Syndicated Lenders Turning to "Flex Pricing'
In the wake of market volatility, some banks have started building protections into loan terms in case syndications run into trouble.
Under so-called “flex pricing,” a lead bank that commits to fund a mortgage reserves the right to increase the spread by a prescribed amount — typically 10-50 bp — if necessary to line up enough syndicate partners. The aim is to prevent the lead bank from being stuck with a larger portion of the loan than it wants.
The provision, while commonly used in corporate-loan syndications, hasn’t been employed for commercial mortgages to any degree since the market crash almost 10 years ago. “In theory, most banks reserve the right to flex,” said one lender. “But the reality is, in good markets banks will remove that from their term-sheet language. And even if it’s in the term-sheet language, it’s not likely to be used.”
But the recent spike in loan spreads has prompted at least a few lenders to reinstitute the practice — and has led many others to consider doing so.
“It’s happening more now because people can’t figure out what it’s going to take to clear the [syndication] market,” said one lender. Added another: “I’d be shocked if you don’t hear more of it.”
While one veteran originator said the practice still is uncommon, he likened it to fare increases among competing airlines: “Once one starts, everybody starts,” he said.
Here’s an example of how the process can work: A borrower signs a term sheet for a $300 million loan pegged to 200 bp over Libor. The lead bank plans to retain half the balance and syndicate the rest. The lender then begins assessing the demand from potential syndicate partners. If enough interest can’t be drummed up at the 200-bp spread, the bank has the right to increase it by 25 bp. The option is generally exercised before the loan closes, but theoretically could take place after the closing.
Banks usually have to provide good-faith evidence that the original spread didn’t generate enough demand, such as the identities of banks that passed up the offer and even the names of specific lending officers approached. “You have to go through a long list of banks that have turned it down because it was priced too tightly,” a syndication pro said.
While borrowers, of course, aren’t happy to see their spreads increase, lenders contend that backlash has been mitigated because the current market dislocation has been so highly publicized. “Clients are aware that there’s a change in appetite for certain asset classes, and a substantial downtick in the market,” said one lender.
Syndicators of corporate loans have traditionally had much more flexibility to adjust loan terms, including spreads, leverage ratios and covenants. But real estate syndications, by contrast, have largely steered clear of the practice in recent years. Indeed, when the market is strong and competition for mortgages is fierce, the inclusion of flex-pricing provisions can be a competitive disadvantage. “No one wants to burden their term sheet with a term that’s going to lose them the deal,” said another syndication pro.