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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   September 2014

Save the Deal With a Show of Faith

A personal-guarantee compromise helps bridge the gap between borrower and lender

As a commercial mortgage broker, imagine telling a potential lender that you simply do not have any faith in your deal and that you’re not sure it will be successful. It’s not exactly confidence-inspiring, is it? But that is exactly the message borrowers send to lenders when they state that they are not willing to offer their personal guarantee.

The reality of life in the lending world is simple. In many states, it’s difficult for lenders to pursue a personal guarantee, but they want to know that their borrowers are fully behind their deals and committed to the success of the business they’re financing. Given today’s more conservative loan-to-value (LTV) requirements and lenders’ focus on the quality of appraisals, it may seem that a borrower should be willing to provide a personal guarantee, unless, of course, your client wants to borrow and run. But sometimes borrowers do not want to put up such a guarantee.

Risk versus reward

Consider the implications of a scenario where you approach a lender with a loan currently in default or with a new construction loan for a hotel, and you tell the lender that your client has invested 25 percent equity and will not be putting any more money into the deal. The borrower is asking for the lender to fund the remaining needed capital: 75 percent of the cost of the project.

The bottom line is that the lender will have more money in the deal than anyone else, yet stands to benefit only from the outstanding balance of the loan, while your client — the borrower or developer — will reap the greatest rewards from the deal. The client is in for 25 percent of the cash and the lender is in for 75 percent of the cost. The developer gets the majority of the return from profits, but the lender must make do with, say, 8 percent on the investment for the construction period and until the deal begins to show positive cash flow.

In a deal such as this, the lender is taking on the clear majority of the risk in the deal at the time when that risk is the greatest. This brings us back to the original question: If the borrower does not believe in the deal enough to offer the guarantee during its high-risk stage, what is the incentive for the lender to believe that the risk is worth taking and thus close the loan?

In some cases, lenders do see the incentive for doing such a deal. After all, there are deals in which the given borrowers are high-net-worth developers with a proven track record and who are likely to be a solid bet, but wish to protect their accumulated wealth. They are opposed to risk and want their lenders to essentially be their partners.

But often, the question of whether the deal will get done comes down to the sensitive issue of borrowers0 and lenders disagreeing about personal guarantees. How do you, as a broker, bridge the gap? After all, banks are here to close deals. As is often the case, with a bit of creativity and open minds on both sides of the table, a solution is possible.

Find middle ground

The first possible solution may be simple: Offer to limit the lender’s exposure. An example of this is to convince your client to provide a guarantee that will be called on only in the event of a default and the liquidation of the deal’s assets.

This modality provides for two things. First, the bank must proceed through the foreclosure process and liquidation before seeking any financial recovery from the personal guarantor. Assuming the deal has a low LTV ratio and has had a proper appraisal, the event of any exposure would be rare. Second, this agreement protects the guarantor because it provides only for liquidated value and not for the guarantor to provide debt service throughout the life of the loan. With this type of solution, the lender is satisfied because the “emotional support” of a guarantee is present, but the borrower’s exposure has been restricted as well.

Another potential option is for the borrower to post a small, agreed-to amount via a letter of credit that is designed to cover any shortfall in the event of default and liquidation. If the deal has a low LTV ratio, a good-faith conversation with the lender will go a long way toward establishing a mutually satisfactory amount for the letter of credit support, which may be released when the asset’s positive cash flow achieves a predetermined debt-service coverage ratio.

The cost of the letter of credit to the borrower is fairly low and will generally satisfy the lender because it demonstrates the borrower’s proactive support. This type of solution often results in a deal being made that might never have closed without communication between the lender and the borrower.

As a loan’s broker, when you think about the issue of loan guarantees, keep your mind open to other possible solutions, which may include additional collateral, short-term guarantees and third-party credit enhancements such as performance bonds, substitute guarantors, etc.

• • •

You shouldn’t let a good deal slip away because a borrower is not initially willing to offer a personal guarantee. When a deal has merit, think creatively and speak openly with your client and your selected lending partner to find a compromise. Remember that all institutions make money by closing deals, so it’s in everyone’s best interests — borrower, lender and your own — to find a compromise instead of walking away from an otherwise mutually beneficial deal.  


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