The owner of the Bay Area’s two largest Hilton hotels has requested help meeting obligations on a $725 million loan backed by the two properties, a potential sign of trouble for a hotel market already battered by the pandemic.

The borrower, Park Hotels & Resorts Group Inc., a publicly traded real estate investment trust based in McLean, Virginia, hasn’t missed any regular debt payments on the loan but has landed on an industry watchlist for commercial-mortgage back securities at risk of defaulting.

The CMBS loan is backed by the Hilton San Francisco Union Square and the Hilton Parc 55, which both remain closed amid the travel slowdown caused by Covid-19. The Union Square property, the region’s largest hotel, has 1,921 rooms and a 2016 appraised value of $1.02 billion, while the Parc 55, a block away from its larger sister hotel, has 1,024 rooms and an appraised value of $540.4 million.

DOUGLAS FRUEHLING

The 2016 loan originally from JP Morgan Chase & Co. was repackaged and sold to Wells Fargo as a CMBS.

Wells Fargo granted Park Hotels (NYSE: PK) a six-month deferral of its regular contributions (typically 4% of revenue at Park Hotels) to fund a set aside for furniture and equipment upgrades. The company is allocating these funds to debt service so it can stay current. Wells Fargo also waived obligations for a debt yield test, which assesses loan risk, through the end of next June.

Park Hotels, which was spun off from Hilton Worldwide in 2017 to own hotel real estate and has stakes in 60 hotels nationwide, declined to comment other than to note the loan is current. Park Hotels’ debt payments typically alternate monthly between $2.49 million and $2.57 million.

The potential distress is a sign of the challenges facing hotel owners nationwide as lenders grow impatient after six months of marginal hotel revenue and an opaque timeline for recovery. As dozens of hotels in New York and Houston fall behind on mortgages, some industry experts anticipate a “tsunami” of default-triggered foreclosures.

Operations at the Hilton Union Square and Parc 55 are suspended indefinitely, according to a Hilton Worldwide (NYSE: HLT) spokesperson. The Hilton’s online reservation system indicates rooms aren’t available to book before Nov. 9 at the Hilton Union Square and Jan. 1 at Parc 55. The spokesperson declined to commit to a specific timeline.

“While we can’t predict long-term outcomes from this crisis, we are confident that our industry will recover and we look forward to welcoming back guests once operations are restored,” the spokesperson said.

San Francisco properties are particularly vulnerable because reopening started later than elsewhere and they face higher operating costs and a slower timeline for recovery.

Alan Reay, founder and president of Irvine-based hotel brokerage Atlas Hospitality, doesn’t expect a foreclosure tsunami but said lenders can make things difficult for hotel owners really fast, especially for those properties securing CMBS loans.

CMBS loans are far more difficult to modify due to their structure. When the loan is bundled with others and sold to another party as a security, it becomes part of a much larger pool, managed by a servicer whose obligations are to third-party bondholders with varying stakes in the pool.

Regulatory rules for bonds require enlisting a third party, a special servicer, to negotiate for changes. The Hilton Union Square and Parc 55 loan has not been transferred to a special servicer.

In most cases, Reay said, borrowers aren’t allowed to begin negotiating until they’ve already defaulted, triggering interest penalties, and the special servicer assesses its own fees on the principal. The properties are reappraised, and in the current environment Reay said he’s seeing significant declines, as much as 30% to 50%, in reappraisals of large convention-driven hotels. If the new appraisal can’t satisfy the remaining debt obligations, a borrower’s only recourse besides foreclosure is outside investors, who are less likely to jump in with the market so difficult to predict.

The watchlist functions as an alert for all parties — and potential outside investors — to patch up vulnerabilities more informally before the first late payment.

“It’s a Band-Aid on the wound,” Reay said. “Unfortunately the way we’re seeing the hotel business right now, especially for major convention center hotels, the client is in the emergency room and having cardiac arrest.”

“Properties that go on the watchlist today have a much higher likelihood of going into default,” he added. “This is not a localized market impact anymore.”

The CMBS market is one of the truest reflections of the stress the hotel industry is experiencing, Reay said, adding that industry delinquency rate historically hovers under 2%. Last month Fitch Ratings put the delinquency rate at 17.23% eclipsing retail, the next closest, at 10.77%. Trepp, a leading financial firm, found more than one in every four hotel loans it tracks were bumped to a special servicer. It’s the highest rate since records began in 2013, and a far cry from February, when the rates for hotels and retail were in the single digits.

Another metric of hotel industry stress is investor confidence, which has predictably plummeted during the pandemic. Park Hotels, which has a market cap of $2.5 billion, saw its stock price fall 55.75% — from $23.19 to $10.58 — in the year ending Sept. 30. That’s on par with nine other major U.S. REITs, which saw a median decline of 53.34%, according to a survey last month from Atlas Hospitality. Pebblebrook Hotel Trust, which owns 12 hotels and about 10% of the city’s room count, saw a 50% decline in that same period.

Park Hotels has taken drastic steps to bolster its liquidity since the spring, fully drawing on its $1 billion revolving credit option in March. It also issued $650 million in senior secured notes in May, halted dividend payments and deferred $150 million to $200 million in capital projects.

“This is the case not only for Park Hotels, but every publicly traded REIT out there, as well as every individual hotel owner,” Reay said. “They’re all facing the same problem. …How much money can they afford to keep feeding these hotels before they run out?”

In its second quarter financial report in August, the REIT said it would expect to burn about $65 million per month through the end of the year if all its 60 hotels remain closed and revenue remained at zero. At its current burn rate, Park Hotels projected it could stay liquid for two years “absent any debt required to be repaid in the event of default.”

That timeline is an upward revision of expectations shared in May of a $70 million monthly burn and 17-month runway. As of Sep. 14, 46 of its hotels are open, representing 59% of rooms, and through August occupancy was at 38% across 37 hotels.

The REIT also owns four other hotels in San Francisco, all acquired last year via a merger with Chesapeake Lodging Trust: Le Meridien San Francisco (366 rooms); JW Marriott San Francisco Union Square (344 rooms); Hyatt Centric Fisherman’s Wharf (316 rooms); and Hotel Adagio (171 rooms). The JW and Fisherman’s Wharf are currently open while Le Meridien and Hotel Adagio will open Oct. 26 and Nov. 1, as judged through room availability on their websites.

Later in its August earnings report, the company noted, “It is possible that our monthly cash burn rate could be significantly higher than the levels we currently anticipate, which could mean we do not have sufficient liquidity to withstand the suspension of our operations for the remainder of 2020.”