(123)456 7890 [email protected]

Blind Loans: What You Don’t Know Can Hurt You

There is no doubt that we are in a fiercely competitive business loan market. Banks and other lenders have more money to lend than creditworthy borrowers looking to borrow. Interest rates remain historically low. Pressure continues to mount to lower borrowing costs to attract new customers.

Commercial real estate loans are no exception. Banks and other commercial lenders are scrambling for borrowers and, on the issue of cost-cutting, many are placing more responsibility for documenting commercial real estate loans on loan processors with limited understanding of the fundamental risks involved. An unfortunate consequence is that many lenders “blind lend.”

What is “blind loans”? Blind loans approach commercial real estate loans with substantially the same approach as residential homeowner loans. Blind lending is making loans secured by commercial real estate without fully understanding the underlying commercial real estate project and the collateral risks it presents. Blind lending is turning a blind eye to important legal, environmental, and land use issues unique to commercial real estate and ignoring available techniques to shift risk in the unfounded hope or belief that if the issues are not carefully considered maybe they won’t exist.

Make no mistake: commercial real estate loans are not the same as residential real estate loans. Many lenders facing customer resistance to higher borrowing costs may want to turn a blind eye to this reality. Ignoring this reality, however, does not change it. Ignoring this reality may appear on the surface to reduce costs, but it can jeopardize bank profits and jeopardize capital.

“Safe and sound lending practices” is not just a phrase used by banking regulators. It should be a way of doing business.

Failing to focus on the genuine risks that commercial real estate loans present is not safe and sound lending practice.

Believing that a commercial real estate loan is properly documented through the use of pre-packaged computer-generated loan documents, without also requiring a qualified and in-depth analysis of the land use controls imposed by registration and zoning documents, informed examination of survey, lease subordination, insurance, access, borrower authority, and other legal issues, and without fully understanding the environmental risks posed by existing, former, or anticipated tenants, occupants, and owners of adjacent land, you are not following sound lending practices and safe.

Blindly following a loan document checklist and filling the loan file with documents and materials that “evidence” a well-documented loan, without a genuine understanding of the legal limitations, pitfalls, and red flags that the documents can is to follow solid and safe loans. practices Using the ostrich approach to lending is a game of Russian roulette. The result can be catastrophic for the bank’s profits and capital if and when the loan defaults.

Banks and other commercial lenders who follow these unsound and insecure banking practices don’t like this message. They often claim that their loan processors are “good people” with excellent training and years of experience using their canned document software.

The fact that a lender’s in-house loan processors are “good people” is not in question. The fact that they are well trained in entering relevant data so that a computer can generate a beautiful set of loan documents is not the problem.

The question is what can be beyond the documents.

A perfectly constructed set of “standard loan documents” can be of little value if it does not adequately address the unique issues posed by the commercial real estate project it serves as collateral. Without a doubt, every commercial real estate project is different. Unlike owner-occupied residential real estate, commercial real estate collateral cannot be safely “assumed” to be legally adequate, or even legally usable for its intended use.

A beautifully drafted mortgage on commercial real estate is of little value if the project does not have a commercially reasonable legal right of access or parking.

CASE IN POINT: How safe is a loan on a banquet hall for 800 people in a mixed-use center if the banquet hall has the legal right to park only 155 cars?

CASE IN POINT: What is the collateral value of a hotel on a highly visible road junction, which has as its main means of access only a license to use a private road that can be closed at any time? [Is the appraiser legally responsible for discovering this fact when making the loan appraisal? What kind of access does the typical title insurance policy insure?]

Obtaining a Lender’s Title Insurance Policy with specialized commercial endorsements is a useful method of taking risks away from the lender, but the lender must understand how to interpret each endorsement to know what it insures.

CASE IN POINT: While attending a loan closing as an “accommodation” for a lender to make a large loan to one of their “best customers” to purchase a warehouse and manufacturing building, with instructions from the lender to simply “supervise the execution of the closing documents”. (the lender had prepared) and approve the title,” the lender’s attorney discovered upon review of the lender’s required zoning endorsement that the borrower’s intended use of the facility was expressly prohibited by the applicable zoning ordinance. The Endorsement Zoning Code HIGH 3.1 to be attached to the loan policy revealed that the borrower’s intended use was expressly excluded as a permitted use on the land Neither the lender nor the borrower had read the endorsement or, if they had, did not understand its endorsement. meaning. The transaction was aborted by the repentant but grateful borrower, who would not have been able to operate his business had the transaction proceeded. If this restriction had not been recognized prior to financing, it would almost certainly have meant the bankruptcy of one of the “best customers” of the bank and a huge non-performing loan for the lender.

Experience shows that lenders should not assume that borrowers and their attorneys will always conduct adequate due diligence to determine all associated risks that may affect the project and underlying assumptions material to a loan.

A lender must also avoid the trap of relying too heavily on the borrower’s representations and warranties in the loan documents. If the borrower is wrong, what is the consequence? Declare a material breach?

CASE STUDY: A mortgage securing a $1,650,000 loan contained an assurance from the borrower that “all leases encumbering the Real Property are, and will remain, subordinate to the lien of the Mortgage.” A lease, in fact, was not automatically subordinate to the Mortgage. The Lender’s Title Insurance Policy included an exception for all existing leases and leases. The non-subordinated lease contained a Lessee Option to purchase the entire strip center for $1,520,000. Will declaring a default for breach of warranty fix this defect? What is the collateral position of the lender if the Lessee exercises the Purchase Option on him?

The lending business is about making sound, safe loans that perform profitably as planned. Performance is the key. No foreclosure. The ability to declare a default and initiate enforcement and enforcement proceedings is a resort of last resort. It is not a viable substitute for diligent evaluation of the material predicates of the loan and will rarely fix problems with the underlying collateral.

Sound and safe loans require a comprehensive understanding of all the relevant issues facing each commercial real estate project that serves as collateral. If lenders are going to make commercial real estate loans, they must follow safe and sound credit practices. To do this, they must learn to fully and meaningfully assess all the risks associated with their collateral, or hire an attorney with specialized knowledge and experience in commercial real estate lending to perform this role.

Turning a blind eye to the uniqueness of commercial real estate collateral and the limitations of many well-intentioned but unaware in-house loan processors is not sound or safe lending practice.

Independent, focused and knowledgeable lender due diligence is a must.

Leave a Reply

Your email address will not be published. Required fields are marked *