With billions in hotel loans set to mature in 2011, there are many borrowers looking to refinance properties. As hotel performance improves, there is also increased activity on the buy side driving the need for acquisition funding. The good news is loan volumes will increase this year, with some lenders looking to grow the number of deals they close by 20% or more.
While more deals will get done, not all projects are created equal. The general characteristics that enable a hotel to get credit in today’s market include a good flag, solid demand generators, low leverage, significant debt service coverage (or DSC), the ability to pledge additional cash or collateral, strong borrower financials and sound operators with good experience.
Most borrowers understand flag, location, leverage, DSC and cash, but many are unclear what it means when lenders talk about strong sponsor financials and experience.
Why lenders like strong borrowers
A strong borrower is one financially capable of making capital contributions in the event of economic stress. Lenders recognize that sponsors who are healthy financially are at a lower risk of default because of short-term cash flow problems and are less likely to exacerbate losses in the event their equity is eroded.
Strong borrowers are also attractive because banks believe these clients have capital market options. Why is that important? In the present credit environment, strong borrowers are viewed as having the ability to access debt more easily. Given the state of many bank balance sheets, it is not uncommon for lenders to ask their strongest borrowers to move their loans or pay down their principal in order to reduce exposure to an individual or a non-preferred asset class like hotels.
Characteristics of sound sponsors
For those reasons, lenders generally like sponsors with the following characteristics:
- high net worth;
- liquidity—minimum 25% of loan amount;
- experience—five or more years is ideal;
- good credit—minimum 600 FICO, 700+ preferred; and
- income-producing assets with positive cash flow.
Of the above, net worth probably carries the least weight. Typically, a sponsor wants to be able to show he has substantial assets, liquid and non-liquid, in his wealth portfolio to access if needed. More important than net worth is liquidity. Lenders place more value on liquid assets that are easily converted to cash because it gives them an idea of the sponsor’s ability to cover debt payments because of cash flow issues or to pay down principal if needed. Liquid assets include cash, United States government and marketable securities, and the cash value of life insurance. Financial institutions prefer a borrower’s liquidity be equal to 25% or more of the loan amount.
Experience is another trait lenders look for in sponsors. Generally, the preference is for five or more years of experience managing, owning or working in the hospitality industry. If the borrower owns or manages another hotel, the performance of this property will be key. Banks look at the performance of other properties as one indicator of how well a sponsor runs his or her business. Positive cash flow and property value, as calculated from capitalized net income, are important.
Credit history is another determining factor of a borrower’s creditworthiness. Lenders typically look for a sponsor’s debt-to-income ratio to be less than 40%. A higher ratio might not be a problem if the sponsor has an exceptionally strong credit profile with no black marks. A FICO score of 700 or higher with no prior bankruptcies or delinquencies is considered excellent. A black mark will not exclude a borrower from being offered a loan if there is a valid reason for it and he has otherwise taken good care of his credit history. While a FICO of 700 or higher is preferred, lenders generally will consider sponsors with a 600 FICO or above. Items in a credit report that can kill a deal include a current or repeating tax lien on a property, or current or repeating delinquencies on personal credit accounts and defaults.
Lastly, in today’s credit market it is all about the global picture. The hotel you are trying to refinance might be throwing off cash, and you may have 10 years experience as an owner-operator, be 80% liquid and have a clean credit history, but after looking at the financials on your other income-producing properties, lenders might have heartburn about making the loan. Why? The reason is lenders want to see that your other properties are producing cash. This is seen as an additional cushion in the event of performance issues at the hotel you’re refinancing.
As you go through the financing process, be prepared to provide tax returns and financial statements for the last three years on all properties in which you have 20% or more ownership. If you own 15 hotels, you will need to provide these documents on all of them. One under- or non-performing property might not kill a deal, but it will make it harder to get done.
Build your borrower muscle
With tighter underwriting it is important to be prepared and to have your i’s dotted and T’s crossed. Presenting yourself as a strong sponsor is critical. Those who have the above characteristics will get the best terms. If you don’t, strengthen your position before looking for debt.
- Build your liquid assets.
- Understand property performance across your portfolio. If you have an under-performing property, make sure you can provide a good rationale for the issues and a clear turnaround plan.
- Check your credit score. Pull your credit report from all three bureaus—Experian, Equifax and TransUnion. Check it for inaccuracies or red flags and contact the agencies to make corrections.
- Resolve any disputes, such as tax liens, and bring all delinquent accounts current.
Being mindful of what is takes to get debt today and attending to details related to your borrower profile can make the process of securing a loan easier. Get yourself in shape now in order to take advantage of the opening of the credit markets.
Jane Larkin is managing director of Larkin Hospitality Finance, a national hotel investment-banking firm focused exclusively on meeting the debt and equity financing needs of hotel owners and developers. She can be reached at jlarkin@larkinhf.com or (469) 916-8518.
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