A Grim Sign of the Times

With the economic downturn inflicting pain on the U.S. lodging industry, it should come as little surprise that some companies are forming entities to provide services to lenders and borrowers in distress. On Oct. 8, HVS Capital Corp. announced the formation of the HVS Special Hospitality Assets Group, which is designed to help hotel lenders and borrowers with workouts of distressed assets, foreclosures and bankruptcy issues. HVS made plans to launch the group in April, according to Mike Sullivan, managing director of HVS Capital Corp., when RevPar growth began to flatten out. Lenders began to look with increased favor on hotel deals, as credit spreads are typically wider than in the other real estate sectors. But spreads declined, and from 2005 until the start of the credit crunch last year, they had fallen from 95 to 110 basis points over Treasuries, from a typical level of between 250 and 275 basis points. Today’s picture is not pleasant. When owners seek to refinance these deals, they will likely be asked to contribute 10 to 15 percent more equity into the property, Sullivan said, at the same time that revenue at their properties is falling. Lower hotel revenues could mean that lenders could those revenues, even if the owner is current on monthly loan payments, if the borrower’s debt-service-coverage ratio has fallen below the level stipulated in the loan, he said. Some banks may have what Sullivan called “boxes of loans” on hotel assets, assets in which the lender has little expertise. That is the case at Bank of America, which purchased Countrywide, an enthusiastic hotel lender. Wells Fargo’s pending purchase of Wachovia, which also was a force in hotel lending, could result in a similar situation, Sullivan said. These “receiver banks” will need valuation expertise to determine the hotel’s value on a mark-to-market basis. Also, distressed hotels may have to go into receivership, and Sullivan says HVS has the capacity to manage the asset while it is in this period. Advisory services will likely be needed as well, such as exploration of re-flagging opportunities and which areas of the property require updating and refurbishing. Sullivan said this downturn does have marked differences from the post-Sept. 11 dip in hotel performance. Travel, while down dramatically after the terrorist attacks, did start to rebound about nine months after that tragedy. Many lenders were willing to work with hotel lenders on loan extensions, as they recognized the downturn was temporary. This time, however, lenders seem much less willing, or able, to help, given that their loans in other real estate sectors are also showing stress. The most compelling need of a distressed asset is liquidity to keep the hotel running and up-to-date, but neither the bank nor the owner, who may be bankrupt, is able to provide it. Sullivan says, however, that there is a substantial amount of equity sitting on the sidelines waiting to play in this opportunistic space. “They have capital, and they are under no pressure to get it out, but they will get it out,” he said, noting that HVS has received inquiries from potential investors, mostly from Russia, Dubai and London.