Private Equity: When Lenders Question Funds on Their Guarantees

Concerns over the net worth and liquidity of private equity funds are increasingly causing disputes and delays in commercial real estate transactions, Schulte, Roth & Zabel’s Jeffrey Lenobel told Mortgage Observer.

“I represent a lot of private equity and disputes and extensive negotiations happen on virtually every deal where a guarantee from a private equity fund is involved,” said Mr. Lenobel, head of the of the New York-based law firm’s real estate group.

With private equity investors now playing such a pivotal role in commercial real estate deals, those investors are now asked to sign guarantees ranging from non-recourse carve-out guarantees to environmental indemnity agreements to completion guarantees in construction deals. A leading cause of friction is unmanaged expectations, wherein lenders expect a consistent and concrete proof of income and liquidity, according to Mr. Lenobel.

“The first and threshold issue is that just because a private equity firm has a series of funds doesn’t mean that fund II can guarantee the obligations of fund I,” he said. “These funds, for the purposes of guarantees, are separate entities and I don’t think the investors in one fund would have any interest in guaranteeing the real estate held by investors in a different fund,” he added.

The concerns are multilayered. During the investment period of a given fund, there is little if any liquidity, Mr. Lenobel said. Instead, the value of that fund comes from uncalled capital commitments made by various investors and is, essentially, theoretical.

“At the point, if a lender says, ‘O.K. private equity fund, you need to guarantee the obligations, what’s your net worth?’, you are going to look at the fund’s financial statement during this investment period and see that it virtually has no assets and virtually no equity,” he explained. In those situations, disputes often arise between lenders and private equity investors over whether uncalled capital commitments count as assets.

After the investment period, when all of the capital has been called and a private equity fund owns several assets, a different issue arises. Since the average lifespan of a private equity fund is relatively short compared to most real estate companies, REITs and pension funds—in many cases between seven and 10 years after the investment period—the sale of a private equity fund’s assets may raise new concerns about its net worth. As a fund sells off its assets, the liquidity and net worth tests often imposed by lenders can yield unsatisfying results, making it more difficult for that fund to prove its solvency.

“Everybody has to look at the timing of the tests imposed by lenders on private equity funds,” the real estate attorney said. “This will avoid unexpected problems.”

In order to comply with customary net worth and liquidity covenants, private equity funds can mitigate guarantee concerns by holding onto a percentage of their assets to establish reserves and also by establishing third party lines of credit, among other measures, he said.

In most cases, lenders just need to manage their expectations, he added.

“Lenders are starting to understand how funds work and that is paramount to these issues, since private equity funds are among thebiggest players in the real estate industry today,” Mr. Lenobel told MO.

Kroll Bond Rating Agency’s Structured Finance Investor Forum Featuring Paul Volcker

New York --(Fort Mills Times)--
Kroll Bond Rating Agency held a Structured Finance Investor Forum on November 7, 2013. The event was attended by more than 50 participants, which included buy and hold and total return investors representing firms with portfolio holdings across the capital stack. Opening remarks were made by Jim Nadler, President, and Jules Kroll, CEO, followed by keynote speaker Paul Volcker, former Chairman of the Federal Reserve, who addressed the attendees on the current state of the capital markets and regulation.

The Forum included two break-out sessions that offered interactive dialogue with investors. The first, focused on CMBS, was led by Kim Diamond, who heads KBRA’s Structured Finance effort. Ms. Diamond posed questions to the panelists, members of KBRA’s senior CMBS team, and the audience, to gauge their overall views on the economy and current credit conditions. The audience believed that credit spreads would tighten over the course of the next year as issuance increases to post financial crises highs, as the economy continues along at its current pace or improves. Panelists and investors agreed that credit poses the biggest risk for the CMBS market.

The RMBS breakout session, led by Senior Managing Director Glenn Costello, discussed the state of the RMBS market and REO-to-rental assets. Specific topics included recent collateral trends, Qualified Mortgages (“QM”) and the potential for non-QM transactions in 2014, reps and warranties, home prices, and single-family rental securitizations, in particular the Invitation Homes 2013-SFR1 transaction.

http://www.fortmilltimes.com/2013/11/11/3089075/kroll-bond-rating-agencys-structured.html