Tag Archives: lenders

5 C's of Credit

The 5 C’s of Credit: 
What Do They Mean To Your Small Business Loan?

One of the most common questions among small business owners seeking financing is: “What will the bank look for from me and my business?” While every bank has its own unique criteria, many use some variation of the five C’s of credit when making credit decisions. Broadly speaking, they are:

  • Character
  • Cash flow
  • Collateral
  • Capitalization
  • Conditions

Let’s take a look at each of these ingredients and review how they may impact your funding request. Review each category, and see how you stack up.

Character ― Your willingness to pay back your loan

What is the character of the management of the company? What is your payment history and patterns in other loans you have taken? What is management’s reputation in the industry and the community?

Bankers want to lend their money to those who have impeccable credentials and references. The way you treat your employees and customers, the way you take responsibility, your timeliness in fulfilling your obligations are all parts of the character question.

This is really about you and your personal leadership. How you conduct both your business and personal life gives the lender a clue about how you are likely to handle leadership as a CEO. It’s a banker’s responsibility to look at the downside of making a loan. Your character immediately comes into play if there is a business crisis, for example. As small business owners, our personal stamp on everything that affects our companies is essential. Because the bank may not know you, your credit score tells the lender how you will pay your business loan. Many times, banks do not even differentiate between us and our businesses. A poor personal credit score is enough information for a lender to outright decline a business loan. In a commercial lender’s eyes, there is no differentiation between handling personal obligations and business obligations. They are one and the same.

Cash Flow ― Your capacity to pay back your loan

What is your company’s borrowing history and track record of repayment? How much debt can your company handle? Will you be able to honor the obligation and repay the debt? There are numerous financial benchmarks, such as debt and liquidity ratios, that investors evaluate before advancing funds. Become familiar with the expected pattern in your industry. Some industries can take a higher debt load; others may operate with less liquidity. As a conservative guideline, you should have $2 of income (business and personal) for every $1 of debt.

Collateral ― How lenders get paid if the business fails

While cash flow will nearly always be the primary source of repayment of a loan, bankers look at what they call the secondary source of repayment. Collateral represents assets that the company pledges as an alternate repayment source for the loan. Most collateral is in the form of hard assets, such as real estate and office or manufacturing equipment. Alternatively, your accounts receivable and inventory can be pledged as collateral. Generally, lenders will want a 1:1 ratio, or $1 of collateral for every $1 you borrow. Bankers typically discount an asset and lend on that basis. So for every $1 of collateral, the bank will lend anywhere from 70 percent to 85 percent of the value depending on whether it is fair market value or liquidation value.

The collateral issue is a bigger challenge for service businesses, as they have fewer hard assets to pledge. Until your business is proven, you’re nearly always going to pledge collateral. If it doesn’t come from your business, the bank will look to your personal assets. This clearly has its risks; you don’t want to be in a situation in which you can lose your house because a business loan has turned sour. If you want to be borrowing from banks or other lenders, you need to think long and hard about how you’ll handle this collateral question.

Capitalization ― How much money have you put into the business?

How well-capitalized is your company? How much money have you invested in the business? Has your business grown? Have you reinvested the profits, or paid yourself a bigger salary? Investors often want to see that you have a financial commitment and that you have put yourself at risk in the company. Both your company’s financial statements and your personal credit are keys to the capital question. If the company is operating with a negative net worth, for example, will you be prepared to add more of your own money? How far will your personal resources support both you and the business as it is growing?

Conditions ― SWOT: What are the Strengths, Weaknesses, Opportunities and Threats that affect your business?

What are the current economic conditions and how is your company affected? If your business is sensitive to economic downturns, for example, the bank wants a comfort level that you’re managing productivity and expenses. What are the trends for your industry, and how does your company fit within them? Are there any economic or political hot potatoes that could negatively impact the growth of your business? (I wrote at length on SWOT analysis in my January blog.)

Keep in mind that in evaluating the five C’s of credit, investors don’t give equal weight to each area. Lenders are cautious. One weak area could offset all the other strengths you show. For example, if your industry is sensitive to economic swings, your company may have difficulty getting a loan during an economic downturn ― even if all other factors are strong. And if you’re not perceived as a person of character and integrity, there’s little likelihood you’ll receive a loan, no matter how good your financial statements may be. As you can see, lenders evaluate your company as a total package, which is often more than the sum of the parts. The biggest element, however, will always be you.

For more information about the five C’s of credit and/or B2B CFO, visit b2bcfo.com.

Ted and Cindy Ferkenhoff

Boefly, A New Online Marketplace, Matches Borrowers With Lenders

One couple searched unsuccessfully for six months to secure a loan. Then, 14 days after using a new online marketplace, Ted and Cindy Ferkenhoff had an offer.

The Ferkenhoffs, who needed a loan to open an AlphaGraphics franchise in Flagstaff, weren’t expecting such a quick response.

“With the lending market being pretty shaken up … it was a little surprising that they contacted us and did so, so quickly,” Ted Ferkenhoff said.

It was Mark Danford, executive vice president of the loan-consulting firm FranFund, who introduced the Ferkenhoffs’ loan request to BoeFly, the online marketplace. Danford, who has used BoeFly since its inception on March 17, 2010, decided that BoeFly was the most efficient way to connect the Ferkenhoffs to an appropriate lender.

BoeFly, which is headquartered in New York City, works much like an online dating service, but instead it matches lenders with borrowers.

“We see websites and technology efficiently matching up a whole world of people,” said Michael Rozman, executive vice president of BoeFly. “Matching up boys and girls looking for dates, down to travel and consumer mortgages. It became apparent to us that small business lending would greatly benefit from a service like ours.”

In an online marketplace setting, borrowers can submit their financing request and have almost 500 lenders see it immediately, Rozman said.

The speed at which lenders and borrowers can see results is what inspired the name BoeFly.

BOE stands for business opportunity exchange, Rozman said.

“It’s an exchange that allows businesses to connect more efficiently, and the idea of adding on the fly is a mix of how quickly transactions can fly through the system with a little bit of whimsy behind it,” he added.

It also helps professionals like Danford by saving them time. BoeFly allows him to connect “almost instantaneously” with lenders.

“It’s a night and day difference,” Rozman said.

Transactions with BoeFly are quick, but the main goal is to also make sure the appropriate lenders see the loan requests. Lenders range from small to large institutions all over the country, with six small community banks in Arizona using BoeFly. On average, a submitted loan request will see six to 12 loan offers through BoeFly, Rozman said.

Not only is BoeFly more efficient than the one-by-one approach of lending, but it can also help franchisees and small businesses owners who aren’t familiar with the lending process.

Rozman said he wants to see the word spread about BoeFly, so more small businesses can “leverage BoeFly to end up with business loans.”

The Ferkenhoffs are doing their part to inform others about their success with BoeFly.

“We have passed that around and, of course, given the feedback to AlphaGraphics,” Ferkenhoff said. “Obviously they’re looking for the best method to get new franchising funded.”

With $1.2 billion in transactions since its start, Rozman said he sees BoeFly continuing to grow as people recognize the ease of the online process.

“More and more banks realize that their clients are turning to the Web to be able to more efficiently connect with lenders,” Rozman said. “Banks historically aren’t the earliest adopters of technology, but they do when their clients lead them in that direction.”

The Ferkenhoffs are set to open their AlphaGraphics this month.

Arizona’s Credit Unions Are Helping - AZ Business Magazune Sept/Oct 2010

Arizona’s Credit Unions Are Helping Those Who Depended On Payday Loans

With Arizona’s payday loan industry now history, the state’s credit unions are jumping into the resulting void to both help consumers and gain new members.

Called REAL Solutions, the Arizona Credit Union League & Affiliates’ new program offers an option for consumers who depended on the short-term loans made by the payday loan industry. But in proverbial teach-to-fish fashion, REAL Solutions also aims to help those consumers build long-term financial security.

One service provided by REAL Solutions is a small dollar emergency loan, which allows credit union members to get short-term loans at lower interest-rates than normal payday lenders would offer.

The average payday loan was typically for 14 to 30 days, and the fees varied between $15 and $20 per $100 borrowed. Under this model, a 14-day loan could carry an APR of 520 percent. With REAL Solutions, interest rates vary by credit union, with rates starting as low as 12 percent.

While these loans are an option for consumers, they are not the solution to borrowers who relied heavily on payday loans. However, credit union loans can benefit the borrower in ways that payday loans cannot. If repaid on schedule, the short-term loans can build the borrower’s credit score, because payments to credit unions are reported to credit bureaus, while most payday loans are not. Credit building allows borrowers to obtain better interest rates and terms on their next loan products.

Some credit unions also will put a portion of the loan repayment in a savings account if paid on time. The amount is small, but normally will cover the fee involved in setting up the loan.

Because borrowers can easily fall into a debt trap with payday loans, credit unions only provide members with the opportunity to have one of these short-term loans at a time. This keeps the borrower from getting into a never-ending cycle of taking out a loan to pay off another loan.

Two additional components of the REAL Solutions program are low-interest credit cards and member-rewards programs.

Low-interest credit cards help members gain financial stability. These credit cards are designed to be less of a financial burden on the cardholder by keeping interest rates lower than normal cards.

Credit union members also can enroll in a member-rewards point program, which is similar to a credit card rewards program. The member receives a point for every dollar paid in interest, as well as incentive-based points for continued membership, referring new members or utilizing member-friendly services such as online bill pay. The members can use the points they accumulate for items such as discounted loan rates or even to waive fees they have incurred.

The Arizona Credit Union League realizes that education is the key to financial stability and freedom. Proper financial education on budgeting, debt management, identity theft prevention, building credit, home buying, retirement savings and buying a car are key to being financially empowered.

REAL Solutions includes such benefits as:

  • Second chance checking
  • Member rewards
  • Credit building loan programs
  • Free financial education (for all stages of life)
  • Short-term, small-dollar emergency loans
  • Credit building credit card programs
  • Reloadable prepaid debit cards
  • Low-cost personal loans
  • Overdraft protection
  • IDAs (Individual Development Accounts)
  • ID theft/fraud services
  • Holiday loan skip pay

Each REAL Solutions Credit Union provides independent programs and services. Names of services and programs may vary depending on the credit union.

Arizona credit unions participating in REAL Solutions:

  • AEA FCU
  • Alhambra CU
  • Altier CU
  • American Southwest CU
  • Arizona Central CU
  • Arizona Federal CU
  • Bashas’ Associates FCU
  • Canyon State CU
  • Credit Union West
  • Desert Medical FCU
  • Desert Schools FCU
  • First Credit Union
  • Hughes FCU
  • MariSol FCU
  • Mohave Community FCU
  • Pima FCU
  • Pyramid CU
  • Southwest Health Care CU
  • Tempe Schools CU
  • TruWest CU
  • Tucson Federal CU
  • Tucson Telco FCU
  • Vantage West CU

Austin De Bey also contributed to this article.  He is vice president of governmental affairs for the Arizona Credit Union League & Affiliates. For more information about the REAL Solutions program and the credit unions that offer it, visit the Arizona Credit Union League website at www.azcreditunions.coop.

Arizona Business Magazine Sept/Oct 2010

Future of Finance - AZRE Magazine September/October 2010

Lenders Experience An Increase In Loan Requests

Depending on whom you talk to, it appears the financing freeze in commercial real estate is starting to thaw a bit. Part of that thawing process, according to Bruce Francis, vice chairman of CB Richard Ellis Capital Markets, may be that there has been an increase in the number of loan requests, and that activity alone is making the industry feel the situation is generally getting better.

With that said, lenders still are looking hard at every financing request. They have gone back to the basic underwriting principals that were used in the years prior to the “go-go” times leading up to the real estate bust.

Francis says these are the questions lenders want answers to:

– Who is the sponsor?
– How long have they been in business?
– Have they been through a downturn in the past and what kind of staying power do they have?
– What is the borrower’s exposure to real estate?
– Where is the property located and how healthy is this market and submarket?
– Are the property’s rents in line with the market?
– What is the relationship of this property relative to competing properties (age, improvements, quality, utility, etc.)?
– What is the health of its tenants and what industries are they in?

“It is not so much that one property type (office, industrial, retail) is favored over another,” says Francis, adding that each of the property types has its challenges.

“Rather, it really comes down to the basic underwriting criteria that we all have learned and used for many years that determines if a lender will have interest in offering financing on a property today.”

James DuMars, senior vice president and managing director for NorthMarq Capital in Phoenix, says permanent financing is happening across all major sectors. Life companies and agency lenders (Freddie Mac and Fannie Mae), he says, are by far the most active lenders in the market. CMBS are attempting to gear up again, with several pools scheduled to hit the market before the end of the year.

“We anticipate that the CMBS market will continue to improve and eventually this will be another good source for investors seeking permanent debt,” DuMars says. “But for now, I am not aware of any recent CMBS loan closings in Phoenix.”

Multi-family forecast

Multi-family owners have a significant advantage over owners of all other types of commercial real estate, DuMars explains, as they can access government-guaranteed debt from Freddie Mac and Fannie Mae.

“As I understand it,” he says, “the investors who buy this debt on the secondary market are rewarded with higher yields than standard U.S. Treasuries, but receive the government’s guaranty on the bonds. Consequently, recent Freddie Mac securitizations have reportedly been very successful as fund managers snap up the paper. Today, rates for multi-family are in the low 5% range, fixed for 10 years and include a 30-year amortization.”

Richard Rosenberg, managing principal for DPFG, agrees.

“The only segment of the commercial real estate market where lending may have loosened up recently is that involving multi-family,” he says. “This is principally due to the availability of agency funds (Fannie Mae, Freddie Mac) to backstop the financing provided.”

Industrial forecast

Institutional lenders (life insurance companies) are very interested in the Phoenix industrial market, DuMars says.

“I am currently processing several loans on big box and light industrial warehouses,” he adds. “The lenders focus on loan per square foot, and want to be in infill locations and lend on properties that have multiple tenants so as to limit the downside if a tenant vacates.”

Retail forecast

“We’re processing loans on retail with life companies,” DuMars says. “Expect lower loan-to-values in the 55% range, and expect the lenders to require a grocery anchor in the income stream with a long-term lease.

“The problem with many retail centers today is you may have most of your rent roll in, say, the $25 per SF range, but recently the landlord did a couple deals in the mid-teens. The lender sees this and gets nervous that all rents will eventually revert to the new lower figure.

“It’s easier for a lender to make a retail loan in Chicago vs. Phoenix, so they have to be compelled to come here. They will want strong sponsors, a significant equity contribution and will ask lots of questions about the rent roll and tenants. If they like what they hear, then they will lend.”

Office forecast

This is a tough product type today, DuMars says. The job loss in Phoenix and the 27% Valley wide office vacancy rate have deterred many permanent lenders from wanting to pursue offices in Phoenix.

“However, we are quoting office loans,” DuMars says. “Underwriting an office building today will include marking rents to market or blending them to market and using a market vacancy rate. Again, expect a loan to purchase price of say 55% and a rate of approximately 6.5%. Expect lenders to be in the sub $75 per SF range for this product type when it comes to loan dollars.”

For more information:
northmarq.com
cbre.com
dpfg.com

 AZRE September/October 2010

money pile

Raising Capital In A Financial Drought Is Tough, But Not Impossible

In today’s turbulent economic environment, many companies are finding their cash flows temporarily reduced due to difficult business conditions. Less cash flow generated from operations can cause a working capital squeeze or make existing lenders uncomfortable and/or uncooperative, particularly if the company has violated a loan covenant or agreement. In the past year, we have witnessed a dramatic pullback on the part of all lenders, especially banks. If a bank has the power in its relationship with a borrower due to a broken agreement or covenant, a company could find itself in real trouble unless it is able to raise capital from another source.

What types of capital are currently available?
The answers vary based on the company’s size (revenue, profits, assets, etc.), history of financial results, strength of its management team, and industry.

In general, there is debt and equity (i.e., stock), but capital should be considered on a spectrum from senior to junior. The most senior capital is typically a bank loan secured by a first lien on all the assets of a company, followed by second lien debt and then unsecured debt. As a general rule, the more junior the capital, the riskier and more expensive it is.

No matter the interest rate, senior debt will be cheaper than other capital. In the current market, cash flow-based senior lending has all but dried up. It seems that cash flow senior loans are available only to those companies with strong cash flows — in other words, those that don’t really need the money. On the other hand, if a company has significant assets and is not already leveraged, the owners should check with their bankers; interest rates may be higher and advance rates lower, but senior debt may be available.

Let’s assume bank debt is not available — that leaves equity (common and preferred stock) and subordinated debt (sometimes called mezzanine debt because it comes between senior debt and equity in the capital structure). It will be least expensive if owners are able to access friends and family as investors. That said, many entrepreneurs prefer to keep business and family separate, so that leaves high net worth individuals (angel investors) and institutional investors.

How can business owners prepare to raise capital?
Regardless of the type and source of capital a company chooses to pursue, there are several steps to take to ensure the capital-raising process runs smoothly and, more importantly, maximizes the chances for success.

Prepare an executive summary of the business. Describe the company and how it makes money, be sure to discuss products and services and talk about the company’s challenges and opportunities. Also provide biographies of key members of the management team. Use charts and graphs to make strong points about financial performance and industry dynamics.

Assemble a historical financial information package. Include at least three full years of historical financial statements. Audited financial statements are best, but statements reviewed or compiled by a recognized accounting firm likely will suffice. Also, include monthly financial statements for the last fiscal year and the year-to-date period. It is helpful to include information such as sales and gross margin by customer and/or product to help investors consider concentration risk. In addition, provide a detailed breakdown of costs and expenses, including information regarding capital expenditures. Try to break down capex by expenses required to maintain the business and those that contributed to growth.

Assemble a financial planning package. Include the current-year budget and a forecast for the coming year. A detailed bottom-up analysis is essential to creating credibility with investors. Future growth will be the decisive factor for equity investors. Include projections for the next five years if possible, even if they are just a best guess driven by top-line growth rates and margin assumptions; they will be helpful for investors who want to understand the potential of the business.

Select an online data room provider and begin uploading documents for investors to review. Be sure to include all key contracts, credit agreements, charter documents, board minutes, tax returns, etc. An online data room will streamline the due diligence process significantly, requiring less of the management team’s time and shortening the overall time to close.

Prepare a PowerPoint presentation that walks investors through the business, its historical results, challenges, opportunities and projections. Include details regarding the use of proceeds. Invite the most interested investors to visit the company and use this presentation as a basis for discussion.


Where do business owners go to find capital?

The best advice for owners and management teams is: Do not underestimate the time required and the complexities involved with undertaking a capital raise. Never be afraid to admit that you are in over your head and need the help of professional advisers. Investors, particularly institutional investors, are currently at an advantage. In today’s business environment, capital is scarce and at a premium. To get the best deal for your company you need to bring your A-Game and your A-Team. A variety of corporate and/or business advisers such as attorneys and accountants may be able to help business owners determine the best sources of capital and recommend an investment bank to assist with a more comprehensive review of capital-raising alternatives, as well as sources of potential capital. It could be the difference between using a watering can versus an industrial sprinkler when combating your company’s capital drought.

Legal Aide

Key Legal Considerations And Strategies Businesses Should Consider In An Economic Downturn

Virtually all Arizona businesses, but disproportionately small and medium-sized enterprises, have been significantly impacted by the recession. The current financial climate has and will undoubtedly continue to have countless business ramifications. Often overlooked, however, are the legal considerations that should be proactively evaluated by companies in a challenging economic environment. Legal strategies should be employed not only to manage present challenges, but also to take advantage of opportunities that present themselves in this ever-evolving business landscape. It is important to carefully consider the key legal variables in play.

Here are a few:

1. Renegotiate contracts
Unfortunately, parties oftentimes neglect to consider the details of their contractual relationships until such time as they are presented with challenges. It is therefore a good practice to closely scrutinize and reevaluate one’s contracts in advance of problems arising, and with an eye toward possibly negotiating more favorable terms. It is essential that businesses look to all of their contractual relationships and incorporate contractual provisions that allow for flexibility during fluctuating economic times and properly allocate business risks, including the protection of payment streams, dealings with vendors and clients, termination provisions, and dispute-resolution mechanisms.

2. Employment policies and procedures
Perhaps the area that presents the greatest challenge for small and medium-sized businesses concerns the legal aspects of employment. Particularly in economically challenging times, companies need to be aware of the potential for employment litigation. Companies should regularly ensure that employment policies are updated and consistent with their operations and the regulatory environment, and should be attuned to the potential impact of their employment-related decisions.

3. Corporate documentation
Reviewing and maintaining the proper business entity and structure for your business is vital to securing proper limited-liability protections, mitigating exposure associated with business and employment disputes, and ensuring the most advantageous tax treatment. Many factors influence the choice of a particular entity, including the number of owners, the source of capitalization, employee and immigration needs, management structure, the size of the organization, taxes, and personal asset protection. Limited-liability protection is particularly important in economically challenging times, when the number of disputes rises dramatically. Businesses should be extraordinarily prudent and diligent in the management and oversight of their corporate formalities to preserve the benefits of their entity status.

4. Intellectual property protection
Patents, trademarks, trade secrets and copyrights are species of intellectual property that can and should be protected under state, federal and international law, as applicable. The use and effectiveness of covenants not-to-compete and confidentiality agreements should also be evaluated. It is critical to assess intellectual property regulations and enforcement mechanisms on a regular basis before engaging in any activity that may jeopardize your business’ intellectual property rights.

5. Pursuing litigation
The prospect of business litigation should be approached with the goal of creating optimum value for the business. Businesses should be cognizant of the significant expense associated with litigation, the time horizon associated with the pursuit of claims through the judicial system, and the prospects, if any, of ultimately collecting on a favorable settlement or judgment. Litigants and their counsel should be acutely aware of the costs and benefits associated with pursuing and defending civil claims. The question should be asked: What is the value proposition in each alternative approach to resolving a dispute?

6. Consider bankruptcy alternatives
Bankruptcy can sometimes provide relief for a struggling enterprise. There are various strategies that can provide a “fresh start” for a business that has been impacted by this economy. A bankruptcy expert can assist in evaluating the utilization of bankruptcy to determine the best course of action. Alternatives to bankruptcy do exist, i.e. “work-outs” with lenders, and these options should also be fully explored in advance of filing for bankruptcy protection.

7. Dispute resolution
It is imperative to plan in advance to manage disputes that may arise in the course of business. Absent a contractual designation by the parties of a governing set of laws, forum or dispute resolution process, there may be uncertainty as to how, when and where disputes will be resolved. This uncertainty can translate into resources being unnecessarily expended. Parties should, at the very least, make efforts to agree in advance to a choice of law and forum to manage disputes, including the use of arbitration and/or mediation to provide for resolution. Businesses should be cautioned not to rush to agree to arbitration, however. In many instances, litigation in the judicial system may be a better option.

8. Identify a lawyer
It is important to seek the assistance of legal counsel who has a keen understanding of how to best structure your business or to help you in confronting your business’ challenges. The lawyer should have the ability to call upon a network of advisors who can provide particularized knowledge of the issues that confront your business, whether the goal is strategic planning or dispute resolution.

Recessionary economic conditions provide for challenges, as well as opportunities. The costs to those businesses that fail to adequately consider the legal ramifications of their actions in this environment can be substantial. These legal issues are best navigated and managed through proper planning, which will in turn maximize your business’ ability to capitalize on available opportunities.

Olivier A. Beabeau, a senior associate at Galbut & Galbut, contributed to this report. He can be reached at obeabeau@galbutlaw.com.

tax calculations

Tax Relief For Lenders May Help Commercial Real Estate Borrowers

The credit crunch is severely reducing the availability of financing and refinancing for commercial real estate. Many borrowers with loans maturing in the next few years, who originally expected to refinance their commercial mortgage loans before maturity, are now concerned that they will not be able to do so and will default when the mortgage becomes due.

This concern extends to all commercial real estate loans, even those secured with properties that have good cash flow. Anticipating the many challenges facing the commercial real estate industry, the U.S. Department of Treasury and the Internal Revenue Service have provided helpful tax guidance to remove some impediments for commercial mortgage loan refinancings. As a result, many commercial real estate borrowers may soon find it easier to renegotiate their commercial mortgage loans.

According to some estimates, roughly one-third of all commercial loans are held by investor pools known as Real Estate Mortgage Investment Conduits (REMICs). REMICs administer their day-to-day operations of the mortgage loan pools through servicers. These servicers also handle the modification and restructuring of defaulted loans, as well as foreclosure or similar conversion of defaulted mortgage loan property.

The Treasury and the IRS believe the loan pool administrators have developed and implemented procedures for monitoring both the status of the commercial properties securing the mortgage loans and the likelihood of borrowers being able to refinance their mortgage loans or sell the mortgaged property as the loans mature. They believe these administrators are able to foresee impending difficulties for a mortgage loan well in advance of any actual payment default.

Until now, despite being able to anticipate loan defaults, REMICs have been reluctant to renegotiate and restructure these mortgages for fear of losing certain favorable tax benefits that apply to them. Existing rules severely hamper the ability of a REMIC to modify any mortgages that it holds. These rules were drafted at a time when the government did not anticipate the challenges faced today by the mortgage industry.

The Treasury and the IRS have now issued some clarifying rules in anticipation of a rise in defaults of commercial real estate loans to give REMICs comfort that they will not face dire tax consequences when they modify commercial mortgages. The regulations say that “(t)hese changes will affect lenders, borrowers, servicers and sponsors of securitizations of mortgages.”

The relief is generally limited to commercial real estate loans and multifamily housing loans, and does not apply to single-family residential mortgages. The new rules will not affect commercial mortgages held by banks because the same tax rules do not apply to banks.

Specifically, the revised rules allow changes in collateral, guarantees, credit enhancements and changes to the nature of an obligation from nonrecourse to recourse without adverse tax consequences to the REMIC. One caveat is that the mortgage must continue to be principally secured by real property after giving effect to any releases, substitutions, additions or other alterations to the collateral. Under the old rules, the fair market value of the real property securing the mortgage would have had to have been at least 80 percent of the face amount of the mortgage at the time it was originated.

The new rules allow for retesting of the fair market value taking into account any reductions in the amount of the mortgage at the time of the modification. Another favorable new rule permits a more relaxed method for satisfying the principally secured test. As long as the fair market value of the real property that secures the loan immediately after the modification equals or exceeds the fair market value of the real property that secured the loan immediately before the modification, the test is satisfied.

According to the Treasury, all these changes are intended to “accommodate evolving commercial mortgage industry practices” and to allow for more loan modifications.

There are numerous other areas of uncertainty in tax law as they apply to loan modifications, which impede loan modifications in other circumstances. For now, it appears that the Treasury and the IRS are working hard to provide clarifying rules in many of these other areas, as well. For example, the Treasury has also asked for comments from tax practitioners and the industry about extending tax flexibility to loan revisions for properties held by other types of investment trusts.

Of course, loan modifications do not only affect lenders from a tax perspective. In many cases, the tax consequences of a loan modification also severely limit the borrower’s options and willingness to enter into a workout. Many borrowers modify their loans only to learn of the negative tax consequences and tax-efficient alternatives after the fact. Although tax consequences may be the tail wagging the dog, they are important considerations for both the lender and the borrower in any debt-workout situation.


credit unions reaching out to small business

Arizona’s Credit Unions Are Reaching Out To Small Businesses

Relative newcomers to the field of making business loans, credit unions nonetheless have become key players in today’s tight-money economy. Barely 10 years ago, credit unions concentrated mainly on savings and checking accounts, and made personal, auto and home loans. But the Credit Union National Association says credit unions nationally originated $6.5 billion in business loans in the first six months of 2008, up 36 percent from the $4.8 billion in the corresponding period of 2007.

Credit union business loans in Arizona average about $240,000. Because the loans are relatively small, credit unions focus on small businesses.

For the past six years, Arizona credit unions have been working closely with the Small Business Administration and have emerged as strong SBA lenders. But because of the expertise involved in making such loans, only the larger credit unions are active in that segment of lending.

Steve Dunham, president and CEO of Canyon State Credit Union and board chairman of the Arizona Credit Union League & Affiliates, suggests that credit unions with assets of at least $400 million generally have the ability and staff support, so they are most likely to make business loans.

Then there is the issue of the federal cap, which the credit union industry has been trying to get Congress to increase or eliminate. Under the cap, credit unions may make business loans totaling no more than 12.25 percent of their assets.
The business lending cap comes into play at Arizona State Credit Union, one of the state’s largest.

“We’re getting very close to the cap, so we are being selective about what we do,” says Paul Stull, senior vice president of marketing at Arizona State Credit Union. “We keep bumping into it, and we have to find a way to make room. It’s quite a challenge to manage that.”

Despite the regulatory limits placed on credit unions, opportunities for businesses to borrow are available. Businesses face a combination of challenges, such as finding a money source and finding the right rate, Stull says.

“For many of the people we deal with, the rate is important, but many times they don’t have too many alternatives to look at for financing,” Stull says. “That usually means their needs are somewhat smaller than the targeted range of other providers. It takes just as much work to originate a small loan as it does a large one. Some would prefer to do only larger loans. A small business person might fall outside of that window. When they do, it’s tough for them to get the attention they want and deserve. Certainly small enterprises are not coming up on the radar of some of the larger lenders. That doesn’t mean rate isn’t important. It still is. But clearly you need to talk to somebody before you can get a rate.”

In all phases of lending, credit unions traditionally follow very conservative underwriting principles and only make loans to members. It’s not uncommon for an individual member to approach a credit union with a business loan request.

“The strong suit for credit unions is what it has always been — credit unions take the time to know their members,” Stull says. “That certainly puts us in a better position to meet the needs of a business. Many of our business customers have a personal relationship with us. They like the way we treat them personally, and they realize they can do their business banking with us as well. And that leads to a deeper relationship. The wider use of our business services is a more recent phenomenon. It’s a natural progression, and is indicative of the way we like to know our customers.”

Most experts see the economy beginning a slow turnaround toward the end of this year or early 2010. Consumers for the most part are still on the sidelines. Credit unions and the business community are keeping an eye on the nation’s savings rate.

For the past 20 to 30 years, Americans saved 7 percent of the income. But in recent years, before the recession hit, people were spending and borrowing more and saving considerably less. The U.S. Department of Commerce notes that the U.S. savings rate has been on the rise after almost five years in which consumers barely saved a penny.

Stull calls the rise in savings a good sign-bad sign situation.

“It’s good because people are being more cautious, developing more security,” he says. “The money they save goes to financial institutions and becomes available for lending. But, it’s a bad sign because people are not buying cars, motor homes, washers and dryers, and they’re not dining out as much as they used to. So it’s really kind of a double-edged sword.”

Big money tight times 2008

Big Money, Tight Times-SBA Loans Can Help

By Don Weiner

It may be true that numbers don’t lie, but they don’t always tell the whole story. When the 2008 fiscal third quarter ended June 30, statewide Small Business Administration-guaranteed lending showed a 25 percent decline from 2007 in both total loans and dollars lent, according to the Arizona District Office.

big money 2008

In fact, District Director Robert Blaney says numbers have been dropping throughout the fiscal year, which is indicative of a slowing economy and business owners holding back.

“I think that we’re feeling the effects like everybody else,” he says. Even active SBA lenders have noticed a slowdown.

“The customers are not expanding as much,” says Dee Burton, an Alliance Bank of Arizona senior vice president dealing with SBA and commercial lending. “The customers are, you know, a little bit leery and they’re not expanding their business. So, yes, that has impacted the number of requests that we get to look at, simply because most of the customers are not in high-growth mode.”

Yet a closer look at the SBA’s third-quarter numbers shows some positive trends. Veteran lending jumped almost 70 percent. Rural lending dollar totals were up 93 percent. And loans for start-ups increased 147 percent.

“When the angels cry, sometimes they also sing,” Blaney says.

The upshot for small-business owners is that if they need money and can meet certain requirements, financial help is available.

“Here at Alliance Bank, we look at these type of slowdowns, if you will, as an opportunity to help people get a loan to expand and grow with them,” Burton says. “We’re definitely still in the lending process.”

Thankfully, business owners have no better friend than the SBA. It provides resources for those starting new businesses or expanding existing ones. And it has programs for businesses in need of capital.

When it comes to the financial side, it’s important to be clear: The SBA is not a lender. Instead, it works with banks, credit unions or other entities that make and administer loans. The SBA backs up loans with guarantees, which can run as high as 75 percent to 85 percent depending on the amount borrowed and the type of loan.

“For us, it’s a critical program,” says Lori Stelling, vice president and SBA lending manager for National Bank of Arizona. “We can serve so many more customers by givingthem a loan with an SBA guarantee, because the loans that we do under SBA we would not be able to do conventionally. And there’s a number of reasons for that. If somebody doesn’t quite meet our conventional cash-flow requirements, under SBA we can give them a longer term than we can conventionally.”

“For lenders, I would say SBA is a critical part of what we do.”

The SBA has several different loan programs.

The most common is the 7(a) loan, which serves a range of business financing needs with a maximum amount of $2 million. Another is the SBAExpress program. It makes smaller loans available, but the SBA only offers a 50 percent guarantee. One of the newest is the Patriot Express Initiative, a program that helps veterans and others in the military community with funding and training. Established businesses in need of long-term financing for major fixed assets can turn to the 504 program.

Not all active SBA lenders participate in all programs. Some specialize in 7(a) loans; others offer SBAExpress loans as their primary product. They also have varying restrictions and minimum loan amounts. Many lenders refuse to offer loans for start-ups. Also, only certain active lenders are approved for certain programs, such as Patriot Express. And some are given special status. Especially active and expert lenders qualify for the Preferred Lenders Program, which equates to a quicker turnaround on SBA loan applications.

Visit the SBA’s Arizona District Web site at www.sba.gov/az to find a completelisting of statewide lenders.

The SBA loan process is not that complicated. Take your proposal to a lender and, according to Blaney, if the lender is unwilling to do a loan without an SBA guarantee, they will deal with the agency’s loan processing center.

“It’s as simple as that,” Blaney says. “You have to fill out a couple of more forms for us. I mean, it is the government, we do have a form or two. But it’s not an arduous process. And it has been severely streamlined over time.”

cover october 2008

Before taking that step, however, Arizona small-business owners may want to take advantage of two other SBA programs: SCORE and the Arizona Small Business Development Network. Their experts can assist with business plans and help you understand lender requirements.

John Alig, branch manager and a counselor for the East Valley SCORE chapter in Mesa, says this may mean passing out what a fellow counselor calls “reality cookies.”

“Sometimes that includes telling people things that they don’t want to hear,” Alig says.

He warns that business owners who lack a proper credit rating, collateral and capital do have one thing: a big problem.

www.sba.gov/az
www.alliancebankofarizona.com
www.nbarizona.com

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Banks Need Accurate Information To Handle Real Estate Assets

As an unintended consequence of the current real estate market, bankers are (reluctantly) being forced into the real estate business. They weren’t necessarily planning on it, but it is a consequence nonetheless.

Arizona Business Magazine, September 2008Right now, lenders are in the position where they have all kinds of real estate and land assets that they need to figure out what to do with. Many banks might not realize that they need certain tools to help understand these assets in order to make educated business decisions. Borrowers may be close to default and banks need to figure out what makes the most sense — selling the asset, keeping it or doing some sort of deal to get a non-performing asset off the books for a period of time until it becomes performing.

Lenders will typically consult with a financial consultant on a bank’s assets, but each real estate asset is truly unique. Performance should be analyzed from a land use/zoning/platting perspective. It is impossible to make a good business decision on the potential disposition (or purchase) of land if you do not have all of this information. Documents granting approvals have to be studied, federal regulatory schemes complied with (404 issues, etc.), development agreement terms studied, ordinance provisions reviewed, etc.

Saying a property is “entitled” can be misleading. The property may be entitled to something, but to what exactly is it entitled? Entitlements are a complex process with multiple steps along the way, each step potentially adding another layer of value to a particular asset. Depending upon where a property is in the process, it may be worthwhile for banks to examine the possibility of continuing the entitlement process in order to add more value. The only way to perform a thorough analysis of any real estate asset is to employ a real estate expert who understands the entitlement process, and the complex legal documents attached to a piece of real estate.

Banks need a comprehensive assessment of real estate assets, which outlines what they have and gives them options for going forward with the assets to realize the most value. The quick and easy decision to simply sell the asset and get it off the books is oftentimes the wrong choice, and banks need to do their homework before making any hasty decisions. Land holding assessment should show each asset and a choice of strategies, along with time lines and cost estimates to get the asset to perform. Very few real estate experts are qualified to perform these non-biased assessments. A broker may have pertinent market knowledge, but to fully evaluate the situation,one must have a very specific understanding of the entitlement process, which is crucial to the value of a piece of land.

Another problematic issue facing banks involves inaccurate real estate appraisals. There are many aspects of the development process that an appraiser might not take into account, which can alter the appraised value of a property. Items such as impact fee credits, development agreements, community facilities districts (a type of funding mechanism for large real estate developments), and improvement costs are just a few examples of relevant pieces to the puzzle that should be analyzed by a qualified real estate expert, in order to make a proper evaluation.
Arizona Business Magazine, September 2008
Although it might not be the plan to get back a piece of real estate, it is a consequence of today’s market. Banks need to equip themselves to make informed business decisions about these unique assets. Involving a law firm with deep experience in land use and zoning is a must, in order to get the type of complete assessment necessary to make these decisions.

Jordan Rose is the president and managing partner of Rose Law Group PC, a full-service real estate and business law firm. Lauren Elrod is an attorney with the firm.

ForeclosureFallout

As More People Lose Their Homes, Banks Are Left Holding The Keys

Acquiring real estate through foreclosures is not exactly the type of transaction banks relish. That’s especially true in a down market that is overloaded with raw land and homes — and a paucity of potential buyers.

Estimates of the amount and value of acquired real estate through foreclosures are difficult, if not impossible, to come by, an industry insider says. A lot of the banks don’t want to talk about it.

“It’s ugly for everyone involved and you can’t even get the Federal Reserve to talk about it,” the insider says.

Anthony B. Sanders, professor of finance and real estate at Arizona State University’s W. P. Carey School of Business, sums up the somewhat dismal situation: “Banks are not in the business of being portfolio managers, either vacant land or housing.

“The way they’re trying to get rid of properties is that most banks are doing packaging. They sell packages of defaulted properties to investors around the United States,” he continues. “They started with national lenders, but there was very little interest in that. Then they went to regional packaging. That didn’t work either. Let’s face it, nobody really wants a Detroit-area loan or housing package.”

What’s happening is that hedge funds and equity funds are looking for very specific types of properties. Raw land value is highly dependent on where the land is.

“That’s why they don’t want to buy large portfolios,” Sanders says. “Because on the urban fringe, when you get way out west or southeast of Phoenix, some of that land they cannot literally give away. The reason is there is no foreseeable development going on in those areas.

“They’re looking for anything related to water rights or mineral rights — anything with natural resource implications still has a positive value,” Sanders says.

Until housing makes a comeback, banks are not finding a lot of interest in 40-acre tracts of desert that someday could be converted into a housing development, Sanders says. Some banks have defaulted single-family homes, often in remote areas.

“During the boom, and until fairly recently, a lot of starter homes were built in areas near Queen Creek, where land prices were fairly inexpensive for the Phoenix market,” Sanders says. “That market has really gotten beaten up pretty hard.”

National and regional bidders for those packages are few and far between.

“It brings back the old adage of location, location, location,” Sanders says. “If you’re planning properties located on major golf courses, or some properties in Scottsdale, there’s interest in that. In the classic subprime neighborhoods, which tend to be lower income, there’s not a lot of interest.”

In the meantime, banks are running around trying to peddle their packages. It’s more feasible to sell packages instead of marketing individual properties, because bank real estate portfolios are overflowing.

“Packages provide a good indication of which areas of Phoenix are likely to keep dropping like a rock,” Sanders says. “It’s those areas where there isn’t any interest in bank packages, which means the market doesn’t think they’re near the bottom. In some areas of Phoenix, the bottom may be a little ways away.”

With packaging of perhaps as many as 200 properties at a time, come discounts.

“The nasty part is that some of these properties are being offered at a big discount and they still can’t get rid of them,” Sanders says.

Even so, there continues to be interest in Ahwatukee, Scottsdale and Paradise Valley, which Sanders says means the housing market is showing some signs of life. But he adds this ominous observation.

“This is very reminiscent of the RTC (Resolution Trust Corporation) fiasco after the savings-and-loan debacle. It’s just like when the RTC was putting together packages. That’s the tipoff. Anytime you see packaging, that should make the hairs stand up on the back of your neck.”

At the Arizona Department of Financial Institutions, which regulates state-chartered banks and none of the large national ones, Tom Wood, division manager for banks, also recalls the S&L collapse.

“We had a lot of raw land in the 1980s,” he says. “Thank goodness we don’t have much of that now.”

Most of the real estate banks are trying to get rid of consists of single-family homes, Wood says.

“Very rarely do we see raw land,” he says. “Some banks don’t want to own it because it takes longer to get rid of. If they foreclose on raw land, they probably sell it at a sheriff’s sale.”

Wood expects a continued uptick in bank acquisitions of real estate, but sees very little of that among state-chartered banks. He suggests that some larger banks might be bundling foreclosed properties and attempting to dispose of their holdings through auctions or developers.

Depending on which economist you talk to, a substantial housing turnaround won’t happen until 2010. Some say 2009; and yet, as Sanders says, there are signs of life in 2008.

“For certain areas, recovery is there,” Sanders says, “but if I’m sitting in Buckeye, Avondale, Queen Creek and parts of Gilbert, I wouldn’t look for a speedy return.”