More banks fall into gap

NEW YORK — Call it the gap loan rush of 1997. Convinced that there’s gold in them thar hills, banks and investment firms are eagerly lending money to independent film producers on the promise of future sales.

Paribas, Imperial Bank, Sumitomo, Comerica, Banque Francaise du Commerce Exterieur and Newmarket Capital Group are among the lenders offering to help producers close the gap between the collateral they have in hand and the size of their budget. These financial institutions are attracted by lucrative fees ranging between 5% and 10%, but they also view gap financing as a tool to lure clients away from competitors and develop new relationships.

“In the last year, several banks have entered the production loan arena because they have seen that it’s good business,” says Lew Horwitz, who runs a boutique within Imperial Bank bearing his name. “But they lack the experience of going through the problems with gap loans. You never learn anything when everything goes well.”

There are no figures available on the size of the gap finance market, but banks confirm that they are increasing their activity in this area. Horwitz made 23 gap loans through the end of May, compared with 31 for all of 1996 and 29 for the previous year.

Anatomy of a loan

In a typical gap loan, the producer of an $8 million project has pre-sold $6 million in distribution contracts. If a reputable sales agent reckons that the pic will bring in another $4 million in foreign sales, his bank will usually lend him the $2 million he needs to begin lensing. Under this scenario, the gap being covered represents 25% of the budget.

The arrival of aggressive newcomers combined with the desire of established players to protect their turf is leading some lenders to relax their standards. The gaps covered by bank loans have risen to as high as 80% from levels of between 20% and 30% two years ago. “People are pushing the gaps wider and wider,” says Stephen Mras, vice president of Sumitomo Bank. “Pretty soon one of them will break.”

Market players say intensified competition between two arms of Imperial Bank — the Horwitz Organization, which is being spun off, and the bank’s in-house entertainment lending group led by Morgan Rector — is also heating up the market. “Those two used to have a gentlemen’s agreement, but now the gloves are off,” says a competitor who asked to remain unidentified.

“There’s a shakeout coming in the market,” says one lender who asked to remain unidentified. “People are being very aggressive. New people are taking on risks that they don’t fully understand. There are any number of ways to get burned.”

Banks and others making gap loans have played a crucial role in the growth of independent companies represented by the American Film Marketing Assn., which registered a 21% gain in exports last year to $1.7 billion. If an overheated market ultimately leads to casualties in the banking community, independent producers will suffer because their ability to obtain financing will be hindered.

While offshore banks have been making gap loans for a decade or more, Los Angeles-based lenders joined the game in earnest about four years ago. Horwitz and Michael Mendelsohn, group portfolio manager for the entertainment finance group of the French bank Paribas, are considered to be the Stateside trailblazers in gap financing.

“There was almost no gapping going on from 1988 to 1993 because there was a healthy pre-sales market,” says attorney Jeffrey Konvitz, the former president of Kings Road Entertainment. “What started to happen was that companies that bought on pre-sales got burned. The foreign buyers wanted to see trailers and preview reels. The banks started to see that with the right database and the right foreign clients, gapping wasn’t as dangerous as they thought.”

While gap lending originated as a way to facilitate foreign sales, more lenders are now willing to do business with producers shopping for U.S. distribution. Making a gap loan without a domestic sale generally carries more risk because the dominance of the Hollywood studios limits the market for independently produced films. This makes the U.S. more difficult to handicap than foreign territories such as Germany or Japan.

The frenzied competition in the gap loan business takes some industryites back to the financial excesses of the mid-1980s, the halcyon era of entertainment industry lender Credit Lyonnais. “When you ride the subway in London, you’re told to ‘Mind the gap.’ I think some bankers need to hear that message,” says James Schamus, who runs the Gotham independent production company Good Machine with Ted Hope. “This is starting to look like the junk bond market.”

Some question whether banks should be making gap loans at all. “I don’t think gap financing is an appropriate activity for a commercial bank. It’s unsecured lending and often the risks you’re asked to take go beyond those associated with a regulated financial institution,” says Jon Ein of Foundry Film Partners, an investment fund that acts as an equity partner in larger gap deals.

Others dismiss this skepticism, claiming that the experience that lenders have gained during the last few years has prepared them to take on greater risk. “It’s a general maturing of the banking business. They’ve been able to learn more about the foreign marketplace by meeting the distributors and spending more time with the sales agents,” says Robbie Little, co-chairman and co-CEO of Overseas Film Group.

Any bank that wants to compete in the gap loan market must analyze creative elements such as genre, script and talent in addition to financial data, says Mendelsohn of Paribas. “We have seven readers, two execs to manage the scripts coming in and three loan officers analyzing distribution,” he says. “Through my company Patriot Pictures and subcontractors, Paribas has access to production and sales capability.”

Self-protection

Paribas isn’t trying to compete with Hollywood’s sales agents or tenpercenteries, says Mendelsohn. In addition to supporting independent filmmakers within a studio environment, the bank is protecting itself against what he calls the “doomsday scenario” — when it must sell a film itself because the sales agent couldn’t do the job.

Doomsday may never come to pass, but one thing is certain. As more banks move into gap financing, they will put pressure on the margins in this business, making it less profitable for all market participants. Lenders who don’t want to downgrade their credit standards will be forced to compete on the basis of price.

Inevitably, some of the banks who stake their claim in the gap loan market will leave town empty-handed. “This is a cyclical business,” says Mendelsohn. “Periodically we have banks that come in and out of the entertainment lending business. They transfer the guy from Minneapolis who used to handle farm equipment loans out to Hollywood. When things don’t work out, he goes back home.”

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