Small market, big problems

It’s a bifurcated market.

At least that’s what sources tell Private Debt Investor. On the one hand, sponsors backing large-cap projects face a market that is awash with liquidity. Investor demand for yield has outpaced potential concerns for credit risk, and that demand has enabled non-traditional lenders to pursue ample opportunities in large or mid-market deals.

Unfortunately, the favourable market conditions that characterise large cap transactions have not permeated into the small or lower mid-markets. This has created problems for agents and sponsors seeking financing for small cap deals. This was certainly the case for Grekan Hospitality, which recently announced the closing of a $5.59 million loan to facilitate the construction of a Candlewood Suites hotel in the West Central Texas city of San Angelo.

In order to pursue financing for the project, Grekan contacted Pioneer Realty, an Arlington, Texas-based commercial real estate firm that specialises in matching real estate asset managers with banks and non-traditional lenders. After locking down an exclusive arrangement with the company in November 2012, Pioneer approached The Bank of San Angelo, a branch of The First National Bank of Ballinger, to see if the bank would approve a loan for the hotel’s construction, estimated at $6 million, explained Pioneer managing director Charles Williams.

“The Bank of San Angelo had a lot of cash,” he told Private Debt Investor. “Ideally when you’re in a small market and someone’s building a hotel in your market. The question’s going to be: ‘Why aren’t we doing this deal?”

Unfortunately, the hotel site’s proximity to the cash-rich local bank failed to elicit the enthusiastic response Williams and Grekan had anticipated. The bank’s loan committee declined the deal in March 2013, citing the size of the loan and discomfort with managing the hotel’s financing during its construction.   

“We did turn it down. Taking on a big project that’s $6 million [in size] gave us a bit of heartburn,” the bank’s vice president of lending Deborah Summers said.

The bank’s decision put Pioneer and Grekan in a difficult position. Finding a loan to cover the full cost of construction and subsequent financing would be difficult without the participation of a bank and, given its available capital and locale, The Bank of San Angelo had appeared to be best suited for the deal.

Shortly after the loan was turned down, Williams asked Summers what steps could be taken to convince the bank to take on Grekan’s Candlewood Suites project.

“They didn’t have the staff to manage a commercial construction project,” he said, adding the problems that arise over the course of a project’s construction are riskiest components to this kind of financing. Even so, “These hotels [make] a ton of money. I needed to understand why they weren’t willing to do it.”

Summers agreed to resubmit the project to the loan committee on the condition that Williams find another partner to back the deal during the hotel’s construction. This would alleviate the bank’s concerns relating to construction risk while still providing Grekan the opportunity to work with a local participant for the hotel’s long-term financing.

Finding another partner to provide third party capital proved to be challenge in its own right. The first firm Williams tapped for a construction bridge loan dropped out of the deal, Williams explained. Eventually, Pioneer reached out to Lincoln Capital, which specialises in providing financing solutions in the US commercial real estate sector’s small to mid-market. 

“The Bank of San Angelo is a smaller, community based …  and they were having some issues taking on this large loan. And that’s basically what our product is typically, to work with a community or regional bank that needs help from a loan-to-value standpoint, or loan total, or are worried with construction risk,” said Alan Crawford of Lincoln Capital. “Our specialty is in construction lending.”

Lincoln agreed to step in to provide a second lien bridge loan equal to 35 percent of the project’s overall cost for up to 12 months, which would effectively finance the bulk of the hotel’s construction. Lincoln typically provides its financing through private equity style investment vehicles. Crawford did not specify what the firm used in the San Angelo deal.

Lincoln’s stake in the hotel’s capital structure would be taken out upon completion of construction, at which point project would be refinanced with US Small Business Administration (SBA) Section 504 insured financing made available by The North Texas Certified Development Corporation, said Crawford and Williams.

“We help shepherd the project throughout the construction … to keep everything in compliance with what the SBA needs,” Crawford said.  “When that comes through, a wire comes through and takes us out.”

“That becomes the borrowers permanent debt structure going forward.”

As the borrower, Grekan agreed to contribute 15 percent of the cost. The remaining financing came in the form of a $3.246 million first lien loan, which The Bank of San Angelo’s loan committee approved in June 2013.

Unfortunately, the SBA declined to insure the loan that would be provided by North Texas CDC unless Grekan agreed to increase its contribution to 20 percent. That delayed the transaction’s close by several months.

“[Grekan] was not happy about it, but they had to do what they had to do,” said Williams, adding that the company eventually acquiesced. “They had already provided equity for the land.”

The SBA authorized the transaction in August 2013. The deal closed shortly thereafter.

The inclusion of third party financing with an SBA refinancing proviso made the deal the first of its kind for The Bank of San Angelo, and should ease the process should any of the deal’s participants work with the bank in the future, Summers said. The bank’s loan committee has yet to raise any sort of concerns over the deal since it closed last year.

And despite whatever reservations the bank’s committee members may have had about Grekan’s ability to manage the Candlewood Suites’ construction at the outset, Lincoln Capital and Pioneer Realty’s performance on the transaction has assuaged them.

“Lincoln Capital – everyone who had worked with them said they were awesome. And to date, that’s what they’ve been,” said Summers. “I’d never done that type of loan before, and they made it very easy … I could take it to my director’s loan committee and help them understand it as well.”

Perhaps most importantly, the hotel’s construction appears to be moving along on schedule, added Williams.

“They’re about 70 percent done with the framing of the building. So they should have it [done] in a couple months,” he said. “They’re scheduled to open [on the] first of August.”