Richard Hamm, Principal, Advantage Consulting
advantagecons@bellsouth.net
or 256-503-5591
Bill Tryon, Director of Strategic Development, Partner
Engineering & Science Inc.
btryon@partneresi.com
or 415-599-1187
Dev Strischek, Senior Credit Policy Officer, SunTrust Bank
Agenda
Introductions
Panel Questions
1-Setting up a real estate construction unit (RECAD) in a bank
2-Frequent construction problem causes
3-effective tools in RECAD “preventive maintenance
4-RECAD’s place in the organization chart
5-RECAD for owner-occupied (O-O) vs. real estate developer-investor (REDI)
construction loans
6-RECAD training and skills
7-minimum size RECAD construction loan 8-RECAD and HV-CRE
Closing & Summary
Q&A with audience
1-Both of you have managed real estate construction administration
(RECAD) units in your banking careers. If you were asked to set up a
new RECAD unit, what would the first 2 or 3 actions you would take?
Richard Hamm
Bill Tryon
1-Assess the experience level of potential staff in terms of project types and sizes
2-Develop at least two levels of
monitoring intensity, based on portfolio size and the
inevitable 80/20 rule
3-Set-up “lunch & learn” sessions with key providers, such as title company and surveyor
1-Review the institution’s strategic plan
2-Assure separation of the unit from lending
3-Establish construction loan administration and
disbursement procedures
2-Each of you has seen your share of problem construction loans.
What have you experienced as the 2 or 3 most frequent causes of
problem construction loans?
Bill Tryon
Richard Hamm
1-Inadequate budgets,
frequently based on
preliminary plans
2-Unexpected conditions,
particularly relative to
subsurface and
environmental conditions
3-Lack of appropriate
mechanisms to control
discretionary changes
1-Lack of payment and
performance bond for
“material size level”
2-Admin staff in “checklist
mode”
3-Lack of inspections, both
random and in minimum
time intervals, regardless of a
draw request
3-What have you found to be your 2 or 3 most effective tools or
techniques in RECAD “preventive maintenance”?
Richard Hamm
Bill Tryon
1-More than a formula for testing interest reserve for “material” credits
2-Having at least two levels of monitoring so that common sense can be used for material credits
3-Having a clear way to report concerns to the line or credit team
1-Independent, critical evaluation before and during the loan
2-Proactive construction loan administration
3-On-going critical and informed project monitoring
4-How do you organize a RECAD department? To whom in the
organization do you think it should report?
Bill Tryon
Richard Hamm
How to organize
The specific organization is less critical than the capabilities and independence of staff. All staff should receive appropriate training and oversight.
Where to report
Reporting should be
independent of loan production, ideally to a senior credit officer
How to organize
It should be as independent as possible
At least a lending support
person that has “dotted line” to credit admin
Where to report
Report to chief credit officer, if possible
NEVER to the lenders
5- What do you view as the 2 or 3 significant differences in
administering construction loans for owner-occupied (O-O)
projects vs. real estate developer-investor (REDI) projects?
Richard Hamm
Bill Tryon
1-Customer wanting to be
his/her own GC
2-Not understanding that
change orders are hidden
profit for GC/subs
3-Unusual interior or exterior
finish/design that affects
market value of property
1-Tend to be less sophisticated
as developers, and more
prone to make discretionary
changes without regard for
budget. As a result they
require more oversight and
assistance to stay on track.
2-The property tends to be
more critical to their business
success, so may be less likely
to default.
See App E: Types of Commercial Construction Projects
6-What kind of training and skills do you look for in staffing a
RECAD department?
Bill Tryon
Richard Hamm
Training
Process, process, process
Legal requirements Construction management Skills Driven by details Critical thinking Understanding of big-picture risks Training
Not so much on credit issues
More on fundamentals of title policies, surveys, etc.
RMA course!!!!!! Skills
Organized
Not afraid to get clear answers from customer
7- A RECAD department is expensive to set up and operate. What 2
or 3 factors would you consider in calculating a minimum size
construction loan to be managed by RECAD?
Richard Hamm
Bill Tryon
1-CRE portfolio’s 80/20=rule
point
2-Loan system capabilities, or
existing automation of the
process
3-Bank size to enable an
independent function
[$750 million++??]
1-Bank strategy and risk
tolerance
2-Client and project type
3-Staffing constraints
4-Competetive practices
8-High Volatility CRE (HVCRE) puts a hefty 150% premium on
construction loans. What 2 or 3 actions would you suggest that RECAD
units take to minimize the impact of HVCRE on a bank’s capital?
Bill Tryon
Richard Hamm
1-Don’t deviate from exceptions
to HVCRE rules
Observe LTV requirements
Assure borrower contribution of > 15% of the as-completed value before advancing funds
Require borrower contributed capital to remain in the project until permanent funding.
1-Ensure accurate reporting of
actual loan outstandings on
loan system and management
reporting
2-Note where equity position of
project changes,
post-approval
3-Minimize any further
exceptions to policy
9-Any best practices you would like to share?
Richard Hamm
Bill Tryon
1.
RECAD field trips to
projects
2.
Approved contractor list
3.
Awareness of take-out
prerequisites
1.
Keep origination & control
function separate
2.
Develop scopes of work and
processes that reflect your
risk tolerance
3.
Don’t assume supervision
by syndication lead bank
satisfies your risk tolerance
Closing and Summary
Closing remarks
Setting up a RECAD unit
Frequent causes of construction problems
RECAD preventive maintenance tools
RECAD in organization chart
O-O vs REDI in RECAD
RECAD training & skills
Right size RECAD construction loan
RECAD and HV-CRE
Glossary
CRE = commercial real estate
HVCRE = High volatility CRE
O-O = owner-occupied
RE = real estate
RECAD = real estate credit administration
REDI = real estate developer/ investor
Resources and References
“Analyzing Construction Contractors,” RMA Course. See www.rmahq.orgfor details.
Ed Beasley, “Construction Lending in Recessionary Times,” RMA Journal, June 2009, pp. 13-15.
Joey Bonin, “Construction Lending Risk: Management That Knows No Bonds,” RMA Journal, June 2014, pp. 15-18.
“Construction Loan Management: Administering the Construction Loan Process,” RMA Course. See www.rmahq.orgfor details.
Frank DiLorenzo, “The Construction Loan Agreement: The Key to the Construction Loan Process, Part 1, RMA Journal, Nov 2006, pp. 58-60; “The Construction Loan Agreement: Use of Proceeds, Part 2,” RMA Journal, Dec 2006-Jan 2007, pp. 106-107; “The
Construction Loan Agreement: Safety in Clarity, Part 3” RMA Journal, Feb 2007, pp. 78-79.
Robert Fuhr and Keith Schlemlein, “Reduce Risk with Rigorous Construction Loan Inspection and Disbursement,” RMA Journal, Nov 2010, pp. 64-67.
Richard Hamm, “Construction Loan Administration: Managing Risk in Commercial Projects,” RMA Journal, April 2007, pp. 102-105.
Marla McIntyre and Dev Strischek, “Mitigating Real Estate Construction Risk: How Surety Bonds Protect Borrowers and Bankers,”
RMA Journal, November 2005, pp. 46-53.
Marla McIntyre and Dev Strischek, “Our Letters Are Not Their Bonds: The Difference between a Bank Letter of Credit and a Surety Bond, RMA Journal, February 2006, pp. 76-79.
OCC Commercial Real Estate Lending, August 2013, http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/cre.pdf
OCC Other Real Estate Owned, September 2013, http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/a-oreo.pdf
“Preventing Black Swans: Avoiding Major Project Failure,” www.KPMG.com, 2013.
Derek Pollard, “Who’s on First? You Are!” RMA Journal, May 2012, pp. 34-41.
“Policy Statement on Prudent Commercial Real Estate Loan Workouts,” OCC, October 30, 2009, http://www.occ.gov/news-issuances/bulletins/2009/bulletin-2009-128a.pdf
Marc Ramsey, “Surety Bond Producers and Underwriters Play Key Role in Construction,” RMA Journal, May 2009, pp. 42-51.
Bob Scales, “Close and Continuous Monitoring of Construction Projects Can Prevent Headaches for Lenders,” RMA Journal, Sept 2008, pp. 74-79.
Dev Strischek, Analyzing Construction Contractors, Third Edition, Risk Management Association: Philadelphia, 2004.
Appendices
App A: Causes of Project Failure
App B: Effective Techniques for Detecting Problems
App C: Four Steps of Construction Rsk Mgt
App D: Construction Risk Management Issues
App E: Types of Commercial Construction Projects
App F: Minimum Construction Loan Size
App G-1: Basel III’s HVCRE Rule
App A: Causes of Project Failure
Inadequate budgets
Contracts based on incomplete designs
Discretionary changes
Inadequate management of project revisions
Unforeseen conditions
Inexperienced project team members
Inadequate project oversight and coordination
Unrealistic schedules
Resource shortages
Completion delays
App B: Effective Techniques for Preventing Problems
Before the loan:
Critical review of construction documents
Reconciliation of plans with the appraisal, survey, geotechnical reports, zoning
approvals, etc.
Evaluation of the developer and contractor teams
Careful documentation of funding requirements
Verification of government approvals and availability of utilities
Require a completion bond or construction commitment
After the loan:
Utilize appropriate loan administration and disbursement controls
Insulate loan administration from the origination function
Independent critical assessment of construction progress and pay applications
Critical review of disbursement requests
Periodic attendance at job-site meetings Monitoring of lien status
Limited release of contingency funds ahead of the percentage of completion Active oversight by the development team
App C: Four Steps of Construction Rsk Mgt
Construction risk management
Definition
Elements
Four Steps in managing construction risk
Determine type of construction
Create construction loan agreement
Ensure permanent take-out loan is
in place to close out construction loan
Monitor and manage construction loan portfolio
App D: Construction Rsk Mgt Issues
Up to date construction risk management policy
Meeting internal demands for fast turnaround times
Balancing risk management
with pressure to stay competitive
Doing more with smaller staff
In-house vs. outsourced functions
App E: Types of Commercial Construction
Projects
New construction
Repairs
Deferred maintenance
Renovations and tenant
improvements
App F: Minimum Construction Loan Size
RECAD resources
Complexity of project
In-market vs. out of
market
App G-1: Basel III’s HVCRE Rule
Basics of Rule
HVCRE defined as all ADC CRE loans except
1-4 family residential loans, or CRE ADC loans that
Meet applicable regulatory LTV requirements (see App C: FDICIA Supervisory LTV Ratios) Borrower has
Contributed cash equity > 15% of property’s “appraised as completed” value before bank’s initial funding, and
Contractually agreed that contributed capital remains in project until credit facility is taken out by permanent financing, sold, or paid in full
HVCRE loans risk-weighted 150% vs. current 100%
HVCRE does not apply to
Purchase or development of ag land if its valuation is limited to ag use ADC loans for community development investments
Owner-occupied permanent financing
App G-2: HVCRE Calculation
Total ADC Loans
Less: 1-4 family residential properties
Less: Ag purpose properties
Less: Community development loans
Less: ADC loans that meet criteria on previous slide
