Transcript Section 108 Underwriting - National Community Development

NCDA – Winter Conference 2013
Economic Development using Community
Development Block Grants/Section 108 Loan
Guarantees
Types of Section 108 Projects
• Commercial development
– Offices, retail, mixed-use, hotel
• Operating businesses
– Manufacturing and service sector businesses
• Industrial development
– Industrial park
Slide 2
Types of Section 108 Projects
• Loan Pools
– Business development & expansions
• Multi-family rental housing rehab
– Rehab vacant building into residential use
• Infrastructure/Public facilities
– Community center, roadwork, under grounding
utilities
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Uses of 108
Slide 4
Why Use Section 108?
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Job creation
Larger, capital-intensive projects
Below-market interest rates
Flexible financing options
Mitigate impact of CDBG cuts
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Section 108 Advantages
• Spread capital costs over time
• Long-term funds at reasonable fixed rates
• Flexibility in repayment
– Provision for interest-only
• Flexibility in structure
– Senior debt instrument
– Subordinated debt instrument
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Section 108 Advantages
• Leverage of limited public dollars
($5 of Section 108 for every $1 CDBG funds)
• Non-competitive & rolling application process
• Not a General Obligation (GO) for borrowing
community
• Local decision-making
Slide 7
Section 108 Basics
Lending Features
• Long-term debt: up to 20 year term
• Flexibility of loan structure
– Possibility of interest only payments
– Flexible principal repayment schedule
– Negotiable collateral/subordination arrangements
• Historic low interest rates
– Short-term, interim rates - 3 month LIBOR and
– Long-term, permanent rates - “low spread" above
the 2, 5, 7, and 10-year U.S. Treasury notes
Slide 9
Section 108 Underwriting:
Program and Financial
Program Underwriting
Eligible Applicants
(24 CFR 570.702 and 570.711)
• Entitlements jurisdictions
• Non-entitlement public entities assisted by
states that administer CDBG (Small Cities)
• States (added in 2009) – conduit for Section
108 loans to non-entitlements
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Program Underwriting Basics
– Eligible Activities
• Subpart M
• 24 CFR 570.703
– National Objectives
• Subpart C
• 24 CFR 570.208
• 70% low-mod benefit – primary objective
– Public Benefit
24 CFR 570.209(b)
• If “special economic development” activity
• If public improvements shared by more than 1 business
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Financial Underwriting
Risk & Return
• Risk and return affect both lenders’ (debt) and
owners’/investors’ (equity) willingness to fund a
deal
• Private Debt: Risk of repayment, operating losses
• Equity: Risk of not earning rate of return
• Risks for Section 108 applicant include
– Program compliance, including public benefits/#
of jobs
– Repayment from 3rd party to local government for
repaying Section 108 funds
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Section 108
Financial Underwriting
• 24 CFR 570.209(a) and 24 CFR 570 Appendix A
provides six key underwriting and evaluation
guidelines for economic development projects
• Following guidelines not mandatory, but must
conduct basic underwriting in order to receive
a Section 108 loan
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Six Financial
Underwriting Guidelines
1. Costs are reasonable
2. Financing is committed
3. Section 108 is not substituting for non-federal
funding
4. Project is financially feasible
5. Return to owner is reasonable (avoid windfall
benefits or undue enrichment)
6. Pro-rata disbursements of funding
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Sources & Uses
• Understand features of all financial “Sources”
• Confirm and evaluate “Uses” of funds
• Do “Sources” = “Uses” ?
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Sources
• Debt—borrowing from lenders
• Equity—ownership/investor
– Cash or contributed asset
• Section 108 — “gap” subsidy
Slide 19
Uses
• Identify where the money goes
– Breakout project’s hard costs (construction, equipment) and
soft costs (e.g., professional/financing fees)
• Evaluate reasonableness of all costs
– Compare to costs standards
• Schedule draws of Sources to timing of Uses
– Predevelopment, closing, construction, cost certification,
certificate of occupancy, lease-up
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Cash Flow
Real Estate
Business
Income
Sales
- Expenses
- Cost of Sales + G&A
(no depreciation or interest)
= Net Operating Income
= Earnings b/f Taxes, Depr.,
interest
Minus Debt
Minus Debt
= Cash Flow
= Cash Flow
Minus Income Taxes
Minus Income Taxes
Slide 21
Collateral:
Pledge of CDBG
• All Section 108 Guaranteed Loans require pledge of
current and future CDBG for repayment of Section
108 loan
– States pledge CDBG for non-entitlement communities’
Section 108 guaranteed loans
– Entitlement communities pledge CDBG for entitlement
communities’ Section 108 guaranteed loans
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Collateral:
Additional Loan Security
• In addition to CDBG pledge, other security is
required. (Evaluate Adequacy of Collateral):
– Real Property: 80% Loan-to-Value
– Machinery & Equipment:
• New: 80% of cost, less other senior debt
• Used: 90% of appraised net liquidation value, less other senior debt
– Inventory: 50% of average of ending balances of last 3
operating years
– Accounts Receivable: 80% of average of ending balances of
last 3 operating years
– Revenues (e.g., Tax Increment Financing, parking
revenues, revenues from loan portfolios)
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Structuring the 108
• Can the deal be done without Section 108?
• Debt has to be sized to fit cash flow
- DSC (Debt Service Coverage)
• Debt has to be sized to fit collateral
– LTV (Loan to Value)
Slide 24
Structuring the 108
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Level I: Community borrows funds to carry out
community/economic development activity
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Repaid with CDBG funds over term; and/or
Repaid with other pledged revenue sources (e.g. TIF)
Flexibility and variation depending on project type, source of
repayment, and nature of parties
Level II: Community borrows funds to re-lend to
Third Party Borrower (business or developer)
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–
Repaid by Third Party Borrower with revenues from project;
Repaid by Third Party Borrower with other pledged revenue
sources and guarantees
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Repayment Sources
• Level I – Loan
– Repayment - generally, CDBG used as source of
repayment
– Collateral
• pledge of existing and future CDBG
• Pledge of additional loan security
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Repayments - Third-Party Loan
• Level II - Loan
• Repayment
– 3rd party borrower loan payment (p & i) to local
government borrower. Debt service payment
cannot be less than Section108 debt service
• Collateral
- CDBG pledged by State or Unit of local gov’t
- Additional loan Security – State or Unit of Local
gov’t pledges interest in 3rd party loan, including
security for loan
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Section 108
Examples
Example: Business Deal
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Local food products business founded in 2006
Existing 18,000 sq. ft. facility seeking to expand.
Experienced business owner
Total project cost is $2.6 mil,
Section 108 request is for $469,000
Sources of funds : bank loan, SBA loan and owner
equity(cash).
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Example: Business deal continued
• Uses of funds:
– purchase a 25,000 sq. ft. building
– purchase additional equipment
– Working Capital
• Benefit: Job creation ( 25 FTE) in LM area
Underwriting process is two-fold:
• Program requirements
• Financial
Slide 30
Example Business Deal
Program Underwriting
• Eligible Activity: Special Economic Development 24
CFR 570.203/570.703(i)(1)
• Nat. Objective: Benefit to LM persons through job
creation 24 CFR 570.208(a)4(i) and (v)
• Public Benefit : Applicable per 24 CFR 570.209(b) #
jobs created & retained < $50k in CDBG $$(incl. 108)
per job [ $469,000/25 = $18,760 per job]
Slide 31
Cash Flow
Real Estate
Business
Income
Sales
- Expenses
- Cost of Sales + G&A
(no depreciation or interest)
= Net Operating Income
= Earnings b/f Taxes, Depr.,
interest
Minus Debt
Minus Debt
= Cash Flow
= Cash Flow
Minus Income Taxes
Minus Income Taxes
Slide 32
Example Business Deal
Financial Underwriting
• Profit and Loss(P&L) statement Analysis:
– Trend is gradual growth (increase in sales)
– Trend is stable cost of goods(COGS) compared to sales
• Cash Flow Analysis:
– Sales – (Cost of Sales + G&A)=Earnings b/f Taxes, Depr., int.
– cash flow available for debt service / total debt service
(incl. 108)
– Desire at least 1.2 for 108 deals
Slide 33
Financial Underwriting contd.
• Balance Sheet Analysis :
– positive & increasing working capital[current assets(CA)current liabilities(CL)]
– Stable Current ratio [CA\CL]
– Good cash mgmt(receivable and payable ratios averaged less than
40 days)
• All other funds are committed
– Commitment letter from bank and net worth statement of
owner were submitted with application.
Slide 34
Business Deal Underwriting
Conclusion
• Program requirements are met
• Finance:
 Costs are reasonable compared to similar businesses
 Other Financing is firmly committed incl private financing
 Project seems financial feasible
 Owner is not unduly enriched
 Pro-rata timing of disbursement
• Project is recommended for funding
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Example: Mixed-Use Real Estate
Deal
Slide 36
Memphis, TN—Court Square Center:
Programmatic Underwriting
– Eligibility of Activities
• Development of commercial/office/retail space, under
24 CFR 570.703(i)(1) and 570.203(b)
• Rehabilitation of housing, under 24 CFR 570.703(h) and
570.202(b)(1)
– National Objective
• Elimination of slums or blight, pursuant to 24 CFR
570.208(b)(1)
– Applicable Public Benefit Standards [570.209(b)]
• $3,500,000/140 FTEs= $25,000 per FTE
Slide 37
Cash Flow
Real Estate
Business
Income
Sales
- Expenses
- Cost of Sales + G&A
(no depreciation or interest)
= Net Operating Income
= Earnings b/f Taxes, Depr.,
interest
Minus Debt
Minus Debt
= Cash Flow
= Cash Flow
Minus Income Taxes
Minus Income Taxes
Slide 38
Memphis, TN—Court Square
Center: Financial Underwriting
Cash Flow
Operating Income
$2,107,000
Operating expenses
$343,000
Other Project Expenses
$559,000
Net Operating Income (NOI) = $1,205,000
Annual Debt Payment= $916,800
NOI ÷ ADP = Debt Coverage Ratio (DCR) of 1.31
Slide 39
Memphis, TN—Court Square
Center: Financial Underwriting
Collateral
– Partnership Interests
– Lien on Real Property
• Loan to Value = less than 80%
Slide 40
Section 108
Application & Approval Steps
Application Pre-submission
Requirements (24 CFR 570.704(a))
• Consult with HUD Field Office
• Draft application and publish for citizen review
and comment
• Prepare final application, with citizen
comments considered
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Final Application Components
1.
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5.
6.
Project Description
Eligible Activity(ies)
National Objective
Public Benefit Standard
Sources and Uses
Project Structure and Participants
Slide 43
Timing
• HUD approval of application for Section 108
loan guarantee commitment is approximately
90 days. It depends on a number of factors:
– Quality of the application and whether additional
documentation is required
– Complexity of project
– Time of year (near holidays, budget hearings, and
local processes)
Slide 44
Section108 Loan Guarantee
• Promissory Notes
- Variable/Fixed interest rate notes issued by
states or units of local gov’t.s
• Loan Guarantee
- HUD issues loan guarantee for each note
pledging full faith and credit of U. S. for
repayment of each note
Slide 45
Contact Information
• Paul Webster – Director, Financial
Management Division (FMD) – 202-708-1871
• Hugh Allen – Deputy Director, FMD, 202-4024654
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