Do You Pari Passu?October 01, 2010
Rick Parmelee, CPA
It's a question that could lead to the financing answer that works best for you or your company.
"Pari passu" is Latin for "equal rate" and, while it is the type of loan arrangement with which many banks and lenders might not be overly familiar, it could open the door to opportunity to those willing to pursue it when seeking a favorable mortgage.
Generally speaking, credit remains tight for most businesses in the United States today, with the issue for many lenders being lack of available capital (customer creditworthiness). Many companies experienced losses or downturns in profitability during 2009, and, as a result, obtaining financing is much more challenging now. This is due to the fact that companies are unable to meet the cash flows and ratio requirements that many lenders currently seek based upon their 2009 financial statements. Additionally, further compounding the lending problem is the fact that banks do not want to be overexposed to certain industries that they deem risky.
We recently worked through such a scenario and found a surprising answer to a client's mortgage dilemma: the pari passu option through the Small Business Administration (SBA).
Here's how it worked.
For many mid-sized businesses, SBA loan programs never used to be practical. However, as a result of the current economic downturn, the Obama administration has raised many of the loan limits and eliminated the fees that SBA normally charges, making the SBA a viable solution to businesses who never may have considered SBA in the past.
In this particular case, a domestic automobile dealership client sought to refinance its $4 million mortgage. Initially banks were approached about a conventional commercial mortgage but, after experiencing a challenging 2009 and being deemed to operate in a risky industry, banks were unwilling to provide this dealership with a conventional mortgage.
We next inquired about an SBA mortgage. The SBA's most popular loan programs are the 7(a) and the 504. The 7(a) program offers mortgages on original owner-occupied real estate purchases up to $5 million but, since our client was refinancing, their option had to be a 504 program loan. Unfortunately, the SBA guarantees $1.5 million of a maximum $2 million loan in the 504 loan program, and the loan can be used to refinance existing debt. So at first glance our client had reached another dead end as this did not meet their $4 million mortgage requirement.
This is where pari passu came in – banks are allowed to pari passu mortgage debt with the SBA. In this kind of arrangement, the SBA assumes a maximum risk of $1.5 million of the first $2 million of the mortgage under the 504 program. The bank then assumes the remainder of the risk and, while both parties have a first lien position on the property, the bank's mortgage is not in a second position to the SBA. In this scenario, the bank mitigates almost half of its risk, making the mortgage more attractive from a risk-tolerance point of view. With the elimination of the SBA fees, this type of mortgage became even more attractive to our client from a cost perspective.
The pari passu option is not often discussed or even well-known in banking circles; in fact, of the eight banks our client approached, only one was even vaguely aware of the concept. What's more, most lenders – even many SBA lenders – are not yet aware of the pari passu arrangement. However, one lender who was experienced with these types of transactions was able to put the deal together.
The moral of the story is to keep all options open and cast a wide net when reviewing financing options, as not all banks are created equal. You just may find that the pari passu option is one that works best for your mortgage loan.