Derek,
We have completed our initial review of the term sheet issued by Pinnacle Atlantic Capital, LLC ("PAC"), dated November 14, 2022, for the proposed $160,000,000 first mortgage refinancing of the Coral Palms Grand Resort & Spa, Key Largo, Florida. Our detailed comments are attached as a redlined/annotated memorandum (see attachment), but I wanted to use this email to highlight the key issues and flag the areas where we need VHG's input and direction before we respond to PAC or its counsel, Whitford Baines & Driscoll LLP.
There is quite a bit to cover, so I've organized the discussion by topic below.
**A. Loan Sizing and Valuation Conditions**
The term sheet provides for a loan amount of $160,000,000, subject to two sizing constraints:
1. **Maximum LTV of 68.0%**, based on the lender's appraised value (not VHG's internal valuation); and 2. **Minimum debt yield of 9.5%**, based on trailing 12-month NOI.
A few observations here. At VHG's internal valuation of $235,000,000, the LTV works out to approximately 68.09% — marginally above the 68.0% cap. This means VHG's own projection only barely supports the requested loan amount. If PAC's appraisal comes in below $235,000,000 (specifically below approximately $235,294,000), the loan would be sized down accordingly. We recommend discussing with PAC whether there is any flexibility on the LTV cap, or whether PAC would agree to waive at the 68.09% level based on VHG's projected value, with final sizing subject to the appraisal.
On the debt yield side, at the property's T-12 NOI of $18,400,000 and a $160,000,000 loan, the debt yield comes to 11.50%, which comfortably exceeds the 9.5% minimum. This metric is not a concern at current operating levels.
One additional point: the appraisal will be commissioned and controlled by PAC, and the borrower will have limited ability to influence the appraiser's conclusions. VHG may want to consider engaging its own valuation consultant to prepare a pre-appraisal analysis, both to pressure-test expectations and to have supporting data in hand if the lender's appraisal comes in below target.
**B. Interest Rate and Amortization**
The term sheet provides for a fixed rate of 5.35% per annum for a 5-year term, based on an interpolated U.S. Treasury rate plus a 175 basis point spread as of the term sheet date. The structure is interest-only for years 1–2, with a 30-year amortization schedule commencing in year 3.
The rate will presumably be subject to a rate lock mechanism. The term sheet references a rate lock deposit but the details are sparse. We recommend negotiating clear rate lock mechanics in the commitment letter, including the lock period, break provisions, and conditions under which the deposit is refundable.
**C. Deposits and Fees**
This is an area where VHG should focus carefully on its pre-closing exposure:
- **Good faith deposit:** $1,600,000 (1.0% of loan amount), to be deposited with an escrow agent upon execution of the commitment letter. The term sheet indicates the deposit is non-refundable upon borrower's default or voluntary termination, but is silent on refundability if the lender fails to close or materially modifies the commitment terms. We recommend negotiating express refundability conditions — particularly if the lender reprices or restructures the loan due to an appraisal shortfall, or fails to satisfy its own conditions precedent.
- **Rate lock deposit:** $800,000 (0.50% of loan amount). Terms to be addressed in the commitment letter; the term sheet is thin on mechanics. We recommend a side letter or commitment letter provision detailing the lock period, refundability, and application of the deposit at closing.
- **Commitment fee:** 0.50% of loan amount ($800,000), payable at closing. This is standard for a facility of this type and does not raise immediate concern, though we should confirm it is not payable if closing does not occur.
- **Exit fee:** 0.25% of outstanding principal at repayment. This is somewhat unusual for a stabilized hospitality loan. We recommend pushing back on this or, at a minimum, negotiating a cap.
In total, VHG's **upfront deposits at risk pre-closing amount to $2,400,000** ($1,600,000 + $800,000). I want to make sure VHG's team is aware of this exposure as you evaluate the term sheet.
**D. Guaranty Structure**
The term sheet contemplates a limited recourse / "bad boy" carve-out guaranty to be provided by Verimark Hospitality Group Inc. as parent guarantor. The listed carve-out events are largely standard — fraud, intentional misrepresentation, misapplication of funds, voluntary bankruptcy, prohibited transfers, and environmental violations — but the term sheet also references springing full recourse triggers. We will need to see the detailed guaranty language in the commitment letter and loan documents; the scope of carve-outs and springing recourse triggers is always heavily negotiated in these transactions.
We recommend confirming with VHG's management and Natasha Ricard whether the guaranty structure is acceptable at the term sheet stage. These provisions become significantly more difficult to negotiate down once the commitment letter is executed.
**E. Extension Options**
The term sheet provides for two 1-year extension options, subject to the following conditions:
- No event of default; - DSCR ≥ 1.25x at the time of extension; and - Extension fee of 0.25% per extension.
The DSCR threshold is reasonable given current levels (DSCR of approximately 2.15x on an interest-only basis at original terms), but should be monitored if the property's NOI fluctuates. We recommend confirming the DSCR test methodology — specifically, whether it is based on trailing 12-month actual NOI versus projected NOI, and whether debt service is calculated on an in-place basis versus a hypothetical amortizing basis.
**F. Prepayment / Defeasance**
The term sheet references prepayment restrictions but does not specify yield maintenance, defeasance, or lockout details. This is a critical economic term that needs to be fleshed out before execution. We recommend that VHG confirm its expected hold period and exit strategy for the property so that we can negotiate appropriate prepayment flexibility in the commitment letter.
**G. Cash Management / Lockbox**
The term sheet contemplates a hard lockbox with a springing cash sweep upon the occurrence of trigger events, which are undefined at the term sheet stage. A hard lockbox with springing cash sweep is aggressive for a stabilized, performing asset of this caliber. We recommend negotiating for a soft lockbox / soft cash sweep structure with clearly defined, limited trigger events and borrower cure rights.
**H. Reserves**
The term sheet requires upfront reserves of $4,800,000 for tax, insurance, FF&E, and capital reserves, but the specific allocation among these categories is not detailed. We recommend requesting a breakdown and confirming that the reserve amounts reflect VHG's actual current obligations. In particular, given the recently completed $47,000,000 renovation (completed August 2021), the near-term capital expenditure requirements for the property should be reduced, and the reserve structure should reflect that.
**I. Lender's Counsel Fees**
The borrower is responsible for lender's counsel fees, capped at $275,000 plus disbursements. Lender's counsel is Whitford Baines & Driscoll LLP (Philip Tarrant Corporation, Partner). The cap is within market range for a transaction of this size, though disbursements can add up. We recommend confirming that the cap is inclusive of any modifications or amendments negotiated prior to closing.
**J. Existing Tidewater Loan — Prepayment Timing**
I want to flag a timing consideration related to the existing Tidewater National Bank loan. The current outstanding balance is approximately $118,500,000 at SOFR + 2.25%, maturing June 1, 2024. The existing loan carries a 1.0% prepayment premium if prepaid before March 1, 2023, which would amount to approximately $1,185,000. If the refinancing can close on or after March 1, 2023, the prepayment premium drops to zero — saving VHG $1,185,000. We recommend that VHG factor this into the target closing timeline. Our separate review of the existing Tidewater loan documents is underway, and we will circulate our findings shortly.
**K. Governing Law**
The term sheet specifies Florida governing law, which is appropriate given the property's location in Monroe County, Florida. No concerns here.
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**Next Steps**
We would like to schedule a call with you early next week — ideally with Natasha joining if her schedule permits — to discuss VHG's positions on the key issues outlined above before we prepare formal comments for submission to PAC and Whitford Baines & Driscoll. Douglas is available to join the call and discuss any items at the partner level as needed.
In the meantime, we would appreciate your direction on one threshold question: is VHG prepared to sign the term sheet in its current form, or does VHG wish to propose modifications to PAC before execution? Our recommendation would be to address at least the items in Sections C (deposit refundability), D (guaranty scope), F (prepayment), and G (lockbox) at the term sheet stage, but we are happy to discuss the best approach on the call.
Please let me know what times work on your end and we will get something on the calendar.
Best regards,
Grace Nakamura Senior Associate Calderwood & Harkness LLP 100 Southeast Second Street, Suite 3800 Miami, FL 33131 Direct: (305) 814-2260 gnakamura@calderwoodharkness.com
Attachment: C&H Comments — PAC Term Sheet (Nov. 14, 2022) — Marked.pdf
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