Monday, September 19, 2011
When a Commitment May Not Be a Commitment
SEPTEMBER 16, 2011 BY GEORGE LOVATO JR
This prospect story is worth telling you about. One of BH Capital Ltd’s 25 affiliates made arrangements for a conference call. These calls are designed to more fully investigate the prospects’ opportunity and usually a chance for the prospect to convince me to take him on as a client. At this point we have usually reviewed a mountain of documentation. We have a pretty good idea of what the project holds. We just want to hear from the horse’s mouth the finer details of the project/engagement and what kind of financing structure the prospect has in mind. This was a real head turner.
Commitment Letter? Foreign Bank?
The prospect pontificated for about twenty minutes when he made a U-turn. He said he had been talking to a foreign bank and that they were willing to issue a commitment letter for long term financing. All I needed to do was lend him money for six months to build a power plant. Six months? Power plant? Commitment letter? Well he mentioned the name of the institution and where it was located…a half a world away. I said that I was not familiar with the bank and that the commitment letter, although it may be real, I could not count on it. He became argumentative and said it is the Bank of America of… I responded and said that that may be true but as the lender taking the biggest risk, and the lender having to rely on a bank I have never heard of, that I felt there was another way to meet his needs without the reliance of the third party. I went on to say that there were a couple of dozen American banks that I would not accept a commitment letter from now for various reasons. Basically he said he wanted to do it his way or no way at all and then he promptly hung up.
Banks Unable to Honor Their Commitment
Over my thirty years in structured finance I cannot tell you how many times I have been on the short end of the commitment letter. In my book The Obstacle Course I told a story of how a banker welched on his commitment. It has happened time and time again. I have seen banks unable and or unwilling to honor their commitments literally dozens of times. Sometimes the bank was financially incapable of funding as prescribed. In other cases they just changed their mind for no good reason. In yet other cases the internal consensus of a transaction shifted and they just pull out and leave you in the breach right at the closing table. After some research the picture was very clear. The prospect was naive and convinced with his own BS that this was a real bank with real capability. After some research the picture of the bank was quite different than he knew.
The bank was facing huge current losses. Their recent attempt to float new equity had failed. Even more recent their attempt to float new debt had failed. They were facing huge projected losses because they had acquired companies that were bleeding at a very rapid rate. In short they were in very poor condition and on top of that fact they had no experience in the energy field. They were just another bank on my list that I would not deal with.
Behind Commitment Letters Are People
So many people think a commitment letter will solve everything. It is the Holy Grail to completing andy kind of project. Frankly it is not. Behind commitment letters are people. Sometimes those people do not do what they say. Also things change and so goes the commitment letter. Banks just like businesses can fall the way of Lehman Brothers. They can fail too. And with the failure so goes the outstanding commitments that the bank has made.
The Deal is Closed When the Cash Shows Up
The rule for commitment letters is who is behind it? Do they honor their commitments and do they have experience in the area the project is situated? Look at who and what is behind this Holy Grail of letters. Remember the deal is closed when the cash shows up. A commitment letter is only a piece of paper.