We are seeing a lot more loan on loan financing deals in the Real Estate Finance markets than we have seen for some time.
Some of these relate to NPLs, where the lenders are backing a turnaround story by financing the purchase of the debt. We have recently closed one such deal, with a compelling business case to revitalise 6 UK hotels with a capex/upgrade programme and a brand change and replacement manager.
Leverage to debt funds and challengers:
Other loans on loan deals are there to provide additional loan funding to debt funds or challenger lenders, that may require deeper pockets than the original equity backers can provide, to turbo charge growth. Typically, these are tightly structured and the underlying loans will need to meet defined, negotiated eligibility criteria to qualify for the funding.
Back to back loan on loan financings:
Most recently, there are various examples on deals we have acted on, of specific loan on loan financings, where a lender, often, but not always an investment bank, will provide back-to-back financing to another lender to provide that lender with the finances it needs to make available loans to the ultimate borrower.
This latter type of loan on loan financing is the type that could raise the most questions. Why are the loan on loan financiers entering this market and what happens when the step in in a default? Are they offloading the loan they make, or taking credit protection? Is the underlying borrower fully aware of what is going on behind the scenes and should it care?
What happens if it go wrong:
Well structured loan on loan deals are relatively simple in terms of the recourse for the ultimate lender should things go wrong, the concepts of sub-mortgages and assignments of underlying security packages are well rehearsed.
The implications of step in will impact the regulatory capital position of the ultimate lender. As the lending market has become more complicated with the arrival and growth of non-bank lenders, so have the funding models supporting the REF market.
When considering entering into a loan on loan financing, we set out below a non-exhaustive list of commercial considerations that should be contemplated:
Pricing and timing, co-ordination with the underlying loan or loans
- Eligibility and flexibility
- Servicing and appointment of a third party servicer
- Discretions to grant waivers and amendments to underlying loan portfolio
- Repayment obligations should underling loan be repaid, and whether proceeds can be recycled to make new loans
- Due diligence requirements on underlying loan documents and collateral package
- Comfort underlying loans comply with all applicable regulatory requirements
- Does the deal constitute a securitisation and the additional regulatory and reporting requirements become relevant
We are lucky to see these deals and structures from the various different positions in the market, acting for loan on loan lenders, the debt funds and challengers that borrow, and the ultimate borrowers that need the funds for bricks and mortar. Interesting times!