Many private lenders are tracking rising delinquencies and starting to feel the realities of the current market.

A brief synopsis of the default landscape according to ATTOM’s Midyear 2022 U.S. Foreclosure Market Report, published in mid-July 2022, includes the following:

In the first six months of 2022, a total of 164,581 U.S. properties are in default as defined by foreclosure filings, default notices, scheduled auctions, or bank repossessions. This figure represents an increase of 153% from the same period in 2021, but it’s down just 1% from the same period in 2020.

States with the highest foreclosure rates in the first half of 2022, in order, were Illinois, New Jersey, Ohio, Delaware, and South Carolina. Other states with the highest first-half foreclosure rates among the 10 highest nationwide were Florida, Nevada, Indiana, Georgia, and Michigan.

Lenders foreclosed (REO) on a total of 20,750 U.S. properties in the first six months of 2022, up 30% from the last half of 2021 and up 113% from the first half of 2020.

States that posted the greatest number of REOs in the first half of 2022 included Illinois (2,434 REOs), Michigan (2,259 REOs), Pennsylvania (1,290 REOs), California (1,043 REOs), and Florida (1,041 REOs).

It seems the U.S. is basically getting back to pre-pandemic levels of delinquency. However, it is important to note that much of the current foreclosure activity, “is on loans that were either already in foreclosure or were more than 120 days delinquent before the pandemic,” stated Rick Sharga, executive vice president of market intelligence at ATTOM.

This report and others have not specifically identified how many of these foreclosures are commercial or business purpose loans, but these figures appear to demonstrate increased delinquency across the board.

Preparing for a Rise in Delinquencies

How do private lenders prepare for the current and inevitable rise in delinquencies? Here are a few tips to consider:

1. Maintain close and regular communication with borrowers. Once the loan closing is complete, borrowers deal with the construction escrow department for draws, but the loan originator and borrower often do not really communicate post-closing.

Consider establishing a post-closing individual or team—a lender representative. From the inception of post-closing, the representative should attempt to schedule a regular call with borrowers every two or three weeks to discuss updates on renovations, budget, income/expenses, marketing, sales/leases, property management, and related issues.

Instead of simply reminding a borrower about payment obligations and deadlines, frame the conversation as an opportunity to collaborate, assist and encourage, and let the borrower know you are both on the same team. For example, if a borrower is having trouble with an inspector or a subcontractor, maybe the lender can connect the borrower with another current or former borrower in the same region who could assist. Similarly, in regions where your operation has or had issued a decent volume of loans, consider assembling a resource list of consultants/professionals you can use and share with borrowers.

2. Keep an open mind. Even though a borrower is current, you may determine based on conversations and other information, there is a likelihood of trouble ahead. Be prepared to present flexible options to prevent actual default (e.g., extensions or refinancing).

Approach the discussions as an advisor who’s being helpful and providing assistance and guidance rather than putting on pressure. A borrower who feels too much stress with respect to the building project and meeting financial obligations often becomes overwhelmed and tends to disengage, leaving the project and loan payments at risk.

3. Engage counsel, if necessary. If the previous suggestions did not prevent default and a borrower misses a payment, schedule a brief call with local counsel. If you need assistance obtaining local counsel, there are various resources available through the AAPL.

Since default on commercial or business purpose loans has been very sparse in recent years, many lenders may not be familiar with the default process in particular states or regions. It is important to understand the process, timeline, costs, fees, etc., in order to effectively negotiate a resolution with a borrower.

4. Don’t give up on resolving out of court. Simultaneously protect your creditor rights while aggressively pursuing non-litigation options. Have counsel send the statutory and/or demand notice pursuant to the loan documents as soon as possible, but make it clear to the borrower you are committed to a non-litigation resolution. Try not to lose time and “wait” for a payment or a refinance closing; continue with the judicial or non-judicial process.

5. Continue to pursue legal remedies while attempting to settle with the borrower. Again, it is important not to let your foot off the gas in protecting creditor rights; however, it is equally important to strive for an out-of-court resolution.

Consider putting pressure on guarantors and implementing a receiver, or at least request permission from the court to appoint one so you can take over a struggling project or collect rental income, if necessary. Remember, even after a judicial or non-judicial sale date, you may still be able to work out a resolution with the borrower. If some standard resolution options are not practical or possible, consider contacting a few former (successful) borrowers in the area to see if they would be interested in taking over the project/loan.

Although lenders can never be fully prepared nor foresee borrower delinquencies, it is important to be diligent in your efforts to connect and communicate with borrowers regularly and to maintain close relationships. Maintaining close relationships will increase your ability as a lender to foresee borrower delinquencies and increase the possibility of workout options and eventually get paid.

As we all know, time is money. Because delinquencies have risen in recent years and are expected to continue to rise, it is imperative that lenders have a plan of action with their legal counsel so you can be prepared for next steps, if necessary. Although communication with borrowers is encouraged, lenders should focus on protecting their own interest and being prepared to take legal action before the influx of delinquencies.