Satisfying a lender’s three Cs: Character, Credit and Collateral
Regional BankCo provides private and commercial banking services to personal and business clients, including trust management, investment management, commercial banking, and residential mortgages.
The bank was considering a leasehold financing for an office development on a former industrial site in Massachusetts. A thirty-five year old ground lease, however, prohibited mortgage financing of either the fee or the leasehold. However, with rent under the ground lease exceedingly low relative to the value of the property, the borrower had a built-in disincentive to default under both the ground lease and the proposed financing. In addition, the principals of the borrower had excellent character and credit references and were well known to Regional BankCo.
But how does a bank make a multimillion dollar real estate construction loan without a mortgage on either the land or the borrower’s interest in the ground lease? Answer: Very carefully.
As an accomodation to the loan officer and in an uncommon role for an attorney, Gary M. Markoff outlined to the bank’s credit committee the risks of such a loan and how the bank could mitigate those risks.
Gary and his team developed an innovative strategy by working through the limitations imposed on the bank’s customer by the existing ground lease. Covenants and procedures were added to the loan documents to reduce the possibility that the borrower would default as the tenant under the ground lease, and to provide that if it did, the bank would have ample time to cure any default.
The borrower was required to prepay the ground rent one year in advance. The rent was low enough relative to the cash flow of the property that this covenant did not place an undue burden on the borrower. The ownership of the borrower was also pledged to the bank much as a mezzanine lender would require. In addition, the rents for the subtenants were paid into a bank-controlled lockbox.
Few banks would have undertaken this loan. But with Regional BankCo’s confidence in the customer’s character and track record and Sherin and Lodgen’s recommendations to mitigate the risks of default under the ground lease, a potentially risky and un-bankable loan turned into an attractive opportunity for Regional BankCo. These efforts resulted in committee approval, and the loan continues to be one of the more profitable performing loans for the Bank today.