Financing Focus

Loan Language

What can borrowers negotiate under today’s stricter standards?

By Thomas R. Petty |

Commercial real estate finance remains in a state of flux. Lenders are re-entering the market with new policies and underwriting criteria. Many lenders have toughened the terms of their form loan documents. It is important for borrowers to understand the source of those tougher terms.

In recent loan negotiations, some lenders have claimed that the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted last year imposes new federal regulations on commercial mortgage- backed securities loan provisions or that new CRE Finance Council rules require certain limitations and representations in loan documents. (CREFC is a trade group advocating for the commercial real estate finance industry.)

In fact, Dodd-Frank does not have the reach that some lenders might claim, and CREFC rules may actually work in borrowers’ favor.

Lenders always have spouted phrases such as “bank policy,” or “rating agency requirements” as reasons for not negotiating particular terms with borrowers. Savvy negotiators can maneuver around such canards, but “federal regulation” seems more daunting. Borrowers need to understand the source of new regulations and be prepared with counterarguments.

Does Dodd-Frank Apply?

One Dodd-Frank provision catching the attention of CMBS lenders is the law’s credit risk retention requirements. To compel lenders to keep some “skin in the game,” Dodd-Frank requires a lender to retain at least 5 percent of the credit risk of any loan asset.

There are a few exemptions from the credit risk retention requirements, including one for qualifying commercial real estate loans. This and other exemptions were crafted intentionally to be hard to satisfy. Federal regulators have acknowledged in the proposed regulations that “many prudently underwritten … loans will not meet the underwriting standards” in the proposed exemptions.

Some of the prohibitively stringent conditions require that a borrower maintain a 1.5 to 1.7 debt service coverage ratio, that the collateral property maintain a maximum loan-to-value ratio of 60 percent to 65 percent, and that the borrower cannot obtain any other junior debt (other than equipment financing). The clear intention is to force CMBS lenders to comply with the credit risk retention requirements by making congressionally mandated exemptions as restrictive as possible.

Some lenders may use these stringent exemption requirements — mistakenly, perhaps — as federally mandated loan conditions. They are not. These requirements are relevant only if a lender intends to exempt itself from the 5 percent credit risk retention requirement. If all of the exemption conditions cannot be satisfied, then none of the conditions is relevant to a loan. If told that Dodd-Frank requires a particular loan provision, the knowledgeable borrower will ask why, and whether the loan is being originated for a zero risk retention securitization. If not, then the provision in question should be open for negotiation.

CREFC Standards

In March, CREFC unveiled new, comprehensive market standards for CMBS loans, which include model representations and warranties to standardize the representations a lender must make to prospective bond investors and rating agencies concerning the CMBS mortgage loans. The representations made by a lender to its CMBS investors should be matched by the representations made by borrowers to the lender.

Generally speaking, CREFC’s new standards are not materially different from those that lenders have had to make in CMBS transactions for the last decade under Standard & Poor’s CMBS Legal and Structured Finance Criteria. However, a few differences tend to benefit borrowers.

For instance, CREFC’s model representations expressly acknowledge the many types of permitted transfers that borrowers often negotiate and lenders agree to allow in “due-on-sale” provisions. S&P’s representations do not acknowledge permitted transfers.

The model representations also refer to eight carveouts to nonrecourse liability. S&P’s representations do not even address recourse obligations. To counter the trend of lenders demanding an increasingly long list of recourse obligations, borrowers can now cite the short list of recourse obligations that CREFC apparently has determined are sufficient for CMBS transactions.

Knowing what lenders have to represent to their investors can be useful for borrowers in negotiating better terms in loan documents. In addition, knowing whether new loan requirements emanate from Dodd-Frank, federally mandated rules, industry standards, or simply from a lender’s internal policies can improve a borrower’s position at the table.

Thomas R. Petty, a partner in the Washington, D.C., office of Anderson Kill & Olick, practices in the area of commercial real estate. Contact him at tpetty@andersonkill.com.