It is well known that the recovery from the pandemic is taking longer than many had expected, and that after the initial surge in occupancies starting in the second quarter of 2021 the rate of growth has slowed, even with the recent suppression of new construction and openings. All of this is impacting the capital markets, especially as interest rates keep rising.
We have repeatedly stated that the industry needs to fix its capital structure. The logjam of borrowers and creditors fighting and not coming to terms that are workable for both sides needs to burst. TPG Capital and Sabra Health Care REIT could not come to any agreement with Fannie Mae over $485 million in debt on their Enlivant portfolio, and basically handed the keys over. But in what may be a transformative agreement between Fannie Mae and Sonida Senior Living, perhaps more people will come to the table and work something out.
The agreement will be transformative to Sonida, and lets them live another day, and at least three years, and may be transformative for the industry if it is an example for others to follow. For Fannie Mae, they will now have a large borrower that had been on shaky financial ground which will now be stronger and that will have the time needed to significantly transform their operations. A classic win-win.
Over the past few years, we have followed Sonida’s financial decline and cash burn rate, concluding late last year that the company would run out of cash in the second quarter of this year. This, despite the fact that occupancy, margins and community operating income were all rising. It was the debt load that was really the killer, and they needed more breathing room to continue improving operations and get to a position where they could try to grow again. Breathing room is what they now have.
The company reached a major agreement with Fannie Mae, which has about $427 million outstanding with Sonida in multiple tranches covering 37 properties. The main components of the agreement include an extension of all maturities until December 2026 or beyond. As part of that, all contractually required principal payments will be deferred for three years or waived until maturity. This results in about $33 million of cash savings through maturity.
A second component of the agreement involves a reduction of the interest rate by 1.5% over the next 12 months. This results in cash savings of $6.1 million over the next year. Sonida will not have to make up this difference. The combined cash savings is about $40 million, which is crucial. In addition to these debt revisions, Conversant Capital, the company’s primary shareholder, has agreed to purchase up to $13.5 million of common equity at $10 per share over the next 18 months, with the drawdowns at Sonida’s discretion. The current share price is $8.74, so there is a small premium. In addition, as part of its agreement with Fannie Mae, Sonida will have to make two $5.0 million principal payments, one now and the other on June 1, 2024. It will take its first drawdown on Conversant’s equity line to fund the first $5.0 million payment.
In addition to the above, Ally Bank, which holds $88.1 million of Sonida’s debt secured by 12 properties, has agreed to temporarily reduce the minimum liquidity requirement for 18 months under its limited corporate guaranty agreement. There are other parts to this agreement, but the common theme of the Ally agreement is the additional runway created for Sonida to attain all-in positive cash flow faster than we thought possible. They have not been cash flow positive in years.
The remaining debt of $120 million with Protective Life is still problematic. Sonida stopped making interest and principal payments in February on three uncrossed tranches of community mortgage debt (four communities in total), and obviously something needs to be done. Maybe sooner than we think.
Spot occupancy in May was about 85% at the company’s owned communities, 1,000 basis points above the pandemic low, and run-rate operating margin is about 23.5%, up from 19.9% in Q4 2022. The margin should increase as more rate increases are instituted across the portfolio over the next 12 months. This, combined with increasing census, a number of operating initiatives implemented by Sonida’s new management team, and the cash saved from the above debt agreements, should provide enough breathing room. But in three years they will have to figure out what to do as the debt starts coming due. In three years, however, we suspect that the credit environment will be more supportive of real estate lending than today, and interest rates should be lower.
It is interesting that management was able to come to terms with Fannie Mae, which was not happy with the company when it handed over the keys to Fannie Mae for 18 communities. As the current management says, that was the previous management and there is a new sheriff in town. They have been transparent along the way and we suppose earned Fannie Mae’s trust that they were doing what they said they would do. That may have gone a long way to get Fannie to move. The negotiations took over six months to get to the finish line, but the healthy principal paydown and corporate guaranty helped quite a bit, not to mention the additional equity pledge from Sonida’s largest investor, which showed their confidence level. We would not be surprised to see Sonida cash flow positive in the first quarter next year, or maybe even earlier.
With $17 billion of seniors housing debt, and a lot of that probably tenuous right now, we do not believe that Fannie will open the negotiating door with every borrower. Nor should they. But perhaps other lenders will look at Sonida’s template and start to think that maybe there is a way, or maybe there is a light at the end of this dark pandemic tunnel. Something has to break the logjam, and this news may punch a hole in it.
