Creative Refinancing Reflects Troubled Times

Creative Refinancing Reflects Troubled Times

Reprinted from Advanstar
Hotel & Motel Management Magazine
February 4, 1991
By Jeff Wilder
Wilder Group, L.L.C.

In many instances, creative financing is really a euphemism for debt restructuring. Getting creative usually becomes necessary when a hotel can't produce the operational cash flow needed to cover an owners debt service. Often, creative financing is also used to help owners accept deep equity looses at the point of sale. In either event, the lender/owner takes a hit on his capital and/or suffers lower-than-market-rate yields as a result of all this creativity.

These days, hotel properties in many markets have experienced such debilitating value slides that major reductions in selling prices, or bankruptcy reorganizations may be unavoidable. Value deterioration, combined with illiquid credit markets, means there is simply no fresh debt capital (and limited equity availability) to paper over yesterday's mistakes and start anew.

Enter the creatively financed mortgage (or note) to accommodate a sale or financial restructuring.

The degree of creativity required to allow a hotel business to financially stand on its own often depends on economic pressures pressing down on either the debtor or creditor. For example, a bank that has written down a hotel loan and taken back the property will be able to accept a market-level price for it but may demand "kickers" to provide financing. Alternately, a weak seller owning a hotel that has not been "wrung out" may be in no position to negotiate. He may have to accept a soft note with minimal payments if his equity in the property is tenuous. In both cases, a sale is contemplated.

Sometimes, the owner wishes to stay in control of the business and needs the benefit of a real - or threatened - bankruptcy reorganization to accomplish his goals. The Taj Mahal Casino Resort is a clear example of creative refinancing. Bondholders agreed to reduce their interest-rate rights and, in return, got half the casino. If Donald Trump eventually gets current on the old rate, he can have the right to reacquire up to 80 percent of his equity. If Trump doesn't meet certain minimum projected income levels, then he's basically got to turn the keys over to the bondholders.

Catch Your Breath

Characteristically, the first two or three years after a sale or restructuring allow for a breather period and for conservative debt-service levels, often at below-market rates. Sometimes the difference between the cash-payment debt schedule and a market interest rate is accrued and tacked on to the principal amount of the loan. The due date of the accrual, while negotiable, is usually deferred until the loan matures.

After the breather period, the creditor may expect an interest-rate kicker in consideration of his earlier accommodation and patience. For example, the creatively recast debt might bear a 10 percent base interest rate with additional interest equal to a percentage of gross room sales. Conceptually, that's really saying, "When the business gets better, I, as creditor, expect to share in the good times too."

In addition to this bonus payment plan, or instead of it, the creditor may negotiate to receive a percentage of the hotel's future resale price. This often falls in the 25 percent range and can be a helpful inducement to convince a creditor to be patient today. Naturally, a clear definition of how this future bonus is paid and calculated is important to avoid future definitional problems.

Finally, since creative financing is usually done during times of financial stress, most participants go into a negotiation feeling that a refinancing with fresh outside capital is unlikely anytime soon. Therefore, the length of the loan's life is usually liberal - often 10 to 20 years in duration.