Stroock & Stroock’s William Campbell Talks Construction Lending and Loan Syndication

Mr. Campbell: I’d have to say New York City, San Francisco and Miami.

What are some of the other trends you’re seeing in construction and construction finance in the States?

The trend in Miami has been, for several years now, to follow a model, which I understand was copied off the way condominium properties are financed in Latin America. The buyers themselves are putting down payments equal to about 50 percent of the purchase price. Under Florida law, everything above 10 percent of the purchase price can be used for construction financing if the contractor permits. A large portion of the capital that is being put into the properties is actually coming as part of the purchase price. It’s very risky. Costs can go up and those down payment investments are subordinate to future financing. I hadn’t heard of that until the last few years and that has apparently been fueling construction in Miami.

How has limited land supply and higher costs in New York affected the work that you and your partners are doing?

The cost of land has gone way up. As every new apartment building in a new cutting edge neighborhood sells a unit, that translates into a higher valuation for the parking lot across the street to be sold for development. Six or seven years ago I was handling a foreclosure on an empty condo in Long Island City where there were just no buyers. It was typical of the time. Now, developers are building both for sale and rental all over that area. It seems to make sense given its transportation, and its land costs are probably comparatively cheaper, so there’s been a lot investment and development there.

Are you seeing any changes in the types of construction loans that lenders are providing? Is there anything different in regards to the terms of those loans?

In a competitive lending enterprise it’s like a buyer’s market for the borrowers, so the sponsors of the borrowers typically do not like to sign guarantees. Generally speaking, we are seeing less in the way of required recourse, not necessarily across the board, but certainly for lower-leverage institutional deals. When I say less in the way of recourse, maybe not in the way where five years ago you would need a partial pay guaranty or carry guaranty. Maybe all a lender will collect now is a completion guaranty.

As far as what the lenders are actually requiring, it is pretty much the same. You see more mezzanine financing in construction deals. In New York that’s popular for a variety of reasons. A lot of times you will have a bank lender doing the senior loan financing and they want to have subordinate debt behind them. It also saves money on mortgage recording tax in New York.

What are you seeing in respect to this in New York?

Something I’ve seen in New York on a couple of occasions is the refinancing of construction loans mid-construction, mostly in rehab or renovations. Debt has gotten cheaper. The few times I’ve seen it the borrower might be paying back preferred equity or mezzanine debt. They are not necessarily cashing out midway through construction. In New York, we have a very old and hard to decipher, and from a lender’s perspective, unfavorable mechanic’s lien law. Lawyers grapple with it all the time. When you go to refinance a construction loan in New York, it creates a lot of issues from the legal side. You usually have to assume and restate a building loan, which is a complicated process.

How has construction lending adapted to EB-5 financing?

From a senior mortgage lender perspective, if the EB-5 lender money is not in place when you are making a loan, lenders do not typically underwrite the loan, as if it will be in place because the regulatory hurdles associated with it are so big. There is constantly a backlog in processing. Lenders will allow for EB-5 financing if it’s in place at the day of the closing, but it’s structured as deeply subordinated mezzanine debt.

What regulations have impacted construction lending?

 The other issue that bank lenders are grappling with in the construction loan industry, and this applies to land acquisition bridge loans and development loans as well, are the High Volatility Commercial Real Estate lending regulations that came out of Basel III. One of the big goals of Basel III is to increase bank capital requirements and make banks operate on a safer basis. HVCRE loans made by banks must be backed by 150 percent of the amount of capital backing ordinary commercial real estate loans.

How do the HVCRE regulations affect bank relationships with customers?

Higher capital requirements increase the banks’ cost of lending and make bank loans comparatively expensive to borrowers than those made by competing nonbank lenders. Generally speaking, banks can avoid having these types of loans classified as HCVRE, and the related higher capital costs, if they satisfy certain requirements. One such requirement says that before the lender advances a dollar of the loan, the borrower has to have cash equity invested equal to 15 percent of the bank loan. This is a problem for borrowers that have held their property for a long time.

There’s also a requirement that says the borrower has to contractually agree to maintain that 15 percent requirement at all times, and some language that suggests that that borrower may be subject to additional restrictions. Because the exceptions are not 100 percent clear, the provisions are often drafted in a manner that leaves the borrowers uncertain about what they are bound by.

What is the most interesting dispute or litigation you’re seeing right now involving a construction loan?

There was recently a title insurance case, BB Syndication Services, Inc. v. First American Title Insurance Company, that has been getting a lot of chatter. The most worrisome thing about BB Syndication was the court’s willingness to find fault with, or balance the equities against the lender in applying the exclusion, and the potential extension of the court’s reasoning to other title claims involving different facts. Title insurance is not a letter of credit to be drawn upon when lenders suffer title-related losses and lenders should expect title insurers to use the policy’s terms to protect their own interests. In many transactions, title insurance is promoted as “the solution” with respect to identified title issues. In many cases, that may be a reasonable position. However, cases like BB Syndication should make lenders think twice before accepting that position.

What does it take to syndicate a loan? What process do lenders go through to become a syndicate on a particular financing?

Most of the institutional lenders or large balance sheet lenders will typically compete to lead deals with institutional equity sponsors. They have a syndications group that has a network of bank or nonbank customers that they go to who can sign on for the loan. Everything is done on a term sheet, non-committed basis. In that world, if you sign term sheets on a business level and get the deal, you are expected to close on the terms in the term sheet. The way it works is you get preliminary approval from the underwriters of the direct lending operations of the lead lender to make a minimum loan amount, which the co-lender committed to the borrower. Then syndications will size it to see how much they can place in the syndications market. That’s a large loan syndication model.

If you’re the lead agent you usually have to take one of the larger, if not the largest, chunk of the deal and oftentimes you have to agree with the borrower that unless the loan goes into default you’re going to retain a decent portion of the loan on your balance sheet.

Are you seeing any trends in syndication?

The lending markets are such that you have arm-to-arm combat. There are so many lenders competing for deals at every level of the capital stack. The idea is that the way to make the most money is to have control over the deal and be the lead lender, so you actually see a lot of non-bank lenders leading the deals. There’s more competition for the banks.