believe that a borrower’s restructure proposal can be trusted. The lender’s discovery of half-truths and misrepresentations will sink a proposal and lead to one-sided lender solutions.
4. Cutting Expenses Too Much
A hotel with too much debt can rarely cut expenses enough to compensate for a debt problem. Efficiency should always be part of proper decision-making; however, major cuts to customer service, quality and marketing become counterproductive. Cuts that effect employee morale, customer return intent and acquisition of new customers are not effective in solving a debt problem. Ultimately, cutting too much diminishes revenue—sometimes for the long term.
5. Accepting a Solution That Does Not Fully Solve the Problem
Banks will sometimes issue forbearance agreements that may offer some breathing room, but that may result in long-term harm for the business. These forbearance agreements often increase the debt, diminish legal protections for the borrower or contain other provisions that are not in the long-term interests of the borrower. Any solution that simply buys time but does not offer a permanent solution should be rejected in favor of a permanent solution.
6. Allowing the Lender Enhanced Rights to Gain Control of Your Assets
Lenders often will demand enhanced security in exchange for concessions on the loan. They often ask for additional security in the form of enhanced personal guarantees, guarantees from spouses, deeds of trusts or mortgages on other assets of the borrower and cross-collateralization of other assets, to name a few. Borrowers are wise to avoid agreeing to these concessions. Lenders would not ask for these new powers if they did not foresee the possibility of using them and handing lenders additional security puts borrowers at a distinct disadvantage in future negotiations and puts assets at additional risk.
A wave of debt restructure, foreclosures and note sales likely is around the corner. Borrowers who are prepared and who know the process will survive, and many will emerge with an enhanced balance sheet that will provide for long-term success. If borrowers do not feel informed about the restructure process or comfortable with the negotiation, they should consider hiring advisors who can negotiate a successful debt reduction.
Mark Bouzians is managing director at Delta Capital Group.