Tides Workouts Heighten Loss Expectations: Morningstar

Last week, Tides principals Sean Kia and Ryan Andrade said they’d executed “dozens”of loan modifications across their distressed portfolio, workouts they characterized as “really, really good news.”

New terms extended maturity dates and cut interest rates, the sponsors detailed, a band-aid to stanch the bleeding and buy them time to boost revenues through renovations.

On Friday, DBRS Morningstar released some not-so-good news. The ratings agency raised loss expectations for two of the amended loans, signaling there’s still risk and a bumpier road to recovery.

DBRS Morningstar now expects losses to be 1.5 times greater for securitized loans tied to Tides on Oakland Hills in Fort Worth, Texas, and Tides on Country Club in Mesa, Arizona, than those of the overall loan pool.

The debt comprises a larger $1.3 billion pool of mortgages originated by MF1 Capital. Nearly half of the loans are watchlisted.

Kia disagreed with Morningstar’s analysis.

In an email, he said the loss levels on the loans “should actually be lower than the overall pool given we have executed loan modifications, and the mortgage shortfalls [are] pre-funded in a reserve for the next few years.”

DBRS Morningstar also made a “negative adjustment” to the firm’s sponsor status, a measure of risk that considers the borrowers’ credit quality and net worth. Kia declined to comment on the adjustment.

Inside the amendments:

An affiliate of MF1, a frequent Tides lender, injected both deals with a preferred equity investment “to cover operating and debt service shortfalls,” according to the Morningstar update.

The investment may save the deal from default, but it also comes at a price. Preferred equity, often called rescue capital, is more expensive than senior debt and gives the lender a stake in the property. Kia countered that the differential isn’t so extreme given the rise in rates on its senior loan.

The deal also adds another layer to the capital stack — Tides will now need to pay back its senior debt, then the preferred equity investment before it doles out returns to the limited partners who made the deal possible.

If Tides can’t salvage the property by the time the debt matures, those investors could see nothing.

Amid that risk, Kia stressed the benefits for investors. He said Tides would need to lean less on limited partners for additional funding — the firm has already executed a few capital calls — and now has more time to wait out a seachange in the multifamily market.

“[This] far outweighs the incremental increased cost of capital as we all know the market will rebound eventually,” Kia said. “It is a matter of when, not if.”

The terms also tweak how Tides’ can tap future funding, cash used to cover capital expenditures, such as apartment renovations.

Executing those upgrades is crucial to its recovery. Organic rent growth has plateaued and even declined in some of the markets where Tides holds assets, making post-renovation rent hikes the fulcrum of its strategy to increase revenue.

“We have value-add: we can actively do something to improve and increase the net operating income at the projects — so the big one is renovations,” Andrade told The Real Deal last week.

Before the workouts, MF1 let Tides automatically access that future funding. In an email, DBRS Morningstar’s Stephen Koehler said Tides and its lender had an “agreement where the borrower was receiving a fixed amount of future funding each month.”

Not anymore. Now, Tides must obtain express approval from MF1 to draw on that debt for Oakland Hills and Country Club.

That’s the typical arrangement for future funding advances, Koehler said. Borrowers must prove they spent the money on capital expenditures through construction invoices, for example, before their lender pays out.

MF1 tacked on those terms after Tides biggest backer AMC Investments told investors the firm was “diverting funds meant to pay vendors for work completed to instead pay mortgage payments.”

Kia said Tides has “always needed MF1’s approval and sign off to tap the future funding.”

Industry observers said that guardrail could affect Tides’ capacity to wrap renovation plans and boost cash flow before the loans mature.

Kia did not indicate the due dates for Oakland Hills and Country Club have been extended. Both are set to mature during the summer of 2024.

Rather, the principal said Tides would no longer need “to qualify to receive the extensions” or pay fees to push a due date.

“So we are not facing a looming maturity anytime soon,” Kia added.

Amid those trickier terms, Tides’ workouts also boosted interest reserve minimums, the firm said, and tweaked interest rates, according to Morningstar.

Both amendments should insulate Tides from the rising cost of debt service; though, it’s unclear the degree of relief Tides secured.

On Oakland Hills, Tides was previously paying a 6.75 percent interest rte — its rate cap. At that level, debt service on the loan would exceed the $2 million the firm told investors it would pull in net operating income by the end of 2024.

The two workouts amount to a sliver of the modifications Tides said it hammered out with MF1. All told, $1 billion in debt tied to 27 Tides properties has been watchlisted, the majority of it for cash flow that is failing to cover monthly debt payments.

“Of the ones that need help, effectively all of them have received some sort of loan modification, which is awesome,” Kia told The Real Deal last week.

As additional servicer commentary on the modifications becomes public, details will show how “awesome” the terms actually are.