Commercial Loan Modifications – What Are They and Why Now?

What is a commercial loan modification?

It has been said that there is nothing new under the Sun and as far as Ben Soifer Commercial Loan Modifications go that is true. For years, since the invention of Commercial Mortgages, there have been Commercial Loan Modifications. In the good old days “modifications” were called workouts and addressed the same issues that a modification does.

Commercial loan modifications can be crafted in a number of guises and could include; a reduction of the face rate of the mortgage, it could include changing the index, fixing the rate, or changing the margin used in the loan.

A commercial modification could also include a change in the term of the loan more specifically the amortization period of the loan. Lenders learned a valuable and expensive lesson in the 1970’s and early 1980’s about long term lending specifically sometimes it doesn’t work. In the 1960’s and 1970’s lenders were given to lending on a long term basis typically for 30 years. The problem that arose is if you have money out at say 5% for 30 years and the interest rate environment changes to 21% the Lender is upside down.

In that scenario the Lender is borrowing money at 105, 15% or even as high as 20% but collecting at 5% that creates a problem. Banks are in the business of borrowing money (via CD’s, Annuities, and Savings Accounts) and lending it a profit. That profit is the “margin” or the spread between what they pay on the CD’s and what they can charge the consumer of capital (Borrower).

In the 1970’s the banks got caught with long term low interest loans in a rapidly rising interest rate environment turning each of those long term loans into a losing proposition for the Lender. Enter the “Balloon Mortgage” it’s the best of both worlds, lower payments based on long term amortization with a Balloon payment due in 5, 7, or 10 years typically.

The problem today is that there is no capital market for commercial loans. Anyone with a Balloon coming due in the near future will have an extremely difficult time refinancing. The fact that there is little in the way of lending going on, and a nearly 40% decline in values since 2007 Lenders have drastically lowered their LTV’s and the problem becomes evident.