In the world of commercial real estate, financing plays a crucial role in transactions. Most of these transactions involve financing through debt, which is usually sourced from banks or non-bank lenders. These lenders provide capital in exchange for certain guarantees and covenants from the borrower. In many cases, they require a first-position mortgage on the property securing the loan, along with compliance to specific debt coverage ratios or loan-to-value metrics.
A key aspect lenders assess is the personal guarantee from the borrowers or sponsors involved in the transaction. This guarantee signifies that should the primary means of repaying the loan fail, the lender has the right to pursue the borrower’s personal assets.
What is a Personal Guarantee?
In a commercial real estate deal, lenders typically evaluate three sources of repayment:
- Primary Source: Cash flow generated from the property itself.
- Secondary Source: The sale of the property in case of default.
- Tertiary Source: The personal guarantee from borrowers.
The lender’s process begins by analyzing the cash flow of the property to ensure it can cover loan payments. If that fails, they will consider selling the property. However, should the sale proceeds be insufficient to cover the loan balance, the lender can enforce the personal guarantee, compelling sponsors to settle outstanding debts out of their own pockets.
For instance, consider a scenario where a borrower defaults on a loan amounting to $1,000,000. If the lender forecloses and sells the property for only $900,000, the borrower is still liable for the remaining $100,000. Thus, the lender can invoke the personal guarantee to ensure repayment of the deficit.
Evaluating Sponsor Financial Strength – The Personal Financial Statement
To aid their evaluation, lenders require each guarantor to complete a Personal Financial Statement (PFS). This document acts as an individual balance sheet, recording the income, assets, and liabilities of the guarantor.
While the specific format of a PFS may differ between lenders, certain information remains universally required:
Personal Information
The introductory section includes essential personal details about the guarantor(s), such as:
- Name
- Address
- Duration of residence
- Ownership status of their primary residence
- Driver’s license information
- Employment details (employer, title, tenure)
The purpose of this information is to confirm the identity of the guarantor and validate the credit report fetching.
Assets & Liabilities
This segment is crucial for any Personal Financial Statement as it details the individual’s assets against their liabilities. Key considerations here include:
- Liquidity: This includes cash, savings, mutual funds, marketable securities, and any assets that can be quickly converted to cash. Lenders generally look for liquidity to be at least 10% of the loan amount. For instance, a $1,000,000 loan would necessitate $100,000 in liquidity.
- Total Assets: This section encompasses both liquid and non-liquid assets, such as properties, retirements accounts, and collectibles. Lenders tend to treat the listed values cautiously, as many borrowers might overstate their worth.
- Liabilities: These divide into short-term and long-term. Short-term liabilities, due in under 12 months, include credit debts while long-term liabilities extend beyond that period, covering mortgages and car loans.
- Contingent Liabilities: Often overlooked, these indicate other obligations that the guarantor has guaranteed. They can impact the lender’s assessment of the individual’s financial reliability.
Income / Expenses
This section of the PFS outlines the individual’s income sources against their expenses. Lenders analyze not just gross income but net income, distinguishing individuals who may have high salaries yet face equally high expenditure.
Typical income streams include wages, interest, and dividends, while expenses encompass regular cost requirements and debt responsibilities.
Other Information
The PFS might also incorporate an “other information” section prompting recent financial history questions, including:
- Have you ever declared bankruptcy?
- Are your assets pledged elsewhere?
- Do you have a will?
- Are your tax returns under audit?
- Do you have past due tax obligations?
Each affirmative answer may lead to further scrutiny by the lender, especially in high-risk situations.
Summary & Conclusions
A Personal Financial Statement is a critical component in the commercial loan approval process. It provides lenders with a comprehensive view of each guarantor’s financial health, highlighting their income, assets, and liabilities effectively. By analyzing this information, lenders assess how strong the loan request is, especially when it comes to the tertiary source of repayment.
Ultimately, a strong PFS can significantly enhance the likelihood of loan approval, reflecting the guarantor’s financial capability. In contrast, a negative net worth could lead to rejection of the loan request, emphasizing the importance of maintaining robust financial health for potential borrowers working in commercial real estate.
Disclaimer: While this article presents a detailed understanding of personal financial statements in commercial lending, each transaction’s individual context will always substantially influence outcomes and available financing options.
