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3.1 INTRODUCTION
The underwriting of a loan is the process by which the lender determines whether the loan is a good investment of capital. The process involves a simultaneous analysis of the creditworthiness of the borrower and the economic value of the property as an income-producing investment. If the borrower is creditworthy and the property has sufficient value under existing market conditions, the lender can enter into the loan with reasonable confidence that the investment will be a good one. The underwriting of a loan guaranteed by the GRRHP involves the same feasibility analysis that the lender uses for any other loan. The only difference is that the GRRHP guaranteed loan will have property use restrictions that must be factored into the underwriting analysis.
This chapter brings together the borrower eligibility, property, and loan requirements of the GRRHP that must be a part of the lender underwriting analysis. In evaluating each transaction, the lender must use their own loan policy processes and procedures and prudent underwriting standards, consistent with the best industry practices and with the requirements set forth in this chapter.
SECTION 1: LENDER UNDERWRITING RESPONSIBILITIES
3.2 OVERVIEW
Prior to requesting a loan guarantee, the lender must underwrite and approve the loan. The underwriting analysis is a detailed evaluation of key elements of borrower experience and creditworthiness, market conditions, the value of improvements, and the ability of the property to attract the rents needed to generate sufficient cash flow to support the loan’s debt service. The lender underwriting must identify and evaluate all of the factors that could affect loan performance. Such factors must be reflected in the underwriter’s conclusions detailed in the lender’s narrative. The lender will underwrite the GRRHP guaranteed loan as prudently as any other loan in their portfolio.
(02-23-12) PN 455
Revised (03-15-17) PN 495
CHAPTER 3: LENDER UNDERWRITING
Key Topics in this Chapter
Lender Responsibilities Lender’s Underwriting Conclusions Borrower Eligibility Requirements Property Requirements Financing Terms and Lender Commitment Determining Property Value
3.3 SUMMARY OF LENDER RESPONSIBILITIES
The lender’s underwriting responsibilities can be summarized as follows:
Review borrower’s qualifications and capacity to own and operate the property in accordance with the loan terms and program requirements;
Approve the plans and specifications for the construction of the property;
Approve the construction and lease-up schedules for the property;
Determine that there is a market for the project – that is, that there is demand for additional rental units of the type proposed at market rents or at the proposed rents, if higher;
Determine the expense amounts and the amount of replacement reserves;
Determine the appropriate debt service coverage ratio;
Review the management plan and management agreement for the management of the property;
Ensure that all materials prepared by outside parties such as appraisers, architects, attorneys, environmental consultants, engineers, or cost estimators are adequate for their intended purpose and comply with Agency requirements; and
Determine the value of the property.
SECTION 2: LENDER NARRATIVE
3.4 NARRATIVE REQUIREMENTS
The lender must submit a complete narrative summary of all of the factors affecting the transaction and provide supporting documentation for all decisions made in underwriting the loan. This will be submitted as part of the loan guarantee application (see Section 3 of Chapter 4). The lender is expected to identify those factors that may impact the performance of the loan. The lender’s underwriting narrative must include the following elements:
Outline of Lender’s Narrative
Summary of Loan Request Financing Terms/Commitment Borrower/Sponsor’s Qualifications Management Review Property History Site/Area/Neighborhood Analysis Improvements/Physical Needs Environmental Issues Market Analysis/Appraisal Income/Expense Proforma Valuation
Be able to maintain and operate rental housing in accordance with program objectives and requirements. Be in compliance with all legal and regulatory requirements with respect to any Agency program and any other Federal debt.
Be a U.S. citizen(s) or permanent legal resident(s), a U.S. owned corporation, a limited liability company, or a partnership in which the principals are U.S. citizens or permanent legal residents.
The lender can establish the citizenship or permanent legal residency of a borrower by examining a birth certificate, passport or by any other method. If the borrower is not a U.S. citizen, the borrower must provide acceptable evidence of eligible status as a permanent legal resident, as listed in Exhibit 3-1.
3.7 INELIGIBLE BORROWERS
Borrowers are not eligible to receive Agency loan guarantees if:
The borrowing entity or any one of its principals has been debarred by the Agency from future participation in any federal credit program; or
The borrowing entity or any one of its principals has defaulted on any Federal debt.
The borrowing entity or any of its principals has a relationship with the lender that violates the GRHHP’s Lender’s Agreement.. In cases where there is an established relationship, there must be a separation of duties.
The State Office will verify that the borrower does not appear on the debarment/suspension list by reviewing the “The System for Award Management” available on the Internet at and filing a copy of the print out of the Sam Search Results page in the application file. The State Office will also verify that the borrower does not appear on the Credit Alert Verification Reporting System (CAIVRS) or any other list the agency uses from time to time to determine borrower eligibility. The State Office should check SAM and CAIVRS at the initial application stage and prior to closing of the GRRHP loan. SAM and CAIVRS may be accessed through Treasury’s Do Not Pay portal at http://donotpay.treas.gov/portal.htm.
3.8 BORROWER TYPES
The lender must determine that the type of borrower is appropriate to carry out the obligations under the loan and GRRHP requirements. Other than public agencies, Indian tribes, and individuals, borrowers must provide documentary evidence that they are valid legal entities, licensed to do business in the state in which the property is located and able to enter into agreements governing the loan and guarantee. The following are examples of eligible borrower types and the documentation, including any amendments that they must provide to prove their legal status for a GRRHP loan.
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A. General or Limited Partnerships
A partnership is a business agreement between one or more managing or general partners and one or more limited or equity partners, organized to carry out the activities related to ownership and operation of rental housing, or similar purposes. Partnerships must provide evidence of legal status in the form of a partnership agreement setting forth the terms of the business relationship. The partnership must be for a term at least equal to the term of the loan.
(02-23-12) PN 455
Revised (03-15-17) PN 495
Exhibit 3- Acceptable Evidence of Permanent Legal Residency Form I-551,” Alien Registration Card” or prior to 1979, Form I-151 “Alien Registration Receipt Card” (for permanent resident aliens). Form I-94, “Arrival-Departure Record” , with one of the following annotations: “Admitted as Refugee Pursuant to Section 207”; “Section 208” or “Asylum”; “Section 243(h)” or “Deportation stayed by Attorney General”; or “Paroled Pursuant to Section 212(d)(5) of the Immigration and Nationality Act (INA)” for a period of at least a year. If Form I-94 is not annotated, it should be accompanied by one of the following documents: A final court decision granting asylum (but only if no appeal is taken); A letter from an asylum officer of the U.S. Immigration and Naturalization Service (INS) granting asylum (if application is filed on or after October 1, 1990) or from an INS district director granting asylum (if application filed before October 1, 1990); A court decision granting withholding of deportation; or A letter from an INS asylum officer granting withholding of deportation (if application filed on or after October 1, 1990). An alien who is granted conditional entry pursuant to section 203(a)(7) of the INA as in effect prior to April 1, 1980, is a qualified alien. A receipt issued by the INS indicating that an application for issuance of a replacement document in one of the above-listed categories has been made, and the applicant’s entitlement to the document has been verified. If other documents are determined by the INS to constitute acceptable evidence of eligible immigration status, they will be announced by a notice published in the Federal Register.
A purpose statement in their Articles of Incorporation which includes a provision to provide decent housing that is affordable to low- and moderate-income persons.
C. Limited Liability Companies (LLC)
An LLC is a legal entity created to own and operate rental housing, or for a similar purpose, and that is structured to provide limited liability in the ownership of real property. LLCs must provide evidence of legal status in the form of Articles of Organization and Operating Agreements. These documents must show that:
The authority of the members of the LLC is limited, and an authorized member who will act on the LLC’s behalf has been appointed; The management functions of the LLC are the responsibility of a member who holds at least a five percent financial interest in the LLC; The LLC has agreed that any new members may only be brought into the organization with prior consent of the lender; and At least one member has committed to meet the equity contribution requirements if the LLC partnership is not able to do so at the time of loan request. D. Trusts
A trust is an entity formed by a legal agreement for the purpose of owning and operating rental housing or for a similar purpose. Organizational documents of legal status should be submitted as evidence.
E. Public Agencies
Public agencies are organizations, including State or local housing finance agencies (HFAs) or public housing authorities or agencies (PHAs), organized to finance and/or own and operate affordable rental housing, or similar purposes. Public agencies must provide evidence of legal status in the form of State or local enabling or implementing legislation or a resolution of an official public body authorizing the creation of the agency.
F. Indian Tribes
Indian tribes are legal entities recognized by the Federal government as representing the legal interests of tribal members. Indian tribes must provide evidence of legal status in the form of a certificate or other official document of recognition from the Interior Department or other authorized agency of the Federal government. Only those entities that meet the definition of "Indian tribe" as provided in the Glossary are considered eligible.
(02-23-12) PN 455
Revised (03-15-17) PN 495
G. Individuals
An individual borrower is any citizen or permanent legal resident of the United States aged 18 years of age or older who has the capacity to enter into a legal agreement to own and operate rental housing. Citizenship status of individuals is addressed in Paragraph 3.6.
3.9 CERTIFICATION OF LEGAL ELIGIBILITY
The borrower’s attorney must review the organizational documents of the borrower, each principal that is an entity, and the organizational documents of any entity that has an ownership interest in a principal and certify that the borrower meets Agency and program requirements. The lender must review this certification for compliance with program requirements.
3.10 BORROWER EXPERIENCE AND CAPACITY
Lenders must verify that borrowers have the experience and capacity to develop and operate the property to the standards established by the lender and the program.
Areas to be reviewed by the lender:
The number and types of projects that the borrower has previously undertaken.
The experience of the borrower in completing projects.
The borrower’s financial resources and management capacity to undertake the project and resolve problems that arise over the course of the loan.
The lender must be able to verify that:
The borrower can construct or rehabilitate rental housing;
The borrower can provide for the financially sound operation of the property over the life of the loan; and
The borrower is legally able to enter into the necessary contracts with the builder, lender, and other parties involved in the development, financing, and operation of the property.
A. Construction and Rehabilitation Experience
The development team includes the people who will build or rehabilitate the real estate. The development team must have experience with the type of construction involved and a history of sound performance. The lender must review and certify as acceptable each member of the development team. The core development team usually consists of the developer, architect, and contractor.
Additional information about the elements of an acceptable management plan and an acceptable management agreement are included in Chapter 8.
C. Financial Capacity
The borrower and its principals must be financially stable and have sufficient resources to develop and operate the property. Credit reports will assist in determining the financial stability of the borrower and will be ordered for the borrower as well as any person having a financial interest greater than .001 percent in the property. If the organization is newly formed and has not established any records of its activities as an organization, credit reports will be ordered on the principal members, stockholders and/or partners who hold at least a .001 percent interest in the property. Individual credit reports may subsequently be requested on these persons. If an organization has substantial interest in another organization, (i.e. tax credit investors) a credit report for such other organization may be obtained in the same manner as for the borrower. The borrower must demonstrate the financial resources to meet the specific requirements of the transaction.
The lender is responsible for verifying that the borrower has the cash and other marketable securities needed to close the loan and meet working capital requirements.
The borrower must meet the following equity and reserve requirements.
Equity Requirement. In the case of a for-profit entity, the borrower must commit equity capital in an amount equal to at least 10 percent of the total development cost. In general, total development cost includes the cost of constructing, purchasing, improving, altering, or repairing new or existing housing and related facilities and purchasing and improving the necessary land. Other items may be approved on a case-by-case basis by the State Office. In the case of a non-profit entity, the borrower must have equity capital in the amount of at least 3 percent of the total development cost. In either case, a deferred developer’s fee cannot be used to fulfill the equity requirement. Equity must be in place prior to closing the construction loan note guarantee or the permanent loan note guarantee. Equity will be in the form of cash or value in the land being developed. On a case by case basis, the Agency at its sole discretion may consider and approve alternative financial instruments to meet equity requirements.
Program Reserve Requirements. In addition to equity capital, the borrower must commit working capital to meet the program requirements for these reserves: an Operating and Maintenance Reserve (O&M Reserve), a Lease-Up Reserve, a Contingency Reserve during construction, an initial deposit to the Replacement Reserve, and an Interest Credit Reserve (if applicable) to be established prior to closing or conversion to permanent depending on the Option. None of these reserve requirements are mortgageable costs. The establishment of the reserves will not be waived.
O&M Reserve
The O&M reserve is applicable under Guarantee Options One (permanent financing only guarantee), Two (construction advances and permanent financing guarantee), and Three (continuous guarantee). The O&M reserve will be at least two percent of the loan amount. The Agency may request additional O&M reserves if rent-up assumptions indicate the need for more reserves. The sources of the O&M reserve must be shown in the construction budget with a schedule of when the funds will be disbursed in the case of a construction loan note guarantee or will be funded prior to the closing of the permanent loan in the case of a permanent loan note guarantee. Funds contributed as O&M reserve funds will be contributed from the borrower’s own resources and are not to be included as part of the total development cost (TDC) calculation. If Low-Income Housing Tax Credit (LIHTC) funds are being used to fund the Agency required O&M reserves, the TDC calculation must be reduced by the amount that is used to fund the O&M reserve.
Under guarantee Options One (permanent financing only guarantee) and Two (construction advances and permanent financing guarantee), funds for the O&M reserve may be contributed to the project upon the closing of a permanent loan. Under Option Three (continuous guarantee), the O&M reserve will be set up and fully funded prior to or at the closing of the construction loan. The funds will be deposited to the project's general operating account and lose their identity as O&M funds. The funds will not be returned except as a "surplus cash distribution" at the end of the year and only if the requirements of Paragraph 7. E. have been met.
The items that are typically funded by the original O&M reserve amount include, but are not limited to, property and liability insurance premiums, fidelity bond premiums when the borrower is also the property management organization, utility installation charges and deposits, maintenance equipment, lease forms, loan payments that may become due during construction, purchase of office equipment and furniture, community room furnishing, other movable equipment and furnishing, congregate items, advertising expenses, management fees, etc. State Office staff should verify that the initial payment for O&M reserves has been made in accordance with the Reserve Account Agreement or any other mortgage document governing O&M reserve accounts.
In lieu of a cash contribution for the O&M reserve, the lender may accept an unconditional and irrevocable letter of credit that is issued by another lending institution in an amount that is at least equal to the required O&M contribution level (at least two percent of the loan amount). The letter of credit must remain in
(02-23-12) PN 455
Revised (03-15-17) PN 495
the guarantee contained in the Conditional Commitment and this part are completed and approved by the Agency by the date stated in the Conditional Commitment and any Agency approved extension(s) (7 CFR 3565.303 (d)).
Under Option Three the lease-up reserve must be established prior to the closing of the construction loan and funded 30 days before the first Certificate of Occupancy is anticipated ( 7 CFR 3565.52(e)(3) ).
Contingency Reserve
When the Agency is guaranteeing the construction draws [as well as the permanent loan], the Agency requires the construction contingency reserve to be set at a minimum of two percent of the construction contract, inclusive of the contractor’s fee and hard and soft costs. This reserve is required under Options Two and Three.
The construction contingency reserve will be set up and fully funded as a cash contribution prior to or at the closing of the construction loan. The construction contingency reserve will be held and managed by the lender. The disbursement of funds from the construction contingency reserve will be made by the lender only for change order requests approved by the lender and an Agency representative.
Unused funds from the construction contingency reserve transferred to the O&M reserve cannot be released until the project reaches occupancy of 90% for 90 days at the underwritten NOI and all reserves remain fully funded. This requirement remains in effect notwithstanding that the lender has established an additional Lease-Up/Conversion reserve in lieu of the occupancy requirement as provided in Chapter 4.19.
The lender at its own discretion, may release unused funds in the construction contingency reserve to the borrower after all other reserve accounts are fully funded, construction/punch list items are complete, certificates of occupancy have been issued, all lien releases have been obtained, and the Agency’s final inspections have taken place and are satisfactory. If the lender decides not to release the unused funds to the borrower then it must transfer those funds to the O&M account and inform the State Office. If any portion of the construction contingency reserve funds are used during the construction period, those remaining funds will be transferred to the O&M reserve account and will lose its identity as construction contingency funds.
(02-23-12) PN 455
Revised (03-15-17) PN 495
Interest Credit Reserve (if Applicable) The interest credit reserve is to be established in order to pay the interest credit to the project in its first year of operations in lieu of the actual interest credit payments which are made in January of each year. The interest credit is payable annually in arrears after the first day of January following the project’s first amortization payment. The interest credit reserve will be reimbursed to the borrower within 60 days of receipt of the interest credit payment to the lender.
Initial Deposit to the Replacement Reserve The Capital Needs Assessment and Capital Improvement Plan may call for a replacement reserve escrow that requires an initial deposit to the replacement reserve. The reserve account balance must meet or exceed a $1,000/unit threshold by year three. Such an initial deposit is typically associated with a rehabilitation project and not with new construction. See Paragraph 7.13 for further details. For new construction projects, the reserve deposit will be based upon local fixture costs, age, and conditions.
SECTION 4: PROPERTY REQUIREMENTS
3.11 OVERVIEW
To achieve long term success, GRRHP projects must be competitive with other rental properties in their market area. Property characteristics such as location, size, amenities, and environmental conditions are important to the success of a rental housing project. Each of these characteristics affects a property’s marketability, financial success, and value.
Ensuring that certain minimum property standards are met is important to maintaining the ability to remain competitive and financially viable over the long term. In evaluating property, lenders are expected to evaluate the site conditions as well as the buildings which will be constructed or rehabilitated on the site.
3.12 RURAL AREA DESIGNATION
Lenders must verify that projects are located in an area that meets the Agency’s definition of a rural area (see Paragraph 1.6). Lenders must contact the State Office to verify eligibility.
3.13 GENERAL SITE REQUIREMENTS
Multifamily housing properties must be located in areas that are appropriate for residential housing and represent reasonable real estate investments. To meet this requirement, the area where the site is located must be a residential area that provides adequate services and facilities and is free from undesirable conditions. The requirements for an appropriate location are detailed below.
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B. Adequate Utilities and Infrastructure Sites must have infrastructure and utilities that are adequate for the needs of the site and that meet all local requirements. Ideally, the utilities should be publicly owned and have adequate capacity for the proposed development. If the project will operate its own system, lenders must approve the justification for private ownership. C. Grading and Drainage Soil and geological conditions must be suitable for the type of construction proposed. In questionable and unserved areas, the lender must obtain an engineering report with supporting data to identify all pertinent subsurface conditions that could adversely affect the structure and show proposed solutions. D. Size and Shape The size and shape of a site must be adequate for the proposed units as well as walks, parking, any onsite septic system, and other site improvements. E. Undesirable Physical Conditions Sites must not have undesirable physical conditions that create hazards or unnecessary development costs, such as: Rocks or soil conditions that increase development costs; Noise from nearby roads, railroad tracks, airports, or factories that create unacceptable residential conditions; and Pollution from nearby sources that create hazardous health conditions.
3.15 SITE DENSITY
Acceptable density standards will vary by market area and local codes. Because of these differences, program rules do not provide specific density standards. Instead, project density should be evaluated based on:
Compatibility and consistency with the market and neighborhood. Sufficient size to accommodate necessary site features. Impact on total development costs and project budget.
3.16 NON-CONTIGUOUS SITES
The Agency prefers to guarantee loans for single and contiguous site projects, since projects on single sites or contiguous sites are generally easier to manage and monitor than non- contiguous sites. Non-contiguous sites may be eligible for guarantees if the lender certifies that the parcels of land are:
Located in one market area (a neighborhood or similar area where the property competes for tenants);
Managed under one management plan and one management agreement; and In sufficiently close proximity to permit convenient and efficient management of the property.
3.17 SITE CONTROL
At the time of closing, the borrower must have control of the housing and related land. Control means either current ownership rights to a long-term lease or a valid option to purchase or lease the land. After closing, the borrower must have a fully marketable title (fee interest) or land lease.
A. Land Ownership
The only form of ownership acceptable to the Agency is fee-simple ownership. Under this form of ownership the borrower holds a fully marketable title, which is evidenced by a deed. The deed vests full interest in the property to the borrower. If proof of site control is in the form of a land purchase contract, full ownership interest must be converted to a deed prior to closing the loan.
B. Land Lease
A land lease is acceptable if the lease meets the following requirements:
The lessor owns the land fee-simple;
Neither the title nor the leasehold are subject to prior liens other than taxes not due and payable;
The amount of the guaranteed loan does not exceed the market value of the property, including the value of the leasehold;
The unexpired term of the lease exceeds the term of the mortgage by at least 25 percent;
Rent charged for the lease does not exceed the rate being paid for similar leases in the area; and
It is recorded in the location necessary to give notice to the public of its existence.
The lease must be in writing and must contain the following provisions:
The lessor must authorize the proposed improvements required by the guaranteed mortgage;
3- (02-23-12) PN 455 Revised (03-15-17) PN 495
B. Agency Environmental Review
The National Environmental Policy Act (NEPA) requires Federal agencies to take into consideration the potential impacts of a proposed project on the human environment and on any protected environmental resources in the vicinity of the proposed site. Therefore, prior to loan approval, obligation of loan funds, issuance of a conditional commitment, or other commitment of Agency resources, whichever occurs first, a NEPA environmental review must be completed and conducted in accordance with 7 CFR part
- The environmental review examines the environmental consequences of the proposed action and ensures that alternatives are developed and incorporated into the proposal to either avoid environmental impacts or to mitigate adverse effects to the environment. Further information is found in Chapter 11. The applicant is responsible for conducting the NEPA review. For projects with 5 - 12 units, the Agency, at its discretion, may conduct the review for the applicant.
3.19 CIVIL RIGHTS
Residents of housing projects benefiting from Federal assistance have the right to live in their homes free from the burden of discrimination. Consequently, for every GRRHP project, the State Office staff will conduct a civil rights impact analysis to determine whether the proposed project would negatively or disproportionately affect tenants by virtue of their race, color, sex, national origin, religion, age, disability, or familial status.
The civil rights impact analysis will address two areas in particular: The extent to which the project serves all eligible members of the community. The Agency will examine applicant plans to market the project affirmatively and to implement non-discriminatory occupancy policies and procedures. The extent to which the project creates disproportionately high and adverse human health or environmental effects on minority and low income populations. The State Office will examine the project proposal to ensure that there are no factors that create adverse environmental impacts. Examples of such factors include locating the project near a sewage treatment facility, train tracks, or a farm that routinely sprays or dusts crops.
Guidance on the civil rights impact analysis can be found in RD Instruction 2006-P. This form should be completed and filed with the Agency’s Environmental file folder.
3.20 PROJECT DEVELOPMENT
All construction, rehabilitation, and use of the property must comply with applicable governmental statutes, codes, rules, and regulations.
(02-23-12) PN 455
Revised (03-15-17) PN 495
A. Project Size
Rental housing properties with less than five dwelling units are ineligible for guarantee. There is no maximum number of dwelling units that renders a project ineligible. However, the market analysis, which is a part of the underwriting process, takes into account market demand and could limit project size.
B. Agency Construction Requirements
New construction, rehabilitation, modular, and manufactured structures must meet the standards contained in RD Instruction 1924-A and the site development standards found in RD Instruction 1924-C. Unless an exception is granted for special housing needs as referenced in Paragraph 3.23, refinancing of existing housing and indebtedness is not an authorized use of guaranteed loan funds.
The lender is responsible for inspection of the project to ensure compliance with contract documents and State and local building requirements.
Acquisition with rehabilitation is permitted, subject to the following conditions:
The portion of the program authority guaranteed funds for acquisition with rehabilitation may be limited depending on program goals;
Rehabilitation requires replacement or alteration of building spaces, mechanical systems, or project facilities;
Existing structures must be structurally sound and functionally adequate prior to the start of repair work;
Per unit rehab costs must be at least $6,500 or more; and
When completed, the rehabilitated building(s) must be energy efficient and in “like new” condition. Rehabilitation with a stay-in-owner is permitted, subject to the following conditions:
Rehab costs must be at least $6,500 per unit and the rehab renders the project in like-new condition [and energy efficient] as corroborated by an Agency approved C.N.A. that shows no deferred maintenance and that no repairs will be needed for at least the next 5 years.
The owner/borrower (or any of its principals) cannot receive any payments/compensation/fees/cash-out (as consultants, developer, contractor (general or sub), equity, etc.) from the guaranteed loan funds.
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