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