OIL SPILL LEGAL NEWS, Vol. 4, The Gulf Oil Spill's Impact on Lenders


Oil Spill Legal News – Update No. 4, June 17, 2010

On June 16, 2010, President Obama announced BP's agreement to place $20 billion into an independently managed account to cover economic damages related to the Gulf Oil Spill. As businesses and state and local governments discovered in the aftermath of Hurricane Katrina, just because money has been designated for relief and recovery efforts it does not mean the funds are immediately available. The Gulf Oil Spill is already having an effect on the oil and natural gas drilling, tourism and fishing industries, as well as the real estate markets along the Gulf Coast. As a result, a chain reaction of loan defaults could occur as area businesses and property owners struggle with the spill's aftermath and its impact on revenue. These issues will also reverberate through related sectors that service or supply the oil and natural gas drilling, tourism and fishing industries. In addition, the real estate market, already hard hit by recent economic issues and the aftermath of hurricanes Katrina and Rita, will likely be dealt another severe blow by the loss of property value and diminished rents. As a result, commercial and residential lenders in those markets could face a dramatic increase in troubled loans that will need to be addressed through forbearances, restructurings or other means.

In an effort to lessen the financial impact of the Gulf Oil Spill, the FDIC issued a Financial Institution Letter "encouraging banks to work constructively with borrowers experiencing difficulties beyond their control because of damage" caused by the Gulf Oil Spill. On June 16, 2010, Fannie Mae announced relief measures for homeowners affected by the oil spill stating that mortgage servicers "may suspend or reduce a borrower's payments for up to 90 days while the servicer determines the nature and extent of the impact the disaster is having on the condition of the property or on the borrower's financial condition." Citigroup Inc. also announced a three-month foreclosure suspension program "to allow distressed homeowners to remain in their homes during these uncertain times as the Gulf communities respond to the oil spill and its economic repercussions."

Although there will be some offset to the problems presented by the oil spill, including the BP claim fund, federal dollars, clean-up expenditures and concomitant revenues, such amount may be insufficient to the cover the full economic impact of the spill. As a result, lenders whose borrowers likely will be affected by the Gulf Oil Spill need to be proactive in planning ahead to mitigate the financial consequences of the oil spill. In general, there are six main recovery strategies for distressed loans:

1. Operational rehabilitation, without the need for relief from creditors or bankruptcy

2. Refinancing from a new lending source

3. Recapitalization involving the addition of new capital into the borrower on an equity basis, whether from existing equity, management or investors, or a debt-for-equity swap

4. Re-amortization of existing debt obligations by reducing the amount owed, the interest rate, or the timing of payments

5. The sale of the company as an operational whole, using the sale proceeds to pay off the borrower's debts

6. Liquidation of the borrower's business in whole or in part.

These strategies are not mutually exclusive, but are often used together to create an efficient and effective recovery strategy.

Addressing a borrower's defaults can be a complex affair because of the many ways to combine and implement strategies. These strategies may be even more difficult to implement if certain businesses (i.e., fishing and tourism) or a certain geographic region (i.e., the Gulf Coast) are substantially devastated by the oil spill. Regardless of how complicated a distressed loan situation may seem, it virtually always comes down to these six overarching financial strategies. When a lender is considering how to deal with a struggling borrower, these six strategies make an effective analytical tool.

Waller Lansden will continue to monitor events and issues related to the Gulf Oil Spill. For additional information on the impact on lenders, please contact Rob Sweeter at 800-487-6380.

The opinions expressed in this bulletin are intended for general guidance only. They are not intended as recommendations for specific situations. As always, readers should consult a qualified attorney for specific legal guidance.