Community Banks Step Into a New Role
Because of the existing credit crunch, community bankers now have the opportunity to look at good loan deals with high-profile companies willing to consider a banking relationship with a small community bank. With the lure of highly leveraged, low-cost, non-recourse debt no longer in play, community banks’ more-traditional approach to lending (lower loan-to-value ratios, proven debt service coverage capability, recourse debt) is not the competitive disadvantage it was a few years ago. Many national banks simply have no appetite for additional commercial mortgage loans — despite long-time pre-existing client relationships — and often are unwilling to issue commercially viable term sheets on new deals. Community bank lending officers recognize these deals are tremendous opportunities to bring larger business clients to the bank, establish meaningful deposit relationships, and, most importantly, create solid loan assets for the bank’s commercial real estate portfolio.
However, there is a catch. Unfortunately, many community banks cannot meet the total funding requirements for the deals. They are constrained by either their legal lending limits or their own policy decisions and simply cannot do the deals on their own.
The solution? Banks can band together with other similarly situated community banks to share the credit risk through a loan participation or syndication arrangement. In its simplest terms, Bank A is presented with a rock-solid $20 million commercial mortgage loan opportunity, but has a $5 million loan limit, so it partners with Banks B, C, and D via a loan participation or syndication arrangement to make the deal.
Borrowers (and even some lenders) often use the terms participation and syndication as synonyms, meaning any type of loan facility that is shared by multiple lenders; but there is a legal distinction. In a participation arrangement the borrower only deals with the lead lender as they are the only parties to the loan agreement and related loan documents. The borrower can look only to the lead lender for funding, and only the lead lender can deal with the borrower with regard to default or other compliance issues. The participant lenders own portions of the loan purchased from the lead lender, with all of the rights and obligations between them specified in a separate participation agreement. The borrower may not even know of the existence of the participation agreement or the identity of any participant lenders.
In a syndicated loan, two or more lenders agree to jointly make a loan to the borrower. Each syndicate lender is a party to the loan agreement and receives a separate promissory note in the amount of its funding commitment. Likewise, the borrower only can look to each syndicate lender for funding of its portion of the loan facility. The loan agreement in a syndicated arrangement actually serves both the traditional function of establishing the terms and conditions imposed on the borrower for the credit facility and the additional function of spelling out the rules of engagement among the various syndicate lenders. Day-to-day decision making with respect to the administration of the loan is handled by an administrative agent.
There is a perception among borrowers that a syndication confers more rights upon the lenders and, therefore, is riskier than a participation loan. But with properly drafted agreements there is very little practical difference in the customer’s borrowing experience under either format. Ideally, the cooperative effort will be seamless to the borrower.
In addition to lending limit concerns, participant and syndicate banks may be motivated by a lack of loan origination capability with certain types of customers or transactions and the desire to leverage their lending partner’s competence in these areas. Depending on the bank’s willingness to rely on the lead lender’s transaction screening and credit analysis of the borrower, the participant or syndicate bank may acquire new loan assets in areas where they do not have expertise at significantly lower internal costs.
Borrowers and lead lenders alike fear that the participant or syndicate banks will not rely on the lead lender’s underwriting, due diligence, or legal documentation efforts, but will want to conduct their own independent review and negotiation processes, thereby adding layers of complexity, cost, and closing risk to each proposed transaction.
Because of the potential for the “too many cooks in the kitchen” problems associated with lender club deals, many borrowers maintain a high degree of skepticism about the chances for actually closing the loan when told by their relationship bank of the need to bring in additional lenders. In one recent $10 million loan transaction to refinance a maturing CMBS loan on a multitenanted office building, the borrower gave instructions to the loan broker to deal only with lenders able to close on its own account because of fears that multiple lenders would equal trouble. However, after many futile months of false promises and false starts by the national banks and other large lenders, it was a combination of two small Northern Virginia community banks, neither of which had the ability to close the deal without the other, working under a participation arrangement, which put together the winning loan package. The loan was full recourse, with a parent guaranty, approximately 55 percent LTV, and relatively high DSC covenants, but it had a very competitive interest rate and fee structure and provided the borrower a performing loan with cost certainty for the term.
We have closed several community bank participation/syndication commercial mortgage loans in the past six months, representing both real estate owners and lenders in the process, and have seen firsthand the impact these community banking “strange bedfellows” can make by working together.
The good news for community banks is that many real estate owners and developers have long memories. If the community banks are willing to put aside their competitive differences and step into the current real estate lending breach to make these much-needed commercial mortgage loans, then they will earn the gratitude and loyalty of a group of strong, high-profile customers they would never have reached in different market circumstances.