DURING THE PAST TWO WEEKS� The Plasencia Group has fielded a vast number of calls from long-time clients in the business of making hotel loans and who are now seeking information about the current state of the lodging
industry. They have also sought our advice in developing strategies for challenged hotel assets in their portfolios.

While the majority of hotel loans in this country can still be labeled as �performing loans�, it is clear that the events of September 11 may now have caused numerous technical defaults. There is a high likelihood that monetary
defaults could follow as debt service payments come due over the next thirty to ninety days. It is indisputable that the lodging industry will recover from the damage it has recently suffered. As the domestic economic recovery will
likely be delayed until the second half of 2002, we have prepared this document to provide our clients and friends with a review of market conditions and a variety of steps that lenders may wish to take to mitigate their risk.

Current Environment 

Prior to the events of September 11th, the United States economy and one of its most closely aligned sectors, the lodging industry,
were already showing signs of considerable weakness. Through August of 2001, Smith Travel Research�s Lodging Outlook reported that 22 of their top 25 markets registered lower year-to-date occupancies than during the same period in 2000. Further, rate growth was less than two percent in 13 of the top 25 markets.

The impact of recent events on the hospitality industry and its associated lending institutions will be that loans which were previously known to be experiencing monetary and non-monetary challenges will likely, and rapidly, move toward foreclosure or some other type of less-than-preferred outcome. Unfortunately, there will be a rather large number of loans that, until recently,
were not on any type of workout or watch list and will likely experience cash flow shortfalls, eventually necessitating a restructure of the facility, a foreclosure of the property or another resolution.

Historical Lessons

During the 1980s and early 1990s, when a large number of hotel loans went into default and eventual foreclosure, many lenders learned hard lessons about the impact of a protracted foreclosure process on the operations of a hotel. The unique nature of hotel operations � with �24-hour leases�, daily receipt of funds, extensive preventive maintenance requirements, aggressive and proactive marketing efforts and rigid brand compliance requirements � forced lending institutions to formally recognize the �ongoing business� nature of the investment versus viewing the collateral simply as real estate to be bought and sold.

One aspect of a problem hotel loan became evident only after ownership was formally transferred. It involved actions taken by the borrowing entity prior to cessation of payments or a request for restructuring. As the financial performance of a hotel begins to deteriorate, ownership is forced to decide whether to inject additional capital into the operation (assuming dollars were even available) for physical maintenance, brand compliance, marketing, debt service payments, etc. Unfortunately, the availability of capital will not be the primary criteria for owners evaluating whether or not to make necessary capital infusions.

Most borrowers make this decision based on whether or not there will eventually be any �return of and on� the capital needed to cure the default, support hotel operations or maintain product quality. Careful thought is also given to their remaining investment, if any, in the asset. In other words, the borrowing entity may have �refinanced out� most, or all, of their original investment and may now be playing with �house money� or profit. This only serves to make releasing the hotel back to the lender even less painful.

Voluntary and Involuntary Transfer of Ownership

During the past two years, the value of many hotels has declined to a point where borrowers may make the determination that the investment of additional capital into a problem loan situation is not warranted. As such, that borrower may then decide to voluntarily or involuntarily transfer ownership to its lender. Unfortunately, many borrowing entities do not make this critical decision expeditiously. While hotel management may, in the interim, be taking steps to create additional cash flow for debt service or distribution to partners, over the longer term, irreparable damage to the property�s physical condition, reputation, and market value may be the end result. To generate this cash flow in the interim, an operator may:

• Delay or cease preventive maintenance activities;
• Delay or cease major and minor repairs;
• Broadly stretch out payables;
• Reduce staffing far below industry norms at numerous levels including housekeeping and engineering;
• Delay franchisor mandated repairs and upgrades;
• Reduce marketing staff and/or dismiss other key management personnel.

What Next?

The �operating business� nature of hotels � essentially a lender�s eventual source of repayment � requires a very proactive, aggressive and immediate evaluation of each loan to obtain the best operating information available. Such steps will then assist in determining the most efficient course of action to maximize recovery of the institution�s financial interests.

Lending institutions will certainly minimize problem situations and asset recovery through the prompt identification of problem situations and the immediate implementation of troubled loan and workout strategies.

A Proactive Strategy

Many difficult decisions concerning problem hotel loans will have to be made by lenders during the next 30, 60 and 90 days as a result of recent events. In addition to these immediate situations, during the next 12, 24 and 36 months, it is expected that additional loan problems will surface and will need to be dealt with in a timely and efficient manner. Based on our extensive
experience in working with lenders related to their distressed properties, The Plasencia Group recommends that the following steps be taken immediately to implement a proactive loan portfolio management strategy:

• Prioritize loans based on readily available information such as location, brand affiliation, service level and debt per key. Certain markets, brands and segments were already experiencing problems before September 11th. Taking this step will provide lenders with �visibility� to anticipate potential problems through general market-based assumptions.

• Immediately request updated operating and market data from the borrower. While the loan might be current now, a quick analysis of property performance and market trends may signal an approaching problem, or provide relief that the property may not need immediate triage.

• Obtain updated information on the borrowing entity and its principals. Most hotel owners typically own multiple properties and have multiple lenders. While one institution�s loan may be performing as agreed, the collateral�s operations or cash flow may be destabilized by problem situations at other assets owned by the borrower.

• Immediately request information on the hotel�s compliance with required or pending franchisor capital and operational requirements that may be necessary to keep the hotel within the brand, thereby avoiding market share deterioration.

• Obtain real-time opinions of value and realistic estimates of future performance from qualified and experienced industry veterans. This information will be critical in evaluating the various courses of action that may be proposed by the borrower or are proactively initiated by the lender�s staff or consultants.

• Do nothing and allow the loan to perform as agreed once it is determined that the probability of loss is minimal;

• Offer to restructure the loan with a temporarily or permanently modified interest rate and/or amortization schedule;

• Offer to modify, reduce or waive prepayment requirements as an inducement to prepay the debt facility in short order;

• Attempt to sell the loan to active note buyers in the market today;

• Offer to discount the loan as an inducement for the borrower to pay it off in the short term;

• Work out a stipulated transfer keeping the borrower involved after a note sale, thereby deferring possible tax consequences;

• Expeditiously negotiate a formal transfer of title to the lending institution.

Take Action

The current environment has created significant, though not unprecedented, challenges to hospitality lenders that may result in significant collateral value impairment. Whether or not current economic conditions persist, the industry has been damaged by recent events and very specific action is required quickly to mitigate the effects on individual properties. In times such as these, The Plasencia Group has extensive experience and knowledge in developing and implementing proactive strategic action steps for individual assets and for portfolios. Our team of seasoned veterans has brought its expertise to bear on behalf of our clients, and as principals, during various national and regional economic downturns. 

Lou Pasencia President & CEO

The Plasencia Group is already bringing its expertise to bear on behalf of our clients in need. If we may be of service to you, to obtain more information or to schedule a Strategic Asset Value Enhancement® review, please call Lou Plasencia at 813 / 932-1234 or email at [email protected].