Recourse vs. Non-Recourse

Whether a loan is recourse or not would depend mostly on three things: the creditworthiness of the business, the interest rate the business is willing to pay and whether other lenders have claims over the collateral.

On creditworthiness - if a company is riskier, the lender would likely require a loan to have security over its business.

On interest rate, insofar as the company has the ability to choose, a non-recourse loan would be more expensive as it is riskier to the lender.

Lastly, if you already have secured debt on your balance sheet, there would already be claims over your assets, which could limit your ability to get non-recourse debt. If you already have unsecured debt, there are probably incurrence covenants which limit how much first lien debt you can take on.

Never worked on the lender side so cannot comment on their economics, but I would imagine that they would use a portion of the higher interest rate and reinvestment in some form of insurance (particularly if there is political risk)

In real estate, what makes a loan recourse or non-recourse depends on what collateral the loan is secured by. Again in real estate, if the loan is secured by only the collateral or asset, then it is non-recourse. However, if the loan or a portion of the loan is secured by someone or something else, then it is generally considered recourse. I would say providing recourse on the loan has the potential to lower the interest rate of a loan, but it depends on the type of deal.

I don't know if in real estate the norm is for recourse loans as there are so many different types of loans out there in this industry, but generally speaking, construction loans are recourse. Bridge or acquisition and even stabilized financing are all up in the air as it depends on the loan's execution (as in CMBS, bank balance, or syndication). In general conduit or CMBS loans are generally non recourse with the exception of certain deal specific events or "bad boy" carve outs. Balance sheet loans depend on the deal. Many large investment banks have balance sheets with non-recourse financing, but it is the most difficult to access and are generally floating rate loans. I have seen commercial banks and insurance companies offer up both recourse and non-recourse financing. It really depends on the loan's risk level.

I can't speak with certainty to the example you're providing, but in general, New York City office space is pretty damn good right now. And, most large lenders (investment banks, finance companies, commercial banks, and insurance companies, and debt funds) will offer loans without recourse. Nevertheless, there may be some type of component not mentioned which changes the dimensions or metrics of the loan.

As for an insurance for taking on recourse, this is something I have not seen. The person signing for the recourse carveouts generally has this as a contingent liability on his/her balance sheet, and there is generally no compensation for assuming this risk. I have seen people post a letter of credit. Usually, lenders require the guarantor on the loan to maintain certain liquidity and net worth requirements throughout the term of the loan. Many CMBS loans have this feature for the guarantor of those "bad boy" carve outs.

Hope this helps.

An interesting caveat is that California is what they call a “Single Action State” or “One Action Foreclosure” state. This means even with a full recourse loan, the lender can only choose one method of repayment and not multiple. 1) The property or 2) by the borrower’s liquidity. I have never heard of a lender choosing route, 2, but I am sure it has happened.

Re-course loans seem to be the norm for your more typical regional and commercial bank. But I believe Chase’s Commercial Term Lending program offers loans on a non-recourse basis for 10-25 bps increase in interest rate, though LTV is likely capped at 65%-70%.

Like above, non-recourse is more common at the institutional level sponsor and property. But even then, there will be individual(s) or an entity who will have to sign the non-recourse bad boy carve-outs whose net worth is at least equal to or greater than the principle balance.

As the old saying goes, if I owe the bank $1MM, that is my problem. If I owe the bank $100MM, that is the banks problem.

"What determines if a loan is recourse or non-recourse?"

Completely depends on the borrower. Large insitutions will typically be non-recourse. One off investors will either be non-recourse or recourse depending on the LTV, DSCR and rate demands. Also banks have final say on who they will dish non-recourse and recourse loans to. A savvy investory, with skin in the game and a great track record who wants "market" terms has a good chance of getting non-recourse whereas someone who has handed keys back to a bank recently does not. Someone looking for above market rates/terms will likely achieve this with a bank by going full recourse--- or they will have to get a portion of their loan in the mezz market.

"Will a recourse loan come with a lower interest rate than a non-recourse loan?"

If person x has an opportunity to purchase a building with a non recourse loan or a full recourse loan, the full recourse loan will be at a lower rate, better lower dscr terms or lower ltv. Non-recourse loans are better for the bank--- its helps them come to grips that they will indeed get their principal amount back should things go sour.

"Are recourse loans the industry norm?"

Completely depends on what terms are being sought, what market you're in and who the borrower is

"I'm working in corporate PE, where none of our loans are recourse. This doesn't really make much sense to me. We are buying middle market businesses with unpredictable cashflows with 30% down. Why should someone have to sign for recourse on a 50% LTV loan for class A office space in NYC?"

You're looking at an extreme in NYC. The 50% LTV loan for a Class A tower in NYC will surely be non-recourse only with bad boy care outs.

"Also, I've heard on this forum that it comes down to getting someone with a balance sheet to sign for recourse. How does this work and do the people signing for recourse get some sort of insurance premium to compensate them for this additional risk? Does that premium go up with the riskiness of the loan?"

If you're talking about an LLC and the bank demands that the LLC put up a balance sheet for the recourse portion of the loan and you ask one of your LP's to put up their large balance sheet then you bet your ass that this HNW investor will be getting a much larger pref (and probably a piece of the promote) and compensated for that risk. The balance sheet participant's returns on the real estate investment will surely not be on par with respect to their peers--his returns will be higher as he is being compensated for a mega risk that he is taking---he is an LP in an LLC and putting up his balance sheet defeats the purpose of being an LC in the first place.

It is not 100% true to say that in corporate PE no loans are recourse. There are instances where loan guarantees need to be signed.

LLC's, Corps and so on are simply vehicles for specific avenues of taxation. You generally see income producing assets in LLC and for sale product in Corps...at least here in SoCal. Yes there is some liability protection but a closely held corp, which most are, the managing members have been sued individually and lost.

"Why should someone have to sign for recourse on a 50% LTV loan for class A office space in NYC?"

In the current market, a borrower almost certainly could find non-recourse loans at great terms for the situation pitched. So the answer is, they probably wouldn't have to sign for recourse.

The best reason to do a non-resource loan is that you can charge a higher interest rate for not much more risk. In the consumer context at least houses, having a recourse loan doesn't really help you all that much. #1, consumers have a lot of protection in the bankruptcy code that will limit which assets you can take. #2 Consumers have an equitable right of redemption which means you can do all of this work, and they'll just make up the payments they have missed and everything you accomplished vanishes. #3 you're going to pay a fuck ton in legal fees to actually pursue a recourse action, which as shown in #1 and #2 may be about as useful as lighting the money on fire. However, having a recourse loan is helpful in one regard at least. You can threaten to pursue it which would throw the debtor into bankruptcy. Pretty stiff bargaining chip. Lastly, if a debtor isn't paying its mortgage; it isn't likely he has a ton of assets outside of the collateral, and you have the issues of #1, #2, and #3 slowing you down in finding out. In the context of a business, there a nonrecourse loan still gives you rights to the businesses assets you just don't have a person as a guarantor, and you can establish controls that protect you essentially as much as having a recourse loan. For example, if a debtor has a bank account with a bank that loaned it money, the bank has the right to "set off" the deposit account against its outstanding debt. Even if the original loan was completely unsecured, and they can do that over all secured creditors. (Can't do this with consumers just businesses) So, basically the banks/lenders know the rules and the loan whether recourse or nonrecourse is going to have the terms that protect them appropriately.

Sort of. The intercreditor isn't there because we decided among outselves that the mezz lender would just take control of day to day and the senior would stay in place, but because our loans are actually secured by different collateral that is how things would occur. And then we use it prenegotiate the what ifs.

In a senior/mezz situation you have: A senior lender A mezz lender A borrower

The senior lender lends funds to the borrower secured by the asset. The mezz lender lends funds to the borrower secured by the interest in the entity that controls the asset (so the actual LLC/SPE).

If you think about it on the equity side, a mezz lender is basically a preferred equity partner (because they get paid first), but they have no voting rights.

If the borrower defaults on the mezz loan, the mezz lender forecloses, wipes every other partner out and becomes the new GP of the borrower (and runs day to day operations of the property). As the new GP, they (the mezz lender) would need to execute new guaranties because the old guarantors are now useless.

the intercreditor spells out what happens in a lot of different situations: Borrower has an Event of Default (monetary or other big issues) on mezz, but not senior loan, and Visa versa Borrower has an EoD on both loans. Borrower in default (missing financial documents or small bullshit) Notice requirements or fees between the two parties, etc.

Because there is mezz debt, the intercreditor will say somewhere in it that the senior lender has to give the mezz lender time to foreclose out the borrower and then cure whatever defaults there are on the senior loan. The intercreditor will also generally give the mezz lender a one time right to pay off the loan at par at the time of foreclosure.

The upside is always for the mezz lender because they are taking the most risk as they are first loss. Most of the mezz debt that we invest in, the senior position is being securitized. Bond holders don't like unexpected redemptions so they are more than happy to give the potential upside to someone else if that buffers them and secures the ratings of their bonds.

Intercreditors are used between lenders all the time in fairly standard forms. A lot of the time the lenders have pre-negotiated forms with their common partners and just tweak a sentence here or there depending on the deal.

The provision that we get where the carve outs default to the borrower and we don't have to put up a monied entity is a special provision that is firm specific. We get grumbles about it, but I can only think of one deal where we didn't get it in the last few years and on that deal the senior wasn't securitizing.

In general, over the years I've seen every junior lien holder have to the opportunity to satisfy the first lien. Either by keeping/making senior lien payments and/or paying off senior lien. Many junior liens from 2008-2011 or so had to make some decisions. Pay the senior note monthly, pay it off, or do nothing, letting senior lien foreclose and hope that net proceeds from sale/auction satisfy some or all of the junior debt.

Many funds I see that have say, fractionalized 1st TD notes or tranches are still just one loan. Part of playing the game and letting a fund manage your cash/debt is accepting some basic provisions as a senior lien holder.

Lenders generally prefer to lend and get paid. Even if by a junior lien if that's what it comes to.

Agreed, we are. In general though you're rarely going to see a senior lien not let somebody pay their note.

1- Do you ever lend mezz secured by the asset (in second position) at your shop or is it always secured by the SPE?

2- Do you always get the inter-creditor agreement completed before intimate talks with the borrower really starts percolating? How do you approach the timing effectively without losing the deal? Mezz debt is fast.

3- “Because there is mezz debt, the inter-creditor will say somewhere in it that the senior lender has to give the mezz lender time to foreclose out the borrower and then cure whatever defaults there are on the senior loan”

How much time is typical? I assume depends on asset size/complexity

4- “Bond holders don't like unexpected redemptions so they are more than happy to give the potential upside to someone else if that buffers them and secures the ratings of their bonds. “

If the mezz debt is added to the stack say 5 years after the senior loan was originated, wouldn’t this affect the ratings of these CMBS bonds? What if the master servicer sucked and made a shitty call on who the mezz debt originator should be and it hurts the true ratings of the cmbs bonds? Seems ripe for a lawsuit.

5- “but I can only think of one deal where we didn't get it in the last few years and on that deal the senior wasn't securitizing.”

So obviously a bank/lifeco/lender who has the entire first mortgage on their books is more prone to deal with the default themselves rather than a Master Servicer who would have to go through the costly procedure of hiring a special servicer and selling the asset themselves to retain par bond value.

Thanks. Healthy discussions and I’m learning about a piece that I don’t see often but hope to see more of. Always good to pick up knowledge here.