Special Problems Of Syndicated Loans

Syndication continues to grow in popularity among lenders. Here, the authors explain the significant legal issues surrounding such transactions.

According to a recent study, lenders closed $244.2 billion of commercial/multifamily mortgage loans in 2012. The multifamily property category accounted for $103.2 billion of that total, leading all real estate loan originations in dollar volume.1 Due to the rapid growth in volume and the escalating size and complexity of mortgage loans and the projects securing such loans, lenders have been forced to further develop methods to adequately diversify their risk. While most mortgage loans are sold into the CMBS securitization market, mortgage loans held for syndication still represent a significant share of the loans made by many real estate lenders. The syndication market provides mortgage originators with an opportunity to create a customized lending product which extends beyond the standard requirements of the rating agencies. The syndication market has recently gained significant momentum for "value-added" lenders who are willing to incur above average risk by placing loans in higher leveraged loan positions in the capital stack or provide financing outside a conduit structure for construction projects, land acquisitions and/or lease-up projects.

The primary incentive for syndicating loans in today's market is diversifying risk and, thus, increasing the granularity of a lender's loan portfolio. Other considerations for lenders who sell loan participations include leveraging income and reducing capital weight while building and maintaining relationships with clients. Access to the know-how and deal flow of established real estate lenders is an incentive for lenders who purchase loan participations to join a syndicate group. The majority of key players in real estate loan syndication in the United States include U.S. lenders and international lenders from such countries as Germany, France, Canada, and England, serving in roles of both agent lenders and participant lenders.

As these trends continue, it becomes increasingly important for real estate lawyers and their clients, whether they be agent banks or participants, to understand not only the driving forces behind syndication, but also the legal issues that arise in connection with these transactions, including issues often negotiated between members of the syndicate group. The respective interests among loan participants vary to the extent that pari-passu loan shares, subordinate loan shares, A/B loan structures, or mezzanine loan interests are involved in the capital stack.

Driving forces behind loan syndication

The major benefit of loan syndication is that it allows arranging lenders (who are often the loan originators) to diversify risk while maintaining close relationships with their customers. In order to minimize credit risk and to ensure acceptable levels of diversification, lenders monitor and impose limits on their exposure with regard to a particular project as well as the amount of loans made to a particular sponsor. As development projects become more complex and expensive, developers require larger loans, which may exceed a particular lender's loan exposure limits or the maximum amount that a particular lender is willing to extend to a sponsor.

By creating a syndication group and, thus, dividing the obligations to lend the entire loan amount among several lenders, participating lenders are more likely to be able to stay within their credit exposure limits. The participating lenders also have the opportunity to access the expertise, business relationships, and deal-flow of arranging lenders, allowing the participants to extend their customer base without investing large amounts for marketing costs and administrative capabilities.

Lenders that arrange the syndication group or serve as the administrative agent for the participants (oftentimes the same lender) can enhance their own profitability by charging and collecting additional fees and other compensation for arranging and administering the loan without the need for committing capital for the entire loan amount. To a certain extent, agent lenders may also expect their participant banks to bring future syndication deals back to the agent lender. All of the lenders in the syndicate group benefit financially from their loan participation by collecting pro-rata interest and fees, particularly commitment fees.

Participation structures for real estate loans

In a loan involving direct participation, each participant lender acts as co-underwriter and becomes a party to the loan documents at the closing of the loan. Although each participant lender has its own contractual relationship with the borrower (and, thus, is called a co-lender), typically one of the lenders (in most cases the originator of the mortgage) will serve as the administrative agent for a group of participants. Such deals may be executed in a "club" format, in which several lenders partner to form a small lender group for transactions that exceed the risk appetite of each individual lender. The agent lender is responsible for administering the loan and maintaining the day-to-day relationship with the borrower. Each of the co-lenders owns its respective portion of the loan, which obligates such co-lender to fund to the borrower the amount to which it has committed to lend and entitles such co-lender to the benefits (i.e., interest and fees) arising out of its portion.

Each co-lender often acquires a promissory note in the amount of such co-lender's share of the loan, made by the borrower payable to the order of such co-lender, as payee. However, the notes often provide that the payments made under the note be sent to the agent lender, who collects the payments and distributes to each co-lender its respective share of the funds.

In a loan involving regular participation, direct participants join as a participant lenders after the initial closing of the loan. An existing lender, often-times, the arranging lender who typically also serves as the administrative agent, sells a portion of the loan to the incoming participant lender (who is also called a co-lender), which sale is documented by an assignment and assumption agreement or assignment and acceptance agreement between the selling lender and the co-lender. The co-lender will acquire by assignment an undivided participation interest in the loan on a pro-rata basis, which means that it will accept the obligation to advance its portion of the loan and will receive a direct interest in the amount of their participation in the right to repayment of the loan and the collateral given to secure the loan. In most other respects, the rights and obligations of the lenders in a regular participation are similar to those in a direct participation.

If a loan is syndicated through indirect participation, the participant lenders are not and do not become parties to the loan documents. An indirect participant enters into an agreement with the selling lender to purchase interests and obligations under the loan and receives a participation certificate executed by the lead lender, and not a note executed by the borrower. The participant lender incurs only a guarantee-like funding obligation and must reimburse the selling lender for any loan expense in...