The domestic economy continues to exhibit positive momentum, but strong employment and persistent inflation suggest that the Federal Reserve will likely continue to tighten policy and raise interest rates. Given recent developments concerning the well-publicized failure of certain prominent banks, the availability of credit to Private Lenders may diminish, and the availability of take-out investors to purchase closed loans will continue to be limited for the foreseeable future
Loan Sale Agreements
Over the last couple of months, we have observed an increase in the appetite of secondary market investors to purchase commercial mortgage loans. With this increase in demand, the volume of loan sales has improved somewhat. However, it is still a Buyer’s market, and demand has not yet met supply. As a result, Buyers are not as willing to negotiate terms as fulsomely as in prior times.
In light of this increased demand, we’d like to highlight certain key terms for Private Lenders when negotiating loan sale agreements.
Purchase Price
In a typical Loan Sale Agreement for Rental/DSCR loans, the Buyer pays a one-time premium to the Seller at the time of sale. However, for short-term bridge and fix-and-flip loans, Buyers typically pay an interest strip to the Seller from the Borrower’s monthly interest payments. Sellers should scrutinize the Loan Sale Agreement carefully to identify those circumstances when a Buyer can cancel the payment of the interest strip.
Loan Due Diligence
Buyers perform due diligence before purchasing loans, and often include provisions in the Loan Sale Agreement requiring the Seller to pay due diligence costs. These costs can vary dramatically. Some Buyers cap due diligence costs (e.g., $15,000 annual cap). Other Buyers may not enforce their right to pass on these costs.
Representations and Warranties
A typical Loan Sale Agreement contains 50 or more representations and warranties, which can expose the Seller to repurchase or indemnification risk upon breach. A careful review by a seasoned lawyer is important to avoid a loan repurchase over a minor “foot fault” and to give the Seller adequate time to cure the breach. It is equally important to make sure that no repurchase is required unless the breach materially and adversely affects the value of the loan.
Examples include representations and warranties that:
- No party to the loan transaction committed fraud
- The Seller complied with all applicable law when originating and servicing the loan
- There are no environmental law violations relating to the mortgaged property
- The Borrower does not occupy the mortgaged property
- Investors will not regard the loan as an unacceptable investment
- The Seller has an anti-money laundering program to prevent violations of anti-money laundering laws
- No loan is cross-collateralized or cross-defaulted with any loan other than a loan sold to the same Buyer
- All fields in the mortgage loan schedule are true, complete, and correct
Repurchase Price
Review the definition of Repurchase Price to avoid paying hidden costs and expenses upon a loan repurchase.
Examples of these costs include:
- Accrued interest on the loan through the last day of the month in which the repurchase occurred (instead of accrued interest through the repurchase date)
- Buyer’s costs to enforce the repurchase of the loan
- Damages from Seller’s breach of its obligations under the Loan Sale Agreement
Early Payoff Protection
Review your Loan Sale Agreement to identify your liability when a Borrower prepays the loan sold to the Buyer. Most Loan Sale Agreements limit a Seller’s prepayment liability to payment in full during the first three months following the sale date.
Early Payment Default
A typical Loan Sale Agreement requires the Seller to repurchase the loan if the Borrower defaults in making any of the first three payments after the sale date. Many Sellers try to limit repurchase liability to a Borrower’s default in making the first payment only, but this is rarely successful.
Whole Loan Sales and Securitization
Many Buyers will either securitize purchased loans or sell those purchased loans to another person. These persons are referred to a “Reconstitution Parties.”
Buyers try to protect themselves from repurchase and indemnification liability to Reconstitution Parties by passing this liability on to the Seller. This is accomplished by requiring the Seller to (a) indemnify the Reconstitution Parties directly, and (b) enter into a new agreement (referred to as a “Reconstitution Agreement”) with the Reconstitution Parties. Reconstitution Agreements typically require a Seller to make representations and warranties directly to the Reconstitution Parties and to indemnify the Reconstitution Parties from claims or damages arising from the issuance of mortgage-backed securities backed by Seller’s loans. This could dramatically increase a Seller’s potential liability and requires a careful legal review.
A diligent lawyer will work to ensure that a Seller has the ability to review and negotiate changes to a Reconstitution Agreement, and that the Reconstitution Agreement does not impose on the Seller any obligations or liabilities in excess of those imposed on the Seller under the Loan Sale Agreement. These provisions are often highly negotiated.
Solicitation of Borrowers
Remember. The Borrower is your customer, and the Loan Sale Agreement should protect you from the Buyer soliciting that customer. This is accomplished by adding a provision to the Loan Sale Agreement prohibiting this type of solicitation.
Warehouse Lines and Other Credit Facilities
Given the recent market turmoil, it is more important than ever for Private Lenders to secure credit facilities. These facilities allow Private Lenders to leverage their loan portfolio. These facilities also allow certain Private Lenders to hold loans on their balance sheet for longer periods pending sale to secondary market investors.
All the warehouse facilities that we have reviewed recently have a variable rate of interest-usually tied to SOFR. That means that, as the Federal Reserve continues to raise interest rates, warehouse facility rates also rise. We have also seen a moderate increase in related fees and charges imposed on warehouse borrowers. The obvious result of the foregoing is tightened margins for warehouse borrowers.
From everything that we have seen, the demand for warehouse facilities continue to out-strip the supply, which has resulted in tighter credit boxes, increased fees, and inflexible negotiating positions.
We recommend that you negotiate material economic and legal terms prior to signing a Term Sheet and paying significant up-front fees to the warehouse lender.
Here are some terms to think about:
- Review and negotiate all fees, including up-front facility fees, draw fees, minimum use fees, and other fees.
- The warehouse lender may require the borrower to be a newly formed special purpose entity
- The warehouse lender will likely require one or more affiliates of the borrower to guaranty the borrower’s obligations under the warehouse facility.
- Negotiate a repayment period that provides you with adequate time to pay off the warehouse facility at maturity.
- The warehouse facility will be secured by the loans leveraged with the facility and possibly by the equity and other assets of the borrower.
- Each warehouse lender has different requirements for eligible collateral loans and collateral borrowers.
- Advance rates can vary widely, so pay attention and negotiate terms that meet your needs.
What Should You Do?
Contracts are for lawyers because they don’t matter until they matter – when a problem occurs.
This means that, whether you are selling a loan or securing a warehouse facility, you are well served to hire an experienced lawyer to carefully review and fully negotiate your transaction agreements. This practice will give you peace of mind and potentially save you significant time and money in the future.
We would be pleased to assist you with your transaction documents or any of your other legal needs. Geraci is the nation’s largest law firm dedicated almost exclusively to the private/non-conventional lending space and is the leading legal resource for specialty lenders, asset-based lenders, private lenders, and non-bank institutions. Contact us today.
