Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.
Issue link: http://cire.epubxp.com/i/143044
Oftentimes compensating balance requirements are buried in standard loan agreements. The minimum fixed balance amount is most typically used in commercial real estate loans. Tis agreement requires a predetermined minimum balance amount be kept on account at all times. When banks require a set minimum — rather than an average balance — the level of inequity is substantially greater. With single-asset entities being the most prevalent borrowing structure for commercial real estate, cash held on the balance sheet of these borrowers is ofen limited. Because of this, banks most ofen will look to the fnancial strength of the deep-pocket sponsor behind the borrowing entity to satisfy their compensating balance requirements. The implementation of the agreement is simplifed if the sponsor has an existing depository relationship with the bank. Since the agreement is binding and the liquidity is restricted, disclosure must occur in the borrower's fnancial statements and the sponsor's personal fnancial statement. Ofentimes, the bank's compensating balance requirement becomes higher if the amount of liquidity available is higher, thus further driving up the efective cost of borrowing. Risks and Challenges Ofentimes compensating balance requirements are buried in standard loan agreements. Many borrowers and principals are unaware that, when signing, they agreed to a compensating balance arrangement. Te efect of entering into a compensating balance agreement in conjunction with a commercial mortgage can be far reaching and is very risky to the borrower and its principals. Te risk is that compensating balances give the bank the right of ofset. In the event of default on the commercial mortgage, it becomes simple for the bank to freeze or set aside the agreed-upon compensating balance amount. Once done, this cash now becomes restricted and is unable to be accessed or used. The restricted cash held by the bank may be applied to reduce the outstanding loan balance. Because of the higher efective cost and the risk of having accounts frozen in an event of default, many sophisticated commercial real estate investors ofen choose to borrow from non-depositary commercial mortgage lenders rather than from their relationship bank. Keeping a commercial mortgage loan separate from deposits is prudent from both a cost and risk management perspective. Steve Zorich is a business development officer for A10 Capital, a full-service nationwide lending business specializing in small- to middlemarket mini-perm commercial mortgage loans. Contact him at szorich@A10Capital.com. Join CCIM members around the country ARING I as they take one day to make a difference N M in their communities. CCIM Chapters TY C NI U and individual CCIM members will take one day from September 9 September 22, 2013, to volunteer for a local cause in the 2nd Annual Community Caring in Motion. ION OT COM M Make the difference C CIM CCIM.com Visit volunteer.ccim.com for more information. July | August | 2013 15