The Dreaded RE Personal Guarantee Loans Are Back

loan_help With the sudden reduction in the availability of loans and credit becoming tough to obtain, WSJ is reporting – the dreaded personal guarantee loans, which essentially is a promise made by an entrepreneur obligating him/her to personally repay debts if he/she defaults on, is making a comeback in the real-estate industry, bringing back the kind of tough terms that borrowers hoped not to see again.

As loans for commercial projects have become difficult to come by in this credit crunch, borrowers are being forced to consider loans that would give the lenders “recourse” to the borrowers’ personal fortunes – terms that led many a developer, including Donald Trump and William Zeckendorf Jr., to near ruin in the real-estate crash of the early ’90s. More recently, New York developer Harry Macklowe found himself in a bind after he signed a personal guarantee on a $1.2 billion loan.

These recourse loans – once a staple of commercial lending – had largely fallen by the wayside during the past decade as banks found ways to minimize their risk. However, now – with the securities market for commercial loans still anemic, recourse loans are popping up again since commercial investors who can’t wait out the credit crisis may have little choice but take a deep breath and sign a recourse loan. Oftentimes, the situation evolves into either sign personally or you don’t get the loan.

During the recent sales frenzy for commercial properties, nonrecourse loans were the norm. Typically, this meant that the developers put up as collateral only the buildings they were purchasing. If they couldn’t pay off the loans, they simply handed the building’s keys to the lender and walked away. The borrowers’ other holdings — including personal assets such as homes and boats — remained intact. The investment banks that originated many of these loans felt comfortable with the arrangement because they typically packaged those loans into commercial-mortgage-backed securities, or CMBS, and sold them as bonds, reducing their own risk if the borrowers couldn’t pay.

Now, with a 90% drop in CMBS sales (commercial-mortgage-backed securities), banks have all but stopped originating loans aimed at the bond markets. Instead, they are returning to the traditional model of holding on to – as opposed to selling – the loans.

But, even for banks, recourse lending can cause headaches. Borrowers are more likely to fight the banks if they face losing much of their net worth over one bad gamble. Plus, the banks make less money; the interest rates they can charge on recourse loans are about 1% lower than on nonrecourse loans.

With such onerous terms, some developers may opt not to do deals at all – consequently, causing a significant slow down in the pace of real-estate transactions. However, many borrowers may have no choice but to swallow the tightened lending terms.

According to a March study by the Mortgage Bankers Association, $16 billion in loans that were packaged into CMBS – which are nonrecourse – are expected to come due this year, followed by about $19 billion next year.

About Ron Haruni 1036 Articles
Ron is the Co-Founder & Editor in Chief of Wall Street Pit. Web Site: Wall Street Pit

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