10 Questions to Ask your Commercial Lender Before Committing to a “Nonrecourse” Loan
Commercial property owners contemplating a refinance may find themselves being offered non-recourse financing through a loan that is being packaged as a Commercial Mortgage Backed Security (CMBS), otherwise known as a “securitized” loan. The financial terms are often attractive, as is the “non-recourse” feature. However, a closer look at the fine print may reveal day-to-day operating terms that are not so attractive. Here are ten things to consider asking your Loan Representative before committing to a CMBS loan.
- Prepayment. Can the loan be prepaid, and if so, under what conditions? Is there a prepayment penalty or a “yield maintenance premium”, and if so, how much is it? Is there a lockout period during which the loan cannot be prepaid, and if so, how long is that period?
- Yield Spread Premium. Is there a “yield spread premium”? If so, how much is it? (A yield spread premium results in a higher interest rate, but lower upfront costs)
- Defeasance. Can the Borrower “defease” the loan? If so, what are the conditions of the defeasance, who pays the costs of the defeasance, and how much are they? (A defeasance involves substituting securities for the collateral)
- Reserves. Will any reserve funds be impounded? If so, how much, what are they for, and what are the conditions of their release?
- Warranties. What warranties will the Borrower be asked to make? (Remember, a warranty is an absolute guarantee)
- Reporting. What sort of reporting will the Borrower have to make to the Lender? What reports will be required, and at what intervals will they be required? What will happen if the reporting is not satisfactory to the Lender? What will the lender be able to do if they’re not satisfied with the reporting?
- Entity. Will the Borrower be required to form a Single Purpose Entity (SPE)? If so, what restrictions will be placed it?
- Transfer Provisions. Will there be any restrictions on the transfer of; 1) ownership interests in the SPE; and 2) the property itself? If so, what are they, who pays what, and what are the costs?
- Insurance. What insurance will be required and in what amounts and types of coverage?
- Securitization. Will the loan be securitized? If so, what are the Borrower’s obligations and who pays for what?
I was recently presented with a 70-page loan document on a 35% loan to value (LTV) refinance that no borrower in their right mind would accept. For example, it required the borrower to pay for a Moody’s rating, a certification from one of the “Big Four” accounting firms and all of the Lender’s legal costs in the event of a defeasance. It gave the lender complete control over the reserve impounds, yet at the same time, it required an indemnity from the borrower. It required quarterly rent rolls and other reports, but if the loan was securitized – which was beyond the borrower’s control – those reports were required monthly. If a principal of the entity died, the entity had only 30 days to “reconstitute” itself to the Lender’s satisfaction. Nine separate lines of insurance were required, plus “other coverage as the lender may require from time to time”. In the event of property damage, the borrower was required to pay for a “Casualty Consultant”, who had total control over whatever restoration work needed to be done and when and how the insurance proceeds were released. Importantly, the lender reserved the right to securitize the loan at any time in their sole discretion, in which event the borrower was required to pay all of the lender’s costs, including legal fees, “big four” accounting fees, and “rating agency” fees. The borrower quickly concluded that the burden imposed by these provisions outweighed any benefits gained from the non-recourse feature of the loan and quickly found other financing.