CEE managing large transactions
14 March 2008
1. Question from an Attorney - Managing large transactions
My clients are buying large numbers of low-value residential and commercial properties for rental income. They will consolidate their loan facilities into term lending, but want me to find ways of keeping the cost and time involved under control. Any suggestions?
First Title Responds
The lender will have to make two basic assessments: will your client pay the interest and repay capital, and will the lender be able to enforce its security if the loan defaults? The lender will decide on the first question, but it will rely on outside advice in terms of deciding whether anything would stop it from realising its security if the loan defaulted. The traditional approach is to have an attorney check the titles to make sure the borrower has good title, and there are no prior burdens to stop the lender getting a first charge. The lender will also want to know that they have a valid and enforceable mortgage with first priority and that they have protection against any third party challenge that may hinder their ability to enforce their security and resell in the event of foreclosure.
With portfolios of hundreds, or even thousands of properties, full examination of all the titles can be time-consuming and costly and, of course, if it takes too long and costs too much the benefit of refinancing may be lost. One option is for the lender to agree to limited due diligence on a sample of titles but, in effect, this transfers a substantial risk back to the lender. A more effective approach may be for an insurer to assess the portfolio, much as a rating agency would, carry out its own due diligence and give cover against risk of loss of title and use of properties, for example, for the whole portfolio. This helps to manage time and cost and affects risk transfer, while the attorney focuses on the contractual and financial aspects.
2. Question from a Developer - Defective title insurance
As a developer, we rely on defective title insurance to address the title issues thrown up during the due diligence process. We do not want to wait until planning permission has been obtained to know whether insurance cover will be given to us, but would rather have insurance to cover our exposure from the first day of our project. Premiums for this form of cover are often high. Is there a way we can get insurance cover at a premium that appears to reflect the real losses that we are exposed to at any given time?
First Title Responds
Traditionally, premiums in this insurance market have been calculated using the full-developed value of the insured land. Many insurers now appreciate that developers and their lenders need insurance cover from the first day of a project to protect the significant levels of investment required to get a development to planning stage, let alone beyond.
Some insurers will now take a view on their potential exposure and offer insurance capped at a sum which is significantly less than the full developed value. This approach certainly provides for lower premiums, but the risks of underinsuring can be a lingering concern. The approach is also unattractive to many lenders.
First Title now provides more sophisticated structures, whereby cover is drawn down in stages. This has the effect of aligning the extent of cover at different stages of a development project more closely with the insured's actual exposure to loss - cover eventually matches the full-developed value, but the insured is not asked to pay for this until they are exposed to this level. Due to the fact that the cover is structured, so is the premium, which means that the insured is not asked to pay the full premium at the outset.