Loan defaults remain in check for now

Hotel & Motel Management, June 7, 2004 by Jeff Higley

National Report--The number of defaults during the recent downturn never reached the epidemic proportions that the industry experienced during the economic crisis of the early 1990s, but hotel owners aren't yet out of the woods.

Several sources said there could be a problem within the next couple of years as commercial-backed mortgage securities debt that was secured in the late 1990s comes due.

Steve Van, president of Prism Hotels, which specializes in assuming management of financially distressed hotels, said CMBS special servicers told him that because of the improving economy, there will be fewer foreclosures as the year progresses.

"Special servicers are saying there will be more defaults [in 2005 and beyond] because all the floating [interest rate] loans coming due and all of the 10-year loans coming due will be hard to get refinanced," Van said.

Government regulations prohibit CMBS trusts from renewing loans they orginated, and Van said that will cause a funding shortage.

"At some point in 2005 or 2006, it's going to be a problem," Van said. "There is $5 billion worth of loans coming due in 2005, and the big question is who is going to refinance those loans?"

Victor Haley, partner and member of the hospitality practice of Sutherland Asbill & Brennan LLP, an Atlanta-based law firm that represents lenders in default and delinquency cases, said the issue is a concern.

"I tend to be an optimist and believe that capital always follows the opportunities," Haley said. "Everybody sees a recovery with increasing velocity. By 2005 and 2006, hotels should be hitting their numbers and should be able to refinance.

"It's not a train wreck yet, but we're planning on staying pretty busy in this part of our business in the next few years," he said.

Rosy outlook

The short-term picture looks good to industry observers.

Bjorn Hanson, industry leader for PricewaterhouseCoopers, said that as of the end of February, the loan delinquency rate in the hotel industry was 5.3 percent. PWC defines financial delinquencies as those situations in which a loan payment is greater than 30 days past due.

The delinquency rate peaked at 5.5 percent in March 2003 and was as low as 5 percent during the latter part of 2003, Hanson said. That's a far cry from 1991, when the rate peaked at 16.2 percent.

"Our forecast is that the delinquency rate will drop fairly dramatically beginning in July," Hanson said. "The catalysts will be a busy travel season and convention season that will drive occupancy and [average daily rate] increases. There will be a better industry performance, therefore more hotels will be doing better financially."

Because the beginning of the most recent downturn was accelerated by 9/11, industry pundits predicted massive delinquency problems. PWC forecasted the delinquency rate would reach as high as 8 percent. Others said it would reach 30 percent or higher.

"In light of the past two years, it's doing amazingly well," Haley said. "Interest rates and very patient lenders have allowed troubled properties to hang on."

Haley said lenders have stayed away from foreclosing on properties because it's unlikely they would be able to find many people who could run the hotels any better.

"However, some of the patience may be shortening," Haley said.

"My sense is that in the past--from four to 15 years ago--banks and lending institutions were very willing to foreclose on hotels to clean up their portfolios," said Kirby Payne, president of American Hospitality Management, which has stepped in to assume management of several financially distressed hotels over the years. "As the economy started slowing down, banks were more hesitant to start foreclosure because they were going to end up with an asset they didn't want to operate.

"As the economy starts to heat up and there is some positive cash flow generated at hotels that have been in trouble in the last few years, you could see some activity if loan payments aren't up to date," Payne said.

Banks have shown a hesitancy to assume the deed of a delinquent hotel because bankers didn't see themselves as being able to operate a hotel more efficiently during the past three years.

"A bank's preference most of the time is to not take a hotel back," Payne said. "If they can't renegotiate, they start the foreclosure process."

Payne's company has assumed the management of hotels in which a bank has the deed in lieu of foreclosure or when a hotel is in receivership.

"We've been in for 60 days or as long as two or three years," Payne said.

Van has 25 to 30 hotels in his portfolio at any given time, and the average length of time properties stay under Prism's management is two years.

Deals help

Van said that judging by lenders' recent willingness to finance deals, finding a lender to refinance a distressed property might not be as difficult as it once was.

Van said hotel-loan originations are booming. He said that in 2002, $2.7 billion in hotel loans were securitized, and as of the end of March this year, more than $6 billion in hotel loans had been securitized.