A standstill while the borrower sells, priced against enforcing today: two branches, one probability, and the term that moves it most.
A forbearance agreement is worth it for a lender when the probability that the borrower completes its sale during the standstill is above a break-even, found by valuing the success branch, the failure branch and enforcement today on the same basis. On an illustrative 30,000,000 loan against a 27,000,000 office, enforcing now is worth 74.6 cents; a nine-month forbearance with a cash sweep is worth 87.2 cents if the sale completes and 71.8 if it does not, so it wins whenever the chance of success is above 17.9 per cent. Without the sweep the bar rises to 40.8 per cent.
Worked in full in The Real Estate Workout by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The loan has matured unpaid. The borrower asks the lender not to enforce for nine months while it sells the building in an orderly process. The lender gives up time: if the sale fails, enforcement starts nine months later, probably on a lower value. In exchange it gets a sale by a willing owner, without the forced-sale yield premium, and whatever cash the forbearance terms make the borrower pay over during the standstill. The decision has the same shape as extend or enforce, on a shorter horizon and with the borrower's own sale as the exit.
All figures illustrative, in euros.
| Input | Value |
|---|---|
| Loan balance | 30,000,000 |
| Net operating income | 1,620,000 |
| Market yield, so market value | 6.0%, 27,000,000 |
| Enforcement: yield premium, price chip, costs | 75 bp, 2%, 3.5% |
| Enforcement: months to completion, income collected | 9, 80% |
| Forbearance: months, share of income swept to the lender | 9, 90% |
| Forbearance fee | 0.5%, 150,000 |
| Consensual sale costs | 1.5% |
| Change in value if the sale fails | −3% |
| Lender's discount rate | 8% |
1. Enforce today. A receiver sells in nine months at a 6.75 per cent yield, less the chip and costs, and collects 80 per cent of the income meanwhile.
Net price = 1,620,000 ÷ 6.75% × (1 − 2%) × (1 − 3.5%) = 22,696,800
PV = 22,696,800 ÷ 1.080.75 + 972,000 of income, worth 944,349 = 22,368,164, 74.6 cents
2. Forbearance succeeds. The borrower sweeps 90 per cent of income, 1,093,500 over nine months (1,062,392 today), and sells at market value less 1.5 per cent: 26,595,000, all of which goes to the lender because it is below the debt.
PV success = 1,062,392 + 26,595,000 ÷ 1.080.75 = 26,165,771, 87.2 cents
3. Forbearance fails. The lender keeps the sweep and enforces from month 9 on a value 3 per cent lower, completing in month 18.
PV fail = 1,062,392 + 20,480,203 = 21,542,595, 71.8 cents
4. The break-even probability.
p* = (enforce now − fail) ÷ (success − fail) = (22,368,164 − 21,542,595) ÷ (26,165,771 − 21,542,595) = 17.9%
Excel: =(EnforceNow-Fail)/(Success-Fail)
| Probability the sale completes | Expected value | Gain over enforcing now |
|---|---|---|
| 25% | 22,698,389 | +330,225 |
| 50% | 23,854,183 | +1,486,019 |
| 75% | 25,009,977 | +2,641,813 |
The failure branch is only 2.8 cents below enforcing today, because the sweep pays the lender during the standstill and the delay is cheap while the income keeps coming. The success branch is 12.7 cents above it, because a willing seller does not pay the forced-sale yield premium. With that asymmetry, a credit committee needs to believe in the sale only a little to agree.
Write the price floor into the agreement. A consensual sale is worth less than enforcing today if it nets below 22,571,742, a gross price of 22,915,474, 84.9 per cent of market value. Any offer below that should need the lender's consent, whatever the timetable says.
| Case | Success | Failure | Break-even |
|---|---|---|---|
| Base: 9 months, 90% sweep, value −3% | 26,165,771 | 21,542,595 | 17.9% |
| No cash sweep | 25,103,379 | 20,480,203 | 40.8% |
| 12-month standstill | 26,027,961 | 21,492,886 | 19.3% |
| Values hold | 26,165,771 | 22,176,003 | 4.8% |
| Values fall 8% | 26,165,771 | 20,486,914 | 33.1% |
The cash sweep is the term that matters most: without it the bar more than doubles. Three extra months of standstill matter little. A falling market matters a great deal, because the failure branch enforces later on a lower value.
Negotiating the fee. On an underwater loan the 150,000 fee comes out of the same sale proceeds as the principal, so a 26,595,000 net sale against a 30,000,000 balance pays it with money the lender would have received anyway. What the lender should negotiate is the sweep, the milestones and the floor price. The second mistake is valuing the success branch at par: a forbearance that ends in a sale below the debt is a discounted payoff with a timetable, and should be priced as one.
The book prices every way out of one broken loan on the same timetable, and the free workbooks for this case show the enforcement value that every other option is measured against.
The terms that move the lender's value: a cash sweep of net income, a marketing timetable with milestones, and a minimum sale price. On the illustrative loan, dropping a 90 per cent sweep raises the break-even probability from 17.9 to 40.8 per cent, and a consensual sale below 22,915,474, 84.9 per cent of market value, is worth less than enforcing today.
Usually not for its own sake. If the sale proceeds are below the debt, the fee comes out of the same proceeds and adds nothing: on the illustrative loan a 150,000 fee is unpaid when a 26,595,000 net sale meets a 30,000,000 balance. The cash sweep and the price floor are worth far more than the fee.
It raises the cost of failure, because enforcement then starts later on a lower value. On the illustrative loan the break-even probability is 4.8 per cent if values hold, 17.9 per cent if they fall 3 per cent during the standstill and 33.1 per cent if they fall 8 per cent.
This article is one calculation from The Real Estate Workout. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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