ref guide loans construction

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Reference Guide for Submitting & ClosingConstruction Loans

For Business Banking & Small Business Banking

Introduction This reference guide provides information and step-by-step instructions forhow to submit construction loan applications and what happens after the

application has been approved.

Responsibility The Business Banker / Small Business Banker is responsible for submittingclients applications for constructional loans, and for certain steps in the

closing process. In addition, the Banker should understand the entire process

to enable him/her to answer clients questions.

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Terminology The table below defines terms you should know to assist your client insubmitting an application for a construction loan.

Term Definition

AIA DrawRequest

An AIA draw request is submitted on an AIA DocumentG702 form and summarizes the original contract sum (+/-)

any change orders and the total completed to date. Thisform is extremely useful when monitoring a constructionproject and should be required for all constructionprojects.

AIA Schedule

of Values

AIA stands for the American Institute of Architects, of

which they drafted a set of uniform documents to be used

by general contractors for construction projects. An AIA

Schedule of Values is the detailed contractor budget that

is included in the construction contract. This term can be

used synonymously with detailed Budget.

As-Built (Final)

Survey

Useful to identify sidewalks, parking lots, and other

completed improvements. This survey is conducted at the

end of the project.

Contractor &

Borrower

Signed

Inspection

To avoid disputes on work performed, both parties should

certify they are ready for inspection by signing the draw

request. We will then fund into the borrowers

construction DDA account and borrower will write a check

to the contractor.

Fund on Work

in Place

Inspections by a 3rd party inspector are used to ensure

that the bank is only funding on work actually completed.

The 3rd party inspector will use the original AIA schedule of

values to confirm the status of completion for individual

items and recommend funding if completed. Note that the

AIA form is amended throughout the project to reflect all

change orders and their associated cost.

General Insurance coverage usually with $1MM in coverage for

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Liability

Insurance

loans of $2MM and less. Coverage of $2MM per

occurrence and $5MM aggregate for jobs between $2MM -

$5MM. Insurance company providing coverage must have

a minimum rating of A

Investor Real

Estate

A real estate project that is built and leased by investors

to generate a stream of lease/rental income. Typically

includes multi-family, multi-tenant office, or leased retailprojects.

Lien Period The period in which to file a lien on a job where they were

not paid. The retainage period is never shorter than the

lien period in case someone files a claim. State law allows

that if the construction contract is recorded at the

beginning of the job and if at the conclusion of the job a

certificate of completion is then filed as well, the lien

period can be reduced from 72 days to 30 days.

Owner

Occupied

Real-Estate loans which are underwritten based on

the operating revenue of the owner-occupied

business that occupies the banks collateral.

Slab Survey Useful to ensure the building is not built in the wrong

place and shows the position of the slab in relation to

property boundary, easements, etc.

Workers

Compensation

Coverage

Insurance coverage provided by the contractor with

amount set by state statute. Insurance company providing

coverage must have a minimum rating of A

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ConstructionLoans vs.ConventionalLoans

Construction loans are Non-Revolving Lines of Credit that allowfor interest-only payments during construction. Typical termsare 24 months and are co-terminus with the duration of theconstruction/renovation timeframe.

Conventional loans specifically deal with residential financing.

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Characteristicsof aConstructionLoan

The following are the characteristics of typical construction loans:

Available for owner-occupied and investor real estate projectsincluding all projects where the take-out is SBA 504 or 7A.

Common types of construction loans are for (i) expansion ofowner-occupied business with the construction of a new

building; (ii) renovations to existing owner-occupied businesses;and (iii) leasehold improvements for tenant space.Construction of an IRE property is less common in the currenteconomic climate and is handled on a case by case basis.

Loan amounts follow the Maximum Credit Exposure guidelinesfor Business Banking Relationships and are typically $3,000M. Regional MCE approval is required for any loanamounts >$3,000M.

Construction loans are Non-Revolving Lines of Credit that allowfor interest-only payments during construction. Typical terms

are 24 months and are co-terminus with the duration of theconstruction/renovation timeframe.

All construction loans must convert to a term loan uponconstruction completion. Terms offered are 5, 7, or 10 yearswith amortizations up to 20 yrs. In special cases, higheramortizations are available. Please consult with your MCE fordetails on available loan structures.

Relationship based pricing is driven by deposits and ancillarybusiness.

Note: The primary repayment source on the loan drives theclassification of a construction loan as either owner-occupied orinvestor. Owner-occupied real estate loans are underwritten basedon the operating revenue of the owner-occupied business thatoccupies the banks collateral. Investor real estate loans areunderwritten based on the 3rd party lease income of the property thatis the banks collateral. As such, each has their own set ofunderwriting guidelines. Please consult with your MCE when youreceive a construction loan request to ensure proper classification forunderwriting and loan structure purposes.

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Factors toconsider whendevelopingTarget Zonefor potentialloancustomers

Higher overhead cost compared to what we earn and higher inrisk.

Only profitable to the bank if we obtain; a) the relationship ofthe owner and all of their business, b) the permanent loan, c)more in fees; and d) a satisfactory interest rate.

Deposits and ancillary business (i.e. Treasury Management&Merchant Services) factor into pricing the loan, but do notmitigate the construction risk.

An MCE approved Loan Pricing Model (LPM) will factor in: a) theconstruction risk; and b) the overall banking relationship toensure that an acceptable Risk Adjusted Return on Capital(RAROC) is generated from the fees and interest rate charged.

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FactsRegardingConstructionLoans

Underwriting LTV (Loan to Value) & LTC (Loan to Cost)

o Owner-Occupied loans, where the primary repayment

source is the operating income of the owner-occupiedbusiness, allow for loan amounts up to the lesser of 80%of cost or 80% of appraised value subject to supportableloan amount derived from cash flow

o

IRE property types where the source of repayment is the3rd party lease income of the property are subject to IREand CRE underwriting guidelines which are morerestrictive than owner-occupied guidelines with LTV/LTCof 75%. Please consult with your IRE RelationshipManager for details on IRE loan structures.

Equity

o Explain to borrower that their equity can be in land value

or cash, and equity is used first. This delays the need toborrow during the project, saving the borrower interestexpense.

o The land value is determined by the original cost if the

property has been owned 3 years or less.

Note: Any cash equity not used for the project at the loan closingmust be deposited into a Capital One bank account with a hard hold.Capital One does not allow staged equity. The final equityrequirement cannot be determined until receipt of the final budgetand appraisal.

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ApplicationRequirements

In addition to the standard application requirements for a loanrequest, the following items are useful if they can be obtained duringthe initial meeting with the borrower:

o Description of Proposed Improvements

o Detailed Budget

o Status of Building Permits, Plans and Specs

o Name of the Contractoro Current Debt on Property (if any)

o Expected Equity Contribution, Requested Loan Amount

and Terms

The IRE construction monitoring team will provide a detailed list of allitems that will be needed to close the loan. Please consult with themaccordingly.

Note: You must submit a request for the construction and thepermanent loan as you would for any other standard loan approval.For owner-occupied real estate construction loans, a TIP Form, IRE

preliminary budget review, and MCE approval is required prior tosubmitting to the BBC for underwriting. If the loan is an IREconstruction loan, then an IRE underwriting memo will be required aswell. The banker, in conjunction with MCE should engage IRE asneeded. Approval of the permanent loan is required to approve theconstruction loan.

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Stages in theOverallProcess

Once the Banker submits the application package on behalf of the client, the

following is a high level overview of the process:

Stage Description

Underwriting The underwriting team reviews the submitted package,

requests any necessary additional documents orinformation and underwrites the project.

Pre-Closing Once the credit is approved, it moves to the Construction

Team who prepares the commitment letter and

coordinates surveys and other necessary pre-closing

work.

Closing Appraisals, environmental report, and all other necessary

reports, contracts, and inspections are coordinated and

conducted. Documentation is prepared and the loan isclosed with the client.

Post Closing The Construction Team monitors the construction,

requests inspections and coordinates draws.

Term Out The construction loan is converted to a permanent loan.

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TheUnderwritingProcess

During the Underwriting Process, the following steps are completed:

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Step Action

1 The Underwriter reviews the application package and

contacts the banker and / or the client to obtain any

missing documentation.

2 The Underwriter determines if the project is Owner Occupied or

Investment Real Estate (IRE).

If Then

Owner

Occupied

Loan capacity is determined by the cash

flow of the operating entity and guarantor

support. The Underwriter continues to

underwrite and makes a credit decision.

IRE The Underwriter will ask the borrower for

additional information to determine the loan

capacity. The Underwriter will share the

information with the IRE Team, who reviews

the project information and generates an IRE

memo to assist with the credit decision.

3 The Underwriter completes the underwriting process and

makes a credit decision (decline, approve, counter-offer)

which is communicated to the Market Credit Executive

(MCE) and the Banker.

4 The Banker communicates the decision to the client.

If Then

Approved Once the client accepts, the Banker will work

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The Pre-ClosingProcess

During the Pre-Closing Process, the following steps are completed:

IREs construction team: Receives the approval Assists with preparing the commitment letter Works with Credit Support Specialist to gather/review all required

docs for closing Engages 3rd party inspector for upfront plan and cost review Engages appraiser for appraisal report based on as complete

value.

Assists with obtaining environmental review (i.e. Phase I or

Environmental Checklist.

The ClosingProcess

During the Closing Process, the following steps are completed:

Banker engages legal counsel and obtains closing checklist from LAD.All documentation that is provided in the closing checklist needs to bereviewed and approved by LAD and banks legal counsel prior toclosing.

All construction documentation is submitted to IRE for review andapproval by 3rd party inspector.

Once all documentation is reviewed and approved, the loan is ready

to close.

The PostClosing &Draw Process

During the Post-Closing & Draw Process, the following steps are

completed:

IRE Construction Team monitors the construction project to

completion to ensure that it is on time and within budget.

The Term-OutProcess

During the Term-out Process, the following steps are completed:

IRE in conjunction with LAD & the Banker close the Construction Loaninto Permanent Loan.

Roles andResponsibilities

The following are the roles and responsibilities of all parties who are needed

to close a construction loan:

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Role Responsibility

IREs

Construction

Monitoring

Team

is to guide the Business Banker and Borrower

throughout the construction process to ensure

a complete project that is on time and within

budget. Prior to approval, IREs construction

monitoring team should be engaged as soon

as a request for construction financing isreceived so they can assist with the

preliminary budget review needed for

underwriting. Post closing, the IRE

construction monitoring team is responsible

for administering all construction advances

and assists in getting required documentation

for the Term Out (Permanent Loan).

IRE

Relationship

Manager

is required to provide an IRE underwritingmemo to the BBC for all investor real estate

construction loans where the primaryrepayment source is 3rd party lease income ofthe property. An IRE underwriting memo isnot needed for owner-occupied constructionloans where the primary repayment source isthe operating revenue of the owner-occupiedbusiness.

LAD (Post

Approval)

is to provide the Banker & CSS a closingchecklist of items needed. LAD is then

responsible for reviewing all of the requireddocumentation and letting the Banker / CSSknow if additional information is needed.LADs approval of all documentation is neededprior to closing. Post closing, LAD worksclosely with the IRE construction monitoringteam to advance funds in accordance withbank policy until substantial completion andclose the Term Out..

Business is to act as the quarterback on the

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Banker transaction to keep the borrower informed on

the status of the request and gather the

needed information. Business Banker is also

responsible for engaging the attorney,

ordering appraisals & environmental reports,

tracking closing costs, and closing.

Client/Borrower

is to provide the information needed tosuccessfully underwrite and close the

transaction. Open lines of communication are

key to getting the loan closed in a timely

manner.

Attorney Attorneys Role is as follows:

a) Review all due diligence items;b) Prepare the loan documents for thebank (as required);c) Revise and review any in-house

prepared documents;d) Review and negotiate the titlepolicy;e) Review the survey and allcertificates of public records that wereordered to check for priorencumbrances on the property to bemortgaged, and;f) Assist in the coordination of the

closing process.

Credit

Support

Specialist

(CSS)

is to draft the commitment letter (IRE canassist as needed) from the Credit ApprovalMemo (CAM), gather all required closingdocumentation per LADs closing checklist,and coordinate loan closing between LAD,funding department, and attorney.

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Construction

Document

Checklist

The following items are standard construction documents that willneed to be reviewed and approved by the banks 3rd party inspectorprior to closing:

A fixed price contract to include a schedule of values, outline of thedraw schedule, progress payments, duration of the project andretainage

A final loan budget that determines borrowers final equityrequirement at closing

Building plans and specifications All appropriate licenses and necessary permits Zoning Certificates and Utility Letters (as applicable) Proof (Certificates) of Insurance (builders risk [during construction],

workers compensation, multi-peril hazard, general liability, and flood[if applicable])

Geotechnical Soils Report (as applicable) Other items as required for each project.

Note: The above list is not comprehensive in nature and is presentedas an overview of the types of construction documents that will beneeded. Each construction project is different and additionaldocumentation may be needed depending on the specifics of the

project.

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AppraiserRequirements

The CSS in conjunction with the banker will order the appraisalrequest through RETECHS to obtain an appraisal report that providesan as complete value. The appraiser will need the followingdocuments:

A full set of plans and specifications, a legal description of theproperty, a copy of the construction contract, and the final budget

to begin the appraisal process.o Plans and Specs (a legible 11 X 17 copy or pdf file from the

engineer/architect will usually work for the appraiser)o Draft or Final Contract (prefer to use the final contract)

o AIA Schedule of Values (i.e. Detailed Budget).

The appraiser will provide us with a turnaround time, which beginsfrom the date the appraiser receives all of the necessary documents.

DrawChecklistsPost closing, IRE will work with the borrower, the contractor, and LADto make sure that the bank is in receipt of all required documentationneeded for each draw advance. Please consult with your IREconstruction monitoring team for the complete draw checklist whichincludes, but is not limited to the following items:

o AIA draw request signed and approved by borrower

o 3rd party inspection report approving the amount to fund

o Proof of builders risk and general liability insurance(s)

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FAQs Frequently asked questions and their respective answers follow.

Question Answer

What is the primary

risk for all

construction loans?

The primary risk of all construction loans is the

non-completion of construction. To mitigate that

risk, the Banks Investor Real Estate Groupmonitors all construction projects for owner-

occupied and investor real estate projects. IRE

provides a monthly report on the status of the

construction portfolio to Bank Risk Management,

the SBB credit officers and the MCEs.

What does prepaid

equity include?

Prepaid equity often includes the land purchase,

site improvements (like clearing and fill), A&E,

permitting fees, etc. When calculating the

borrowers cash requirement at closing,

verifiable prepaid items can be deducted from

the borrowers cash injection since these are sunk

costs.

Why does the bank

require equity on

construction loans?

Equity is required to ensure that there is enoughcash available to complete the project. Equity isalways funded first before any loan proceeds areadvanced. The amount of equity required isalways based on the total project cost. Totalproject costs include land, hard costs(improvements), and soft costs.

Total Project Costs Equity = Loan Amount

Equity + Loan Amount = Total Project Costs

What are change

orders?

Change orders occur in most construction projectsas the borrower may add (increase costs) ordeduct (decrease costs) items from the originalplans. Also, unforeseen costs related toconstruction delays or other extraordinary events,can increase costs. All change orders must beapproved by the bank.

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Who can be the

inspector in the

construction process?

IRE will engage a licensed, 3rd party real estate

inspector to perform an initial plan/cost review,

and to monitor the construction progress. All

inspectors need to be a neutral, 3rd party to the

project to ensure that there is no bias. The bank

will not allow the borrower or an agent of theborrower to monitor the project. IRE has a list of

bank approved inspectors.

The construction

phase seems

complicated; how

can I get this done

efficiently?

The Investor Real Estate construction monitoring

team will guide you through the entire process.

The IRE construction monitoring team will answer

questions that your or your borrower may have to

ensure that the project is completed on time and

within budget. Leave it to the experts.

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