As the senior lender, what "risks" are there if a borrower is willing to fully guarantee 100% of the loan and there is a foreclosure? Borrower is looking to push proceeds from 60% LTV to 70% LTV and has offered to personally guarantee the entire loan amount as a credit enhancement.
As a lender, what exposure could there theoretically be assuming this scenario?
A few questions:
1. Under what law (what jurisdiction) is the Financing Agreement ? What's the historical average to enforce a loan under that jurisdiction?
2. Is the loan secured or unsecured?
3. What sort of personal guarantee is the borrower offering ? I.e. pledge over bank accounts.
Your biggest risk is that the guaranty is worthless. While right now they may have 100mm in net worth, if something goes bad and you are foreclosing, are depressed values from other assets going to be enough to cover you?
Also, you have to sue under guarantys. It could take years and years to actually get a judgement and then many more years to actually get paid.
100% this. Also, somebody once told me this and it’s something that has served me well (as a non-recourse lender): Guarantees are not about collection, they are about tempering bad behavior.
Suing under guarantees is hard. And expensive. Guarantees can be worthless. You would need to make sure your credit is good.
For a real estate loan, the net worth of the guarantor is often derived mostly from other real estate holdings. The values of those other real estate holdings are probably substantially correlated with the value of the asset being lent against. And the guarantor may have used his real estate holdings to guarantee other loans as well. So, in a downturn when values drop, his net worth will drop a lot and he may not be able to actually make the lenders whole.
Confirming what others have said: personal guarantees should be viewed as worthless and not a credit enhancement. In most cases, they do not enhance the collectability of the credit. The only value they add is moderating behaviors and (potentially) providing some support to payment performance. The former is more true in larger sized transactions than the latter is. The opposite applies in smaller transactions.
Any reliance you have on the guaranty needs to be supported by a thorough analysis of contingent liabilities. This should not be something you guess at - you will want the individual to list out everything they have guaranteed and get all the details on each loan and then have them sign/certify that schedule of contingent liabilities stating that you are relying on it and they attest to its accuracy.
I don't really understand all the comments saying personal guarantees are "worthless" except to moderate behavior. That's insane. Most reputable lenders do a deep dive into personal financials, and figure out what the contingent liabilities are. So yeah, if you don't do your due diligence, and your borrower has pledged their "assets" 10x over, then the guarantee is worthless... but that's hardly the fault of the guarantee, it's a failure of the lender.
Also worth pointing out that most guarantees also come with liquidity covenants, so the argument that in a scenario in which the collateral value doesn't cover the loan, the borrower is probably wiped out on their other assets doesn't quite ring true. It is important to remember that functionally, personal guarantees aren't meant to cover 100% of the loan value, or provide a full recovery for the lender - in that sense, a personal guarantee is indeed worthless. What they're meant to do is bridge some small delta between the (theoretically reduced) value of the asset and the remaining principal on the loan. Practically speaking, that means like 5-15% of the loan value, not 100%. Again, if the lender's risk assessment is so far off that they're holding at asset worth 25% of what its value was at the time of origination, then they have no cause to complain that they can't be made whole from the guarantees they tacked on.
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