'To note mod, or not to note mod; that is the question..." Maybe that's not exactly what Shakespeare wrote in the Tragedy of Hamlet, but not carefully considering whether or not to proceed with a note modification can be a tragedy for a HUD borrower.
Columbus, OH - June 30, 2021:
'To note mod, or not to note mod; that is the question..." Maybe that's not exactly what Shakespeare wrote in the Tragedy of Hamlet, but not carefully considering whether or not to proceed with a note modification (also known as a "note mod" or interest rate reduction "IRR") can be a tragedy for a HUD borrower. As interest rates continue to remain historically low, many borrowers quickly look toward their existing lender to reduce monthly payments of their HUD-insured loan through a note mod, failing to assess the shortfalls of the note modification option and the comparable benefits provided by a HUD 232/223(a)7 refinance ("a7'') or other HUD-related funding alternative. Is resetting your prepayment provisions without re-amortizing your loan or
utilizing loan proceeds to fund expenses, all while remaining with your current lender, worth some annual debt service savings?
A note modification is not a new loan. Rather, it is the repricing of an existing HUD-insured loan with both HUD's and the lender's consent. A note mod is a relatively quick way to reduce the loan's interest rate wherein the borrower funds any costs associated with the process through cash at an above market interest rate (read: GNMA investor is funding the costs). A borrower can only complete a note modification with its existing lender, so some lenders can be guilty of pitching note mods at the expense of other alternatives that any
HUD-approved lender can complete.
Although note modifications can help lower monthly debt service costs, there are a handful of benefits that the HUD 232/223(a)7 refinance alternative provides that cannot be accomplished through a note mod. First, the new loan can be re-amortized to the lesser of the original HUD loan term or 12 additional years. Stretching out the term and amortization can reduce monthly debt service, maximizing annual cash flow savings when combined with a lower interest rate.
Second, the cost of the refinance can be funded through loan proceeds. Typically the largest cost is the prepayment penalty associated with paying off the outstanding HUD loan. The a7 borrower can borrow those proceeds at the low, HUD-insured market interest rate rather than using cash or borrowing those proceeds from the GNMA investor through an above-market interest rate. Third, you can elect to work with your existing HUD lender or use a new HUD lender. If you are not satisfied with your existing HUD lender, or if you simply want to assess the comparable differences, an a7 is a great opportunity to test the waters for a new lending relationship.
Finally, there are alternatives to a note mod or an a7, including a short-term bridge loan to be taken back into HUD through a new HUD 232/223(f) refinance. This strategy can enable a borrower to payoff secondary indebtedness, fund the payoff of a partner(s), or simply re-leverage the loan to more appropriately capitalize the project. And unless the bridge loan is funding equity out with an LTV over 70%, the bridge loan should not be required to season and can be refinanced back into HUD immediately after the bridge closing.
Within 30 days from late April to late May 2021, VIUM Capital closed several "note mod alternative" transactions, including three separate a7's. Our clients were able to significantly reduce monthly debt service through re-amortizing their existing loans at a lower interest rate while funding prepayment penalty costs and elective repairs through loan proceeds. These loans, which paid off three separate legacy HUD lenders, totaled approximately $30 million and consisted of seniors housing and healthcare properties throughout the Midwest, including one in Ohio and two in Illinois. Additionally, within the same 30-day period, VIUM closed a bridge loan from its proprietary bank balance sheet for a skilled nursing facility in Texas that paid off an existing HUD loan and recapitalized the project. The new HUD 232/223(f) insured loan has already been submitted back into HUD, ensuring that the project will only be out of HUD for a few months.
Existing HUD borrowers that want to capitalize on the current interest rate environment should make sure to assess all possible options (note mod, a7 and bridge) before completing a note mod to make sure they are structuring the financing ideally for their near and longer term organizational goals. Considerations to think about include minimizing the interest rate, taking advantage of longer amortization to further reduce debt service payments, whether to fund any near term capital projects, and appropriately leveraging the asset so as not to trap equity in the project. These points become even more relevant if a sale or buyout of existing partners is on the horizon in the next 3-5 years.
Shakespeare reminds us in The Merchant of Venice that "all that glitters is not gold." Was he referencing note modifications?
·This article was completed with contributions from VIUM Capital's Summer Analysts, George Economus and Savannah Madden.
VIUM, headquartered in Columbus, OH with offices in Austin, TX, Boca Raton, FL, and Carmel, IN, is privately owned and controlled. Municipal advisory services for tax-exempt issuers are provided through the firm's wholly owned subsidiary, VIUM Capital MA LLC. The company can be reached at viumcapital.com.
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