Lending Law Report : Corporate Finance Lawyer & Attorney : Reed Smith Law Firm : Lending Transactions, Secured Investments

This post was written by Joel Schaider, a partner in the Financial Industry Group here at Reed Smith.

With failed financial institutions approaching record numbers, the Federal Deposit Insurance Corporation (“FDIC”) has been required to step in and seize the assets of these institutions.  The single largest categories of assets held by a failed financial institution are its performing and non-performing loans.  These loans are in the process of being sold to the public in bulk through a sealed bid process.

How to Find Information on Loan Sales  

The FDIC’s website contains information on current loans which are available for bid.  The loans of each failed institution are grouped into pools by loan type (e.g. commercial and industrial, consumer, residential, agriculture).  The website contains a list of offering announcements which are currently available for bid including the name of the financial institution which originally held the loans, the number of loans in each pool, a general description of the loan type, a description of the nature of the collateral securing the loans, the location of the collateral and the percentages of seasoned performing and non-performing loans in each group.  There are also key dates listed for the commencement of due diligence and the due date for the submission of a bid.

Additional information on loan sales may be obtained from two loan sales advisors (First Financial Network and DebtX) who the FDIC has retained to manage the sales process. The offering announcement for each loan sale will identify the sales advisor who has been assigned to manage the particular sale. 

How the Sale Process Works

• Purchaser Qualification.   The first step in the sale process to for the purchaser to become qualified.  First Financial and DebtX have established similar qualification requirements, however, it is advisable for the purchaser to qualify with both advisors.  Once the qualification requirements have been met, purchasers will be given passwords and access instructions to the loan due diligence and other information pertaining to a particular loan sale.
   
• Timing.  Generally, the period of time involved in bidding and purchasing a group of loans from the FDIC is approximately 6 to 8 weeks from the time the offering is first announced. The initial period of due diligence is typically 4 to 5 weeks in length with the bids to be submitted on a specified date after the expiration of the due diligence period. Generally, it takes two weeks for the bid to be awarded. The closing would then occur within a short period after the bid is awarded.
   
• Due Diligence.   The FDIC makes no representations or warranties in connection with the purchase of any loans and all of the risk of loss associated with the loans are passed to the purchaser upon closing.  The rights and remedies available to the purchaser are solely contained in the underlying loan documents and the associated collateral.  Therefore, a review of the loan files including the collateral is a critical element which must be completed prior to the submission of a bid. 
  
  The due diligence process may vary depending on the size and characteristic of the loans contained in each portfolio. Larger-sized commercial loans may require greater scrutiny than smaller consumer loans. However, a large number of consumer loans, for example, may contain defective terms which could affect the enforceability of all the loans in the portfolio. The loan files may be missing signed documents or important pieces of collateral. Experienced counsel needs to be involved in order to conduct due diligence in an efficient and effective manner.
  
  The due diligence files are obtained through the financial advisor assigned to the particular sale. The files are typically available on a secured website, on a separate hard drive (which may be purchased) or in a physical location.
   
• Bid Submission.  Upon completion of due diligence, an interested purchaser needs to submit a bid.  An initial deposit of $100,000 is required from each bidder to be sent by wire transfer at the time of bid submission.  The deposit is fully refundable, without interest, if the purchaser’s bid is not accepted.  If the purchaser’s bid is accepted, a final deposit equal to 10% of the purchase price of the loan portfolio, less the amount of the initial deposit, is required to be deposited within one business day following the bid award.
   
• Closing.  Closing occurs on a specified date within a short period of time after the bid is accepted by mail or in person at a place designated by the sales advisor.  The balance of the purchase price is due at the time of closing. All loan documentation such as notes, collateral documents and loan files will be delivered to the purchaser within a reasonable time after closing.

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Last week, our firm hosted a workshop at the annual conference for the Los Angeles chapter of the Association for Corporate Growth (ACG).  Our topic was “Finding Financing in a Difficult Market”.  No one in the room needed to be convinced that the market is indeed difficult these days. 

Our workshop was focused on trying to find the few bright spots in the market.  There was a senior lender on the panel, who indicated that the market for senior loans may not be quite as dead as people seem to think.  For example, the ABL market continues to be active and can be a good source of funding for underperforming companies that have valuable assets.  On the cash flow side of the house, there are some borrowers that the banks would like to loan money to, but many of those companies seem to be on the sidelines waiting for the market to change. 

Our experience in recent months has been that senior loans are still available in some situations, but for a number of companies this kind of financing can be hard (or impossible) to find.  Within this constricted market, we’re still seeing acquisitions and other types of deals getting done, but rather than relying solely on senior financing, most seem to involve a combination of sources of funds, including equity, mezzanine and sometimes various forms of second-lien/mezz hybrid financing. 

We’ve seen the role of mezz lenders in corporate acquisitions dramatically increase in the last few months.  In the workshop, I described a recent deal to acquire a middle market manufacturing company.  The private equity fund relied on a combination of equity financing, a structurally subordinated loan to the holding company, a small senior revolving loan for working capital, and a secured mezzanine loan that looked much like a second-lien loan. Piecing together financing from various sources –with some very complex intercreditor arrangements – got the deal done.

My corporate partner John Iino discussed a major trend that our mergers and acquisitions practice is seeing:  an increase in deals being done on an all-equity basis, without a debt component.  This is the only way to go when debt financing is unavailable.  Many of the acquisitions are strategic combinations.  And it's not uncommon to see the equity funding for companies (and transactions) come from foreign investors.

It will be interesting to see where the market takes us in the next few months.

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One question we hear a lot these days is whether a syndicated loan agreement can be amended to do certain things without consent of all of the lenders. 

Several kinds of changes that may be made to a loan agreement, such as reducing the principal amount, decreasing the interest rate, postponing payment dates and the like, typically will require all of the lenders affected by the change to approve.  With more borrowers in financial trouble, it has become increasingly important - and sometimes necessary for the borrower’s survival - to get amendments passed quickly.  But it can be difficult, if not impossible, to get all of the lenders to agree.

This is part one of a series of posts about what to do when this issue comes up.

When the borrower asks for relief on some of its obligations, and the agent and majority lenders are willing to agree to what the borrower has requested, in many deals there will be strong incentive to take a narrow view of the other lenders’ voting rights in order to get the amendment passed.  Agents are analyzing amendment provisions very carefully to determine precisely what is and is not required in terms of lender voting.  If there are ways to get the amendment passed without triggering the other lenders’ voting rights, then that can end up being the desired course.

For example, we know we can’t extend an interest payment date without a 100% vote, but there is no such prohibition on amending events of default.  So, the agent and majority lenders may start thinking about whether they can lengthen the cure period for payment defaults by a few days, which could have the effect of permitting the borrower to pay later without changing the date the payment is due.  This type of amendment would have other consequences, of course, and it may not be a good idea for a number of reasons.  Whether changes like this can even be considered will depend on the circumstances, and on the terms of the loan agreement.

In any event, these situations call for some clever thinking on the part of the agent and its counsel.  And they call for careful consideration of how the non-consenting lenders will view the amendment.  Elevating form over substance (i.e. “we know we can’t amend section 2.04 without consent, so we’ll add a new section 2.05”) is likely to result in objections from the non-consenting lenders – and rightfully so.  Finding alternative types of amendments that can properly be made, and other substantive provisions to amend, is a safer course.

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