Lender workouts and forbearance

The lender decides more than the sponsor does

When a multifamily deal gets into difficulty, investors watch the sponsor. The decisions that determine the outcome are usually being made across a table from the sponsor, by a lender.

That is a structural fact rather than a criticism. The loan is typically the largest claim on the property, its covenants govern whether cash may be distributed, its maturity sets the real deadline, and in a default the lender's remedies reach the asset itself. A sponsor working through a difficult period is largely negotiating, and what they can obtain determines whether a capital call is needed, whether the hold extends, and whether equity survives.

Most investors have no vocabulary for this part, which makes it hard to ask useful questions. The purpose of this page is to supply that vocabulary, from the guidance that federal banking regulators actually give their examiners, so you can ask a sponsor precisely what has been sought and what has been agreed.

The narrative of how a deal deteriorates, stage by stage, is set out separately in what happens when a deal underperforms. This page is about the lender side of that story.

What regulators tell lenders to do

The instinct of most investors on hearing that a loan is under stress is that the lender will foreclose. The supervisory guidance points in the opposite direction, and knowing that changes what you should expect.

In June 2023 the federal banking agencies issued a policy statement on prudent commercial real estate loan accommodations and workouts, distributed by the Federal Reserve as SR 23-5 and by the OCC as Bulletin 2023-23. Its stated purpose is to "reinforce the message that financial institutions should work prudently and constructively with creditworthy commercial borrowers experiencing financial difficulties," and to "ensure that supervisory policies and actions do not inadvertently curtail the availability of credit to sound borrowers."

The policy statement goes further, encouraging institutions "to work proactively and prudently with borrowers who are, or may be, unable to meet their contractual payment obligations during periods of financial stress," noting such actions "can mitigate long-term adverse effects on borrowers" and "are often in the best interest of financial institutions and their borrowers."

So a lender agreeing to a modification is doing something regulators explicitly encourage, not something exceptional. A sponsor who says the lender will not engage should be asked what specifically was requested and what reason was given.

Accommodation and workout are different things

These two words are used loosely in investor updates and they mean different things. The policy statement defines both.

An accommodation is the lighter, earlier step. Per the statement, it "includes any agreement to defer one or more payments, make a partial payment, forbear any delinquent amounts, modify a loan or contract, or provide other assistance or relief to a borrower who is experiencing a financial challenge." Accommodations are described as "generally short-term or temporary in nature" and as occurring "before a loan reaches a workout scenario."

A workout is the heavier, later arrangement. The statement notes that workouts "can take many forms, including a renewal or extension of loan terms, extension of additional credit, or a restructuring with or without concessions."

The distinction is diagnostic. A sponsor who has obtained a ninety day payment deferral is at a different point from one negotiating a restructuring with concessions, even though an update might describe both as "working with our lender." Ask which of the two is in progress, and ask for the term in the lender's language rather than the sponsor's.

One further point from the statement that is easy to miss: it is prudent for the institution "to provide clear, accurate, and timely information about the arrangement to the borrower and any guarantor." The guarantor is a party to this. If a key principal outside the sponsor's own team signed the loan, they are in the room and their interests are their own.

Why a lender can restructure without being punished for it

Lenders have historically been reluctant to modify loans partly from fear that examiners would criticize the result. The policy statement addresses that directly, and the sentence is worth quoting because it explains why workouts are available at all.

"Consistent with safety and soundness standards, examiners will not criticize a financial institution for engaging in loan workout arrangements, even though such loans may be adversely classified, so long as management has ... developed a well-conceived and prudent workout plan that supports the ultimate collection of principal and interest."

Two further protections sit alongside it. "Loans to sound borrowers that are modified in accordance with prudent underwriting standards should not be adversely classified by examiners unless well-defined weaknesses exist that jeopardize repayment." And "examiners should not adversely classify loans solely because the borrower is associated with a particular industry that is experiencing financial difficulties."

The practical implication for you is that the lender has room to work, provided the sponsor brings a plan the lender can defend. The condition is a well-conceived plan supporting ultimate collection. That is precisely what a sponsor should be able to describe to you.

What the lender is looking at

The statement sets out what an examiner assesses in reviewing such a loan, which is a close proxy for what the lender must be able to show. "The primary focus ... is an assessment of the borrower's ability to repay the loan. The major factors that influence this analysis are the borrower's willingness and ability to repay the loan under reasonable terms and the cash flow potential of the underlying collateral or business."

Note that willingness sits alongside ability. A sponsor who has stopped communicating, or who has taken fees while asking for relief, is undermining the willingness half of a test the lender has to satisfy.

The analysis also reaches beyond the property. The statement refers to analyzing "the available cash flow of guarantors," to considering the borrower's "character, overall financial condition, resources, and payment history," and to global debt service coverage, which is "inclusive of the cash flows generated by both the borrower(s) and guarantor(s), as well as the combined financial obligations (including contingent obligations)."

That last point explains something investors often find opaque. A guarantor with several other stressed deals weakens the position of yours, even where your property is performing acceptably. It is one of the better reasons to have asked, before subscribing, who signs the loan and what else they guarantee.

The relief that actually gets granted

In practice a small set of arrangements recurs, and each has a different cost to you.

Payment deferral or forbearance on delinquent amounts. Cheap and short. Interest usually continues to accrue and is capitalized, so the balance grows.

Conversion to interest-only, suspending principal amortization. This preserves cash but removes one of the four components of your return, since amortization is real value accruing quietly.

Covenant waiver or reset, where a debt service coverage or loan-to-value test has been breached. Often granted in exchange for a reserve deposit, a paydown, or a cash management trigger, any of which can require equity and therefore a capital call.

Maturity extension, which is frequently the most valuable and is usually conditioned. Common conditions include a principal paydown, purchase of a new interest rate cap, replenished reserves, and a higher spread.

Restructuring with concessions, including rate reduction or principal forgiveness. Rare, and it generally requires the equity to contribute or to be substantially diluted first. Debt forgiveness can also produce cancellation of indebtedness income allocated to partners, which is a tax consequence arriving in a year with no cash to pay it.

Each of the first four commonly requires new equity as a condition. That is the bridge between the lender negotiation and the notice that arrives in your inbox, which is covered in capital calls.

Agency debt behaves differently

A large share of multifamily debt is not held by a bank at all. Loans purchased or securitized through the government-sponsored enterprises, Fannie Mae and Freddie Mac, and loans in commercial mortgage-backed securities, run on different rails.

The distinction that matters is who has authority. A balance sheet lender can negotiate directly. Securitized debt is administered by a servicer under a pooling and servicing agreement, and once a loan is in distress it typically transfers to a special servicer whose duties run to the certificate holders rather than to you or to the sponsor. Relief is slower, more formulaic, and less negotiable, and the special servicer earns fees on the workout itself.

Prepayment provisions differ too. Agency and securitized loans commonly carry yield maintenance or defeasance, which can make an early sale uneconomic even where a buyer exists. That is one of the reasons a hold extends, as described in liquidity and hold periods.

So a useful early question, asked long before there is any difficulty, is simply: who holds this loan, and if it is securitized, who would we be negotiating with?

What to ask, and what an answer should look like

If a deal you hold is under stress, the questions below are answerable and a competent sponsor will already have the answers, because the lender has asked most of them first.

A good answer names the counterparty, the specific relief requested, the conditions attached, the deadline, and what happens if it is not granted. A weak answer restates the business plan and describes the relationship with the lender as constructive. The difference between those two is most of what you can learn without seeing the loan documents.

You should also ask to see the reporting the lender receives. A sponsor sending a monthly operating statement and rent roll to a servicer can send the same to you, and a reluctance to do so while asking you for money is worth noticing.

None of this gives you a vote. Limited partners generally have no standing with the lender and no right to be at that table. What it gives you is the ability to tell a sponsor who is managing a problem from one who is describing it, which is the judgment you will actually have to make.

What to ask before you wire

1. Who holds the loan, and if it is securitized, who would we negotiate with?
2. Have you requested an accommodation or a workout, and what specifically did you ask for?
3. What conditions has the lender attached, and what is the deadline?
4. Does the relief require new equity, and if so how much and by when?
5. Is the guarantor supporting other loans currently under stress?
6. Will interest continue to accrue and be capitalized, and what does that do to the balance?
7. May I see the same monthly reporting package the servicer receives?

What this is built on

1. Board of Governors of the Federal Reserve System, SR 23-5, Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts
2. Board of Governors of the Federal Reserve System, Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts, full text
3. Office of the Comptroller of the Currency, Bulletin 2023-23, final interagency policy statement on prudent commercial real estate loan accommodations and workouts
4. Fannie Mae, Multifamily business
5. Freddie Mac, Multifamily business
6. Internal Revenue Service, Publication 541, Partnerships
7. Internal Revenue Service, Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits
8. Investor.gov, Private placements under Rule 506(b) and 506(c)