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CRE Finance World, Winter 2014

First Resolution: Exercise More (Good Judgment): CMBS “Do’s” and “Don’ts” on the Lender Side A publication of Winter issue 2014 sponsored by CRE Finance World Winter 2014 81 will, in the event reconstruction is required, have the potential to decrease the available floor space for improvements and must be mitigated. (ii) Title and Survey: Borrowers will request a title commitment and survey. Counsel reviews these documents to ensure conformity with lender’s and securitization requirements. While reviewing the exceptions to the title commitment, DON’T fail to consider, among other things, easements, leases, SNDAs and/or oil and mineral rights leases. DO thoroughly review these documents for any provisions that might affect the collateral (e.g., purchase options, rights of first refusal, lease exclusivity clauses or any restrictive use covenants). The survey should be free of encroachments and depict the property “as-built” with all necessary easements, setbacks and square-footage measurements. Even a minor encroachment may pose serious risk. For example, if an improvement encroaches two feet across a property line, a title company may provide insurance covering forced removal of such structure, if said two feet are critical to operations (and, for example, includes the front entry to retail or the managing office for a storage facility) the removal of such area could devastate future cash flow. These risks need to be analyzed by both counsel and the underwriter. (iii) Lease Review and Estoppels: Counsel should understand that the borrower’s ability to pay its debt service is highly dependent upon cash flow (i.e., tenant rents). DO afford special attention to renewal, expansion and termination options in leases estoppels. If a tenant has the right to terminate its lease without cause, the lender should re-evaluate the net cash flow and subsequently review its analysis of the property value. In addition to standard lease review, counsel may need to acquire estoppels to confirm that there are no existing claims against the borrower and that no major tenant will be vacating the property shortly after closing. Counsel may also require that tenants sign SNDAs if estoppel language is insufficient. If a tenant has a right to purchase the premises, DON’T forget that such a purchase option must be subordinated in an SNDA prior to closing. (iv) Condominium Documents: When the proposed collateral consists of a condominium, there may be problems if the borrower does not own a controlling percentage of the condominium association, or if the association ceases to exist. An estoppel from the condominium association will sometimes mitigate the risk; however, DO ensure such estoppel specifically addresses any risks in the condominium documents. (v) Environmental: DO bring together a hired environmental consultant with environmental counsel to identify any potential or existing environmental issues. The lender should require an indemnity from the borrower for all past, present and future environmental harms that will survive past the loan’s retirement. (vi) Ground Lease Issues: Ground leases are those loans secured either entirely by a leasehold interest or by part fee/part leasehold interest in real property. DO provide summaries on ground lease provisions and evaluate against representations and warranties. An estoppel signed by the ground lessor, addressing the specific terms of the lease and loan, is critical to ensuring such loan will be securitized. Understanding Mechanics of the Sale into the Secondary Market Since CMBS loans are pooled and transferred into securitization trust vehicles, DO understand the ever-fluid nature of capital markets and the evolving regulation thereof that makes “CMBS 3.0” much different than CMBS 2.0. For example, the Dodd-Frank Wall Street Reform and Consumer Protection Act has several implications for the CMBS market. First, it enacts a 5% risk-retention requirement on the securitization process.8 This was in response to the notion that CMBS loan originators had little incentive to conduct proper due diligence because they were seen to have little to no “skin in the game.”9 However, risk-retention requirements may not apply for loans that pose low credit risk if they satisfy stringent underwriting criteria.10 For example, underwriting standards require that “the borrower will have a total liabilities to total tangible assets ratio of 50% or less, a leverage ratio of 3.0 or less and a debt service coverage ratio of no less than 1.5.”11 DON’T forget the Dodd-Frank rules are still being negotiated and are not yet fully implemented. DO structure documents proactively to deal with a changing regulatory environment. Representations and Warranties In securitization, loan sellers represent and warrant to the purchaser(s) about the loans. Origination counsel should ensure the loan satisfies such representations and warranties. DO remember the borrower needs to attest to representations and warranties about its corporate existence and related matters, as well as property-related matters. DON’T forget for every representation or warranty that the lender cannot make, an exception must be made. Such exceptions may negatively impact price and/or even prevent securitization. Loan sellers face severe consequences for materially breaching loan


CRE Finance World, Winter 2014
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