Lets explore how to structure, manage and monitor a deal so that investors are afforded significant protection against fraud.
Rupy Cheema: The first question we ask when looking at an offering is what is the NCE’s industry knowledge and experience? When I conduct a site visit and meet the NCE management, I want to better understand the manager’s experience with underwriting a loan or investment.
Do they understand the industry and the market they are investing in? Do they have access to the market data they need to prepare cash-flow models? Do they have an investment committee that ultimately makes the investment decisions?
What conditions must be met prior to closing the loan? Will the Manager require that the project budget is final. Will they talk to multiple general contractors to determine if the budget being presented is accurate? Will they require a maximum price contract? Will they require a completion guarantee? Are they going to make sure that all the capital is contractually committed before they release the funds?
So understanding the NCE’s underwriting process is critical to a due diligence process.
Ronald Fieldstone: It's important to understand that in the EB-5 world there are generally three types of issuers. An independent new commercial enterprise; a regional center who also acts as the issuer; and the developer of the project acting as the issuer.
In the first two scenarios, Rupy’s comments are very much applicable, but it is more complicated when the developer of the project is acting as the issuer (the fiduciary of the EB-5 investors). When you have a regional center that is the issuer, the regional center may or may not be independent of the developer. If it's independent, then it should be doing the underwriting Rupy's suggesting.
In some cases, the agent is in effect the issuer, because they're the one driving the bus and they're the one organizing the team and directing traffic.
In a loan model, a lot of the focus is on immigration issues, on securities issues and on making sure the offerings are done right, are marketed right, and comply with the law. Even if everything is prepared correctly, I think we realize given some of the problems that have been encountered recently, there may not be any proper administration of the use of the funds.
At the end of the day, the question is who's policing the money? If you're dealing with a third-party lender such as a bank or an institution, they will monitor the money very carefully because they're heavily regulated.
One of the big issues or problems I've seen in the industry is when the offering documents are done and the package goes to market, but the actual loan terms have not been finalized. In my recent experience the agents are starting to demand that loan documents be prepared and circulated along with offering documents.
I've been involved in a handful of transactions where the money was raised and went into escrow and was ready to be lent, but the loan terms were not yet negotiated. There was just a basic overview such as this is the interest rate, this is the term, etc. No detailed loan terms were actually negotiated.
Now you get to the table and we're negotiating loan terms and the NCE manager (assuming they're independent) and agents, don't have a lot of leverage when the money is already in the account, the investors have funded and filed their I-526s. Many times the investors are approved and now they’ve got a problem with the borrower, who is making it very difficult to get the loan documents done in a satisfactory way to the investors. There needs to be a major focus on getting the loan terms and the details done well in advance to avoid a disconnect down the road.
Rupy Cheema: In my experience it is typical to see a one or two-page loan term sheet that has been negotiated before the project goes to market.
Ronald Fieldstone: I think that the loan term sheet is a necessity, however many times a loan term sheet does not deal with issues like inter-creditor agreements or subordination. It doesn’t delve into questions such as: Will the EB-5 lender agree to a complete standstill on exercising his collateral rights if there's a foreclosure?
If there's a bankruptcy filed by the developer, and you have a senior lender, sometimes the senior lenders will block the junior lenders from taking any position in bankruptcy. Is there a completion guarantee and, if so, who is signing it? What types of reports are being provided and when are they being provided? What happens if the developer is out of budget in developing the project? Does the lending stop and does the developer put in more equity, like a normal lender would do?
These are the types of issues that are addressed in a loan agreement that generally are not addressed in a term sheet.
Robert Cornish: One of the things that I see in loan documents is that someone has created a boilerplate loan document and it has no synergy whatsoever with the PPM. In this case you end up having different conflicts of law issues, different choice of law issues, different forum issues, etc.
In terms of enforcing remedies and dealing with defaults and other matters, having an inconsistent loan document can create enormous headaches for everybody in the deal.
Ronald Fieldstone: To go a step further we need to ask who's administering and where is the independence because in many case the developer is the manager or the developer owns the regional center? Therefore, there's a need in the marketplace for independence and individuals or organizations willing to accept the responsibility of independently overseeing all aspects of a loan, from ensuring the loan documents are executed to ensuring that the loan is properly closed and administered, with appropriate remedies taken as needed.
Kurt Reuss: While many developers have acted as the Manager of the NCE in the past, it seems to me that it's time for our industry to move beyond putting the developer in a position of managing and being the fiduciary responsible for the investors' interests.
Robert Cornish: That's correct, and a little bit of a historical backdrop is necessary to explain why developers serving as the loan manager is problematic.
From the 2008 financial crisis we saw the downfall of various hedge funds. These were funds that were not only using modest accounting firms for audit purposes, but a lot of these funds were self-administered.
The reason that the financial crisis is important to this issue is that now fund administration is the norm rather than the exception with institutional investors. Institutional investors will generally not deal with alternative asset managers that do not have a third-party fund administrator. There may well be a handful of funds out there that still do it, but for those managers that are going to be raising money from institutions, endowments, foundations, sovereign funds, etc., third-party administration is an absolute necessity.
Fund administrators perform in various ways, simply looking at the cash flows, in and out, providing financial statements and account values to investors, engaging with auditors, handling the in-flow and out-flow of investments and being the gatekeeper for the managers.
Kurt Reuss: As a representative for EB-5 investors, I concur. I would be hard-pressed to imagine a deal that I would feel completely comfortable with where the developer was responsible for looking after the best interests of the limited partners.