By Gilbert Green, Partner and Head of Commercial Property.
The housebuilding industry is being urged to build Britain out of recession. Most housebuilders would be delighted to oblige if they could raise the funding. The mezzanine lender can help by providing top up funding. Despite being secured, this is not without risk.
Invariably mezzanine funding is subordinated to the senior debt provided by a major bank. Understandably the bank wants to have first call on the security for its loan. However, problems arise where the borrower has borrowings from the bank in relation to more than the scheme being funded by the mezzanine lender.
Standard documents of major lenders are invariably on an all monies basis - the charge over one specific property provides security for any money owed by the borrower to the bank. Potentially, this makes the security being offered to the mezzanine lender worthless.
Usually the bank will enter into a deed of priority to regulate the priorities of each loan. Often the bank is prepared to limit its priority to a specified amount. Provided that leaves sufficient equity in the property the mezzanine lender should be adequately secured. However, the standard deed of priority adopted does not limit the bank’s priority to the funds advanced for that specific project.
A intends to buy and develop Blackacre. B agrees to lend £6,000,000 towards the purchase and development - 60% of the purchase price and construction costs. A agrees to borrow the remaining 40% from C. A gives C a second charge over Blackacre. B limits its priority to £6,600,000. The gross developed value of Blackacre is estimated at £12,500,000. C on the face of it has sufficient margin for repayment of its loan. The deal proceeds, B lends £2,400,000 on completion and C provides the balance of the purchase price, £1,600,000.
A already has borrowings of £10,000,000 from B. Another project fails and B calls in A’s debts. B is left with a shortfall of £1,500,000. Blackacre becomes security for £3,900,000 owed to B. If B realises its security, with Blackacre still only worth the original purchase price of £4,000,000, C is left with nothing.
The solution is simple, although hard to agree with major banks. If B initially limits its priority to the money advanced for the Blackacre project, and only after C has been repaid does Blackacre secure other borrowings of A, both B and C would have recouped their investment in Blackacre.
The role of the mezzanine lender is important in this difficult market. The housebuilding industry is one of the major players in the road to economic recovery. If we are to build Britain out of recession then the major banks need to take a more realistic approach to issues of priority with mezzanine lenders.