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7. Staff Report - Loan UnderwritingPage 1 of 4 City of Scandia 14727 209th St. N. PO Box 128, Scandia, Minnesota 55073 Phone (651) 433-2274 Fax (651) 433-5112 http://www.ci.scandia.mn.us DATE: June 10, 2022 TO: EDA Commissioners FROM: Ken Cammilleri, City Administrator RE: Drafting Loan Underwriting Procedures and Colateralization The following memorandum is intended to provide the Board of Commissioners with the basic principles that need to be considered when developing a business subsidy loan program. The program document for our existing fasade improvement program is mostly adequate, but it’s the application and the review process that needs improved upon so that the program can effectively be used. The Review Process and the Roll of the Loan Review Subcommittee Typically staff or a consultant carries out a full review of the application with supporting materials and information and provides a recommendation to a review subcommittee. This is an independent committee responsible for direct oversight of loan underwriting so that private financial information of applicants are kept private and not openly discussed on the record at the EDA or City Council. The subcommittee, upon completion of review of the staff report and application materials will make the final recommendation necessary to bring the loan request forward to the EDA Board and eventually, the City Council. Because of the nature of the subcommittee’s role, it is helpful to have experienced members familiar with the underwriting process such as bankers and other experienced lending officers to help provide the added level of due diligence the review process requires. Membership should exclude appointments that could constitute a quarum of the EDA Board or City Council. Review Considerations for Staff and Subcommittee The first step in the review process is to determine if an applicant’s request meets the rules and criteria of our lending policy. Often this due diligence process requires following up with the applicant to obtain any necessary materials, information, and confirmations from the applicant. The primary goal in this phase is to clarify that the request meets our loan program’s lending criteria and to establish the understanding of the financial risk associated with providing the loan. To assess the likely viability of repayment and overall financial risk, we should consider reviewing credit history with credit reports from all three credit agencies, review of bankruptcy status, obtaining information on existing liens, pending civil actions, financial statements, business and management experience, the personal equity or investment the applicant (essential!), and the assessment of available collateral including personal or corporate guarantees. (On a related note, our policy should stress personal equity minimum or a minimum on personal capital supplied to the façade improvement. In other words, we should be expecting money down from the applicant.) If there are other lenders providing financing for the same request, then it is important to actively reach out to these lenders when assessing a loan. Other lenders may have a total threshold of Page 2 of 4 City of Scandia 14727 209th St. N. PO Box 128, Scandia, Minnesota 55073 Phone (651) 433-2274 Fax (651) 433-5112 http://www.ci.scandia.mn.us financing they are willing to provide based on available collateral and risk, so this will ultimately influence what the ultimate loan amount may be and what collateral may be available to back our loan. It is also important to remember that the City and EDA will often be in a subordinated position, typically last position, when collecting on a collateral package when lending is leveraged by other financiers. Given we are dealing with dollars derived from the public, it should be important that our policy includes a priority statement that indicates that the EDA & City will supply loans at moderate to low risk level. The determination of this threshold is at the discretion of the Board and City Council. Maintaining flexibility is an option, but high risks may bring higher rewards but often result in financial losses. So, high risk lending should be avoided all together. Setting an Interest Rate and Structuring Loan Once credit worthiness or an agreeable level of risk is established, the next step is to adopt an interest rate based on policy criteria and to apply it to a structured repayment plan or amortization schedule which will lay out the timing of payments for the reduction of the loan obligation. (*On the loan serving side or the side where loan payments are collected, it is important to adjust the amortization based on time of receipt and amount paid over minimum payment.) Again the current loan ammounts and interest policy included in this program are adequate, but its important to remember that we are both attempting to encourage beneficial outcomes for our local economy, i.e. improving the physical appearances of our businesses to attract customers, and to potentially grow our fund to carry out future lending. Interest rates for façade improvement programs are typically much lower than normal revolving loans as the intent is to incentivize improvements. A typical revolving loan policy will set the minimum interest rate of a loan at 2 to 4 percentage points below the current money center prime interest rate quoted in the Wall Street Journal (WSJ Prime Rate). (The prime rate is a rate that a lending institution would be offered to the most ideal and creditworthy customers). The EDA was to consider a RLF, its policy should recommend a set rate, I suggest a rate as low as 2 points below prime with an exception a higher rate may be offered dependent to the nature of a particular request.) Façade improvement loans and revolving loans typically apply strain line or linear amortization schedules as this is both the simplest and most straightforward way to structure debt repayment. With fixed periodic total payment and interest amount, the principal repayment is also constant over the life of the loan, except at the start and end of the loan cycle. (This would be calculated by staff and included as part of the final loan agreement.) Grace periods can be considered and built into the amortization plan or schedule to help an applicant leverage other obligations before payments on a loan are to begin. Typically, interest accrues during this period with no financial penalties. Most periods that are typically considered are between a few months to a year. Closing On Loans Here is are steps for closing on a loan once the EDA Board and City Council have approved the loan: Page 3 of 4 City of Scandia 14727 209th St. N. PO Box 128, Scandia, Minnesota 55073 Phone (651) 433-2274 Fax (651) 433-5112 http://www.ci.scandia.mn.us Drafting and executing a loan agreement with the inclusion of final calculated amortization schedule. (This process is carried out by staff and the City Attorney.) Mostly likely we will develop a standard template for this after the first loan. It will include all necessary legal compliance criteria including what is required. · Drafting and completing a loan subordination agreement only when collateral positions must be shifted or determined with other lenders. However, most mortgage and other lenders include in their loan agreements a subordination clause that automatically places them in first priority position to collect collateral on loans. · Submit a Uniform Commercial Code (UCC) filing of a lien with the Minnesota Secretary of State for applicable personal property or equipment and/or other physical assets. (Note that liens not only formalize commitment to repay debt but also statutorily extends the debt obligations over 10 years. This requires the loan administrator to assure that lien filings are renewed before expiration, especially when a loan exceeds the ten year threshold.) · Recording of lien to the property records applicable for real property or buildings and land) · It is not necessary or customary to file with credit rating buearus because lien filings are often searched by them and are frequently included in reports. The setting of Application Fees It is important to note that when lending public funds, a number of additional costs are associated with it. Often, loan fees are subsidized to cover some of these costs, but it will be up to the Board to recommend what that fee should be upon considerations of costs. Loan process cost considerations: - Cost of administrative review and staff time working with applicant - Cost of obtaining credit reports - Costs associated with obtaining a letter report from the County to review any applicable real property liens. - Cost of legal review of documentation - Cost of preparation and legal review of loan documentation - Recording costs associated with closing - Cost of filing liens, renewing liens, and the satisfaction of liens (typically $20 per filing or recordings $81.00 for 1st page and $5.00 for each additional page) - Costs associated with partial lien releases, if applicable and permitted by rules Loan Processing and Contracting of Services City staff will be responsible for collecting payment, adjusting amortization accordingly, calculating payoffs, and maintaining business subsidy compliance reporting with the state of Minnesota if loans exceed $25,000 in the future. This process can be contracted along with the staff underwriting process, if our City lacks the professional experience necessary to complete a diligent review. Page 4 of 4 City of Scandia 14727 209th St. N. PO Box 128, Scandia, Minnesota 55073 Phone (651) 433-2274 Fax (651) 433-5112 http://www.ci.scandia.mn.us Legal Compliance Considerations with State Business Subsidy Laws Lending more than $25,000 or a guarantee of $75,000 or more, but less than the $150,000 required to constitute a business subsidy. If a city offers such financial assistance it must develop criteria and set minimum wage floor levels as prescribed in business subsidy law. Cities granting such financial assistance must submit business assistance reports to DEED within one year of granting the assistance. Therefore, it is recommended that lending under this program not exceed 24,999 or available fund balance below this threshold. I have included an example form and proposed minor amendments to the policy in your packet. Please let me know if you have any questions.