Possibly the most heard requested change that I heard from credit unions for MBLs was to change the guarantor rule. The current regulation requires a guarantee of the full loan by a majority of the ownership. Exceptions are granted for any loan to a non-profit or a loan that is tied to a governmental guarantee that has different rules.
The new regulation allows the guarantee decision to be make at the lender level. Lenders can decide when to require a guarantee or when to disregard the need for one. This portion of the new MBL regulation goes into effect within 60 days after publication in the Federal Registry.
I do agree that the decision to require a guarantee or not should be a lender level decision. But I do think that not requiring a guarantee from the sponsors should be rare and warranted in certain credit circumstances. In one of the first loan committee meetings I attended as a young commercial lending pup, we were discussing a credit request for a small manufacturer. The owner wanted the loan on a non-recourse basis. Our head of commercial credit said something that has stuck with me since then, “If the borrower expects us to loan money and thinks the company is good enough to support the request, he should be willing to back it up personally.” Since that time there have been a handful of times, that I have not had a guarantee on a loan. The lender has little upside in a loan on a project that excels. We only get our required payment but do not benefit in the wild profits when they come. However, we do bear the risk on the downside with most loans putting more funds into the project than the borrower does. Hence the need for a guarantee.
So what are some circumstances you should look for to waive a guarantee? The first requirement is to find out if the business can historically and going forward support the debt request without any intervention from the sponsor. This is why some projects like a construction loan that has the risk of completing the project, should always have guarantors backing the project. I have also never seen a business credit that requires a lot of sponsor involvement to make the business perform as a candidate for non-recourse.
So this leaves projects that are somewhat passive in income in terms of sponsor involvement. So a manufacturer or a hotel that has the main sponsor on site each day would not be a good non-recourse possibility. Some options that may be options would be a financing a building with a long term lease to the US Government, an established apartment with management outside of the sponsor group, or a long term leased building with a strong credit tenant in an industry with a strong future. The last one we have to be careful with as we can point to companies that were once strong like Circuit City or Kmart that used to be very stout but are gone or a shell of what they were in their heyday. Consideration of the future use for the building outside of the present use should also be contemplated.
Non-recourse lending should also be more attractive to the lender than recourse lending. Some ways to do this would be to require a lower LTV, underwrite to a higher debt service threshold, or shorten the term. In banks I worked at, we would often require another 5-10% down to entertain the prospect of a non-recourse loan. Strategies like this reserve non-recourse for stronger credits.
Some things to consider would be if the non-recourse loan request has a term that exceeds the lease term. If it does, how easy is it and does the sponsor have any responsibility in finding new tenants? If it is somewhat difficult and there is sponsor involvement, you probably want to tie them to the loan.
Other options may be to require limited guarantees. An example of this if you have five owners of a company would be to require each of them to guarantee an amount slightly higher than their ownership percentage. In this case we ask for each to provide a 25% guarantee of the total of the credit. As a whole you have more than 100% of the credit guaranteed which allows the lender some space to deal with any costs to service and dispose of the property.
Whenever you do have the case with a non-recourse loan that you decide to do, you will have to establish a case of why this is acceptable and what steps were taken to mitigate the risk of leaving out the guarantor. This will be required by the examiners but is also a good practice to manage the credit wisely. Using the excuse, “We had to offer this because the competition did,” is not sufficient on either count.