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How COVID-19 has Impacted the Refinancing of Mexican Real Estate Assets

5 MIN READSeptember 03, 2020
GUEST GRI WRITERS:

RODRIGO AVENDAÑO
Partner
Cuatrecasas
JOSE HIGINIO NUÑEZ HEATHER
Partner
Cuatrecasas
ALBERTO DE VILLA
Associate
Cuatrecasas
COVID-19 is prompting the industry to rewrite the rules of the game when it comes to financing and refinancing real estate projects in Mexico. The quarantine and suspension of activities have left real estate assets gasping for air as this unprecedented event has generated a lack of liquidity in the short and medium term. This has been further aggravated by widespread uncertainty, record unemployment rates and Mexico’s expected 10.5% economic recession in 2020, according to the IMF. 
 
This uncertainty has led companies to seek solutions to cover short-term liquidity problems, while waiting for what may happen in the medium and long term. In this sense, companies have tried to obtain income via capital contributions from its shareholders or third party investors, or to refinance debt that was previously contracted. Companies’ main concern has been to find a solution for these problems in the short term, without putting at risk their development and financial stability in the medium and long term. Especially since the real scope of the current crisis and the repercussions it may have in the commercial sphere are still unknown. 
 
In the real estate sector, this has taken on special relevance due to the effects on tourism, shopping centers, office spaces and housing in general. In the hospitality industry, around 80% of the hotels have closed temporarily. However, some hotels have recently started to reopen. These reopenings are operating under health protocols including 30% capacity limits. Similarly, around 65% of the retail stores were closed, including malls, restaurants, department stores and entertainment centers, with an estimated loss of MX$24.5 billion. The construction industry has been similarly affected, impacting the price base in housing, and longer terms for down payments. The way we travel, work and live is changing by leaps and bounds so lenders, whether capital funds or traditional banks, have had to adapt the terms and conditions of the loans and financing they provide.
 
It is highly probable that new types of problems will arise as the crisis has affected companies’ capital flows in a way never seen before, surpassing by far the worst scenarios that could have been projected when starting the development of a project and its financing. So far, companies have solved these problems in the short term by refinancing their liabilities. In our experience, most of these refinancing operations include waivers and defaults on the payment of principal, and even interest, for a given period of time, resulting in an increase in the final payment (or balloon) and/or an extension in the term of the credit. Likewise, the fulfillment of financial ratios is also being waived for a certain period of time, hoping that they can be met in the 1Q21. However, many financiers are considering altering these waivers since the projections are beginning to show downward results that are very similar to the current ones throughout the different real estate industry sectors, which means that the flows will not be as expected to cover their short-term financial obligations. 
 
In the event that companies with contracted debt decide to turn to new creditors to meet their operational needs and to raise short-term capital, it is critical to determine whether or not current financings allow them to contract additional debt and under what conditions. Due to the economic situation caused by the sanitary emergency, the creditors’ tendency is not to grant waivers when contracting additional debt, which increases the risk of a possible bankruptcy of the borrowers. Even if these creditors have an isolated guarantee package for their credit, this is generating intense negotiations and thorough contractual analysis so that the parties under the existing financing do not assume additional risks that may jeopardize their credits. However, existing creditors seek to provide liquidity to the companies that will indirectly benefit from the existing credits, and the reactivation of the economic activity of the borrowers, making risk analyses are even more susceptible than they were before the crisis.
 
Risk analysis regarding possible assets, including real estate assets or flows from collection rights, that could be part of the new financiers’ guarantees package has taken on special relevance due to the situation being suffered by the same clients, suppliers and investors of the borrowers. This is in addition to the fact that most, if not all, of the companies' assets will be encumbered in favor of the company's senior creditors, in many cases, with excess collateral. Nonetheless, possible partial collateral releases are proving difficult to negotiate since senior creditors are very reluctant to increase a potential bankruptcy risk.
 
Therefore, the contracting of mezzanine debt has become the new trend, which is sometimes convertible to equity with aggressive conditions in favor of the financiers. Contractual risks that were not previously assumed by borrowers are beginning to be more frequent since the financiers also assume more commercial risk. These flexibilities are critical for solving upcoming medium and long-term problems. This is why it is very important to obtain a balance of the legal risks assumed by both parties, since the objective is not to cause a contractual damage that would imply a substantial stake loss for the financiers and the borrowers.
 
Each scenario will be different and from a legal perspective, the decisions made regarding the structure of guarantees and/or the source of payment of mezzanine finance will go hand in hand with the risk appetite that each financier has by virtue of the fact that we are facing an unprecedented and highly unpredictable environment. Therefore, lawyers will have to be very creative in presenting elegant, efficient and practical solutions, and structures to problems that are out of the hands of the parties involved. 
 
Regarding new projects, we are facing a generalized problem since banks, investors and companies in the sector are focused on attending and solving the problems originated by the health crisis in relation to existing projects. Even with the reopening of hotels and shopping centers, as well as the resumption of the construction activity, it is unknown if activities could be suspended at any time, which would impact flow and liquidity once again. Additionally, it is not known what the "new normality" will be with respect to the office and housing sector.
 
Taking into consideration the health protocols under which operations have been resumed in the hospitality and retail industry, it is not known whether these established sectors will be able to generate again the income that was projected at the time, which could lead to a scenario of distress. The risk analyses of the various institutions are undergoing constant changes to reassign probabilities of materialization to scenarios that were previously considered unlikely.
 
We are faced with a unique situation that will generate changes in how various sectors behave, and in the way the market analyzes different industries. In addition, due to the nature of the crisis, we are also anticipating the beginning of other problems of a legal and logistical nature. For example, in the processing of lawsuits, obtaining and processing of licenses, authorizations and permits, as well as in registration procedures, all of which are crucial for the real estate sector. The suspension of activities has caused a significant burden today and therefore a considerable delay in the issuance of permits and licenses for the development and operation of properties within the hospitality, offices and housing sectors. For this reason, it is necessary to have the support of the authorities to accelerate the regulatory framework and allow the commercial and real estate sector to fully reactivate the industry.
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