Banks seldom issue second mortgages to developers even if there are sound arguments as to why it might actually be in their best interest to allow them. According to Dan Holden of construction finance firm HoldenCAPITAL, there are several reasons why banks need a lot of convincing to award developers with second mortgages.
For banks, the financial strength and experience of a developer should be demonstrated to them so that they can be sure that the developer can withstand any unforeseen financial pressures along the way.
While second mortgage funding is a smart way to leverage equity, sponsors or developers should provide statements of positions, group cash flows, and approved standby arrangements to support their ability to meet ongoing commitments to the project.
Banks also do not want any potential hurdles to their release of security. To address this issue, Holden advises developers to find a second mortgage provider that the banks are comfortable with so as not to affect the first mortgage.
It can also be alarming to banks if the developer does not provide at least 10 per cent “risk money” of the required capital stack in a project since developers are more likely to act in the right way if they have a substantial amount of their own cash at risk in the project.
“Banks tend to view all second mortgages as complicating transactions rather than adding value as their interests are not always aligned with those of the borrower,” Holden said. “It is, therefore, a negotiating exercise that requires a complete understanding of the interests of both sides.”
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