The Developer Handbook - Project finance and Facility Agreements
Financing development projects has become much harder. What are the key fundamentals that a financier will look for in the current climate?
The principal document in many lending structures is the Facility Agreement. They are usually lengthy, detailed and complex documents. Understanding the key issues in a Facility Agreement is crucial as this is the rule book that governs how and when finance will be provided and, in turn, when a financier may withdraw or suspend that finance. Key issues we have encountered when negotiating those documents with financiers are set out below.
Cashflow is king and management of project costs is critical. In a typical construction loan facility, the agreed facility limit set aside to meet the construction and other agreed funding costs is drawn down on a progressive cost to complete basis. The financier will only fund on receipt of a certified progress claim making sure that there are always sufficient undrawn commitment to fund agreed project costs.
Any project costs which are not approved are deemed to be a cost overrun which must be funded by the developer from their own resources and are not guaranteed to have recourse to the contingency cost category.
Financiers recognise that due to the size of construction debt, many developers are not in a position to make monthly payments to service interest accruing on the progressive drawdowns. Most construction facilities have a prepaid interest reserve which the financier allocates each month towards accruing interest calculated for the term of the facility.
Be aware that, if a project is delayed and the facility expires, then typically a developer will be required to service interest on the facility from its own resources.
Conditions Precedent to Draw Down
When the terms of a facility agreement have been agreed with a financier, it will contain conditions precedent to draw down of funds. In our experience, the list of conditions precedent is growing and it can take at least 6 weeks to adequately satisfy the conditions to enable funding to be drawn down. Give yourself plenty of time.
If senior debt is being procured, negative pledge covenants will be required whereby the developer/borrower/project sponsors covenant that they will not obtain any additional debt associated with the project nor create any subsequent encumbrances over the project. In this way the senior financier may constrain a developers ability to procure mezzanine or subordinated debt. Planning the funding structure at the outset of a project is critical in the current climate to consider how these types of undertakings can be managed.
The agreed facility agreement terms will set out all security that a developer is required to provide. The more complex the project and the more parties involved in the project, then the more complex the security structure will be. Such security often includes:
- Mortgage - typical security for a lending transaction will involve the land owner (if it is not also the developer) providing a first mortgage.
- General Security Deed - in addition a general security deed will also be taken from all corporate parties involved in the transaction to include all assets and intellectual property rights associated with the project not directly related to the land component such as benefit of presales, planning permits, building approvals and intellectual property associated with the architectural design.
- Guarantees and indemnities from all obligor parties who are not the borrower.
- Builder’s side deed - the builder and the financier will need to agree what happens if a developer defaults. The financier will want the right to step in to keep construction going.
- Subordination deeds against existing directors or shareholder/sponsor loans. They will be made subject to the senior debt.
- Mortgage of shares from the shareholders in the borrower/land owner entities.
Event of default
A financier will want to ensure that the facility agreement clearly specifies when a developer is in default, so it can suspend or terminate the facility, or step in and take over the project.
The facility agreement will contain an expansive list of events of default, ranging from a monetary default, to insolvency and breach of project related covenants.
A developer should pay careful attention to the listed events of default. It is the project related events which can create the greater difficulty to avoid because they are subject to events or circumstances beyond the control of the developer. For example, default by the builder, cost overruns, latent site conditions or delays in achieving the practical completion milestone dates can all impact on the maturity date of the facility and sunset dates of pre-sale contracts.
If any circumstances exist which could lead to a potential event of default, the financier should be notified at the earliest opportunity together with submitting a detailed plan in respect to how the potential default can be remedied. Usually, financiers will agree to work closely with the parties to remedy the default and to restore the project timetable to ensure the project is completed in a timely manner.
iaWe dive deeper into project funding issues in the Developer’s Handbook, including looking at APRA liquidity requirements and how that affects banks and non-banks, as well as the cornerstone of many residential project finance requirements – pre-sales and the ever moving target of what constitutes a qualifying pre-sale.
The Developer Handbook will be released later this year. In the meantime, stay tuned for our next extract where we look at key issues when negotiating Facility Agreements with financiers.
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