As communities mature more and more boards are faced with the responsibility and need to do major repairs of their common areas. Often, because of unanticipated problems lack of or un-funded reserves, associations do not have sufficient funds to make necessary repairs.
In the past when faced with a situation where major repairs were required and funds were not available, associations had no alternative but to pass a special assessment, defer repairs, or complete the work piecemeal over time. Each of these solutions has its own shortcomings and can create new problems for the board and the association members.
Special assessments, are never popular, can create a real hardship for owners, and are often difficult or impossible to pass. Putting off necessary repairs is in clear conflict with the board’s fiduciary responsibility to “preserve enhance and protect” the value of the asset, and can create additional liability for the association if questions of health and safety are involved. Spreading the work over time often will increase the overall cost of the project; lead to excessive insurance claims for repairs and can become a source of owner dissent.
Fortunately, some banks are becoming increasingly aware of the large and growing association industry and, in some cases, are willing to lend money to associations for major repairs. A few institutions have even established specialized divisions to handle association financial needs and offer special loan programs to associations. Although such loans are not always easy to obtain and require special documentation, they do offer a practical, and attractive alternative to the other choices.
ASSOCIATIONS AS BORROWERS
Associations have all of the powers and characteristics of any other corporate borrower with two important exceptions. The first is that associations are not dependent on sales, or the vagaries of the economy to produce revenue for operations and debt service. The assessment and enforcement powers of the association guarantee revenues. The fact that associations can generate revenue simply by raising assessments or by passing a special assessment will obviously be seen as a plus by a lender considering a loan to an association. The second important difference between associations and other businesses is the associations; because elected volunteers run them, do not have the continuity of management, which is typical of a business borrower. A lender looking at an association loan request will be aware that the individuals negotiating the loan may not be the same people representing the association during the life of the loan. For this reason, the lender’s assessment of the general business practices as well as the financial management of the association will be a critical part of the credit decision. Association financial reports, board minutes, resolutions passed relative to the loan transaction and other association records which are in good order will help convince the lender that the association conducts its affairs in a businesslike manner.
Relations between the association board and owners will also be a crucial element in the credit decision. The association should be prepared to discuss the attitude of the owners concerning the financial situation of the association and the proposed loan transaction. Association representatives should document precious communications with the owners and have plans in place to keep membership informed about the proposed loan. Nothing will damage a loan request faster than the appearance that the board is circumventing its responsibility to communicate with the owners. Organized resistance by owners, which is often the result of poor or failed communication, will invariably result in the loan being declined by the lender.
An informed and united board, which presents a clear and well thought out loan proposal will have a much better chance for a favorable decision. Before submitting a loan application the association’s board must do their homework. The loan proposal should be for a clearly defined purpose. The tentative completion schedules should be included in the proposal. Most importantly, financial projections, demonstrating the association’s plans and financial capacity to repay the loan, should be in place.
In considering a loan it is important that the board have realistic expectation. The loan amount must have some prudent relationship to the resale value of the units. The proposed loan repayment period must amortize the loan in a logical period of time relative to the amount borrowed. If repayment is to be funded by a special assessment payable over time, the special assessment payment should have some reasonable relationship to the regular assessment amount and the unit owner’s capacity to repay. Above all the board must understand that a loan is not a magical solution to the association’s financial problems. There is no free lunch. Loan costs, including fees and interest, will be significant and must be factored into the association’s budget and repayment plans.
WHERE TO FIND A LENDER
When shopping for a loan, an association will clearly be better off if they can find a lending institution, which offers specialized financial services to associations. A lender who does extensive business with associations will have a better understanding of the powers of association boards, the complex responsibilities of association’s directors and will be familiar with association governing documents. If there are no financial institutions in your area, which specialize in services to associations, the next best prospect will be to find a lender who lives in an association. With luck you ma find a banker who serves on an association board.
If you cannot find a lender familiar with the basics of community associations, the board’s representative should be prepared to discuss the organizational structure of the association, assessment powers of the board, association governing documents, and the fiduciary duties of association directors. The individual proposing the credit request for the association will need to be both a salesperson for the association and an educator.
COLLATERAL
A typical lender when approached for a loan by an association will think in terms of tangible collateral for the loan, i.e. a lien on the common areas, liens on the individual units or personal guarantees for the loan by directors and officers of the corporation. None of these alternatives is practical in most situations.
Typically the common areas of an association are already so encumbered that a lien on the common areas has little useful value to a lender as collateral for a loan. In order to lien individual properties lenders must do title searches, pay recording fees and obtain the permission of the unit owner. These problems render placing individual liens impractical. As for personal guarantees of directors and officers, even the most dedicated volunteers would not be likely to make such a commitment.
Unless the association has title to a manager’s unit, owns commercial leases, owns build able land or has other such assets to pledge as collateral, the most practical way to secure a loan is by pledging future assessment revenue as collateral. Such a transaction is similar to a for-profit business borrowing against its accounts receivable.
Lenders who understand the collection and enforcement powers of association’s boards usually will secure loans with future assessment revenue. If the association has sufficient cash flow to service the debt form regular assessments, the lender will probably require a line item in future budgets for loan payments. If a special assessment is required to pay the loan, the lender may request a specific assignment of special assessment payments. As a condition of the loan, most lenders will also require a conditional assignment of the association’s enforcement and collection powers. This will place the lender in the position to enforce collection of assessments should the board cease to do so and the association defaults on the loan.
LOAN STRUCTURE
In many loan situations the exact amount of money needed to complete repairs may not be known when the project begins. This is particularly true with roofing projects, dry rot repairs and similar jobs where the full extent of work to be done sometimes cannot be determined until after the project is underway. Another variable, which can affect the amount borrowed, is the pre payment of special assessments by some owners. This will reduce the amount needed by the association from the lender.
The easiest way to manage these variables is to have the loan structured, initially, as a line of credit for the maximum amount needed. Such loans should include a provision in the loan agreement that the loan will be converted to a term loan, for a fixed period, upon completion of the project. A loan structured in this way will give the association needed flexibility and will minimize loan costs. Funds can be drawn on the line of credit as needed. During the drawdown period interest payments will be due, but only on the amount drawn, not the full amount of the loan. When the project is completed the final principal balance will be converted to a term loan and regular payments, including principal and interest, will commence.
For loans involving a line of credit to be converted to a term loan, lenders will require that the draw down period have a definite expiration date, usually one year or less. Most lenders will usually require that the association negotiate “not to exceed” contracts so that the exposure of the association is limited once work has begun and the maximum amount of the loan can be determined when funding is committed.
For less complicated or short-term projects, the loan can be structured as a regular term loan. These loans are funded in full when approved and will be paid off over a fixed term with an amortization schedule such as is used for real estate of installment loans.
Most borrowing situations can be accommodated by the loans described above. However, in some circumstances other structures may be useful. This is especially true when the association anticipates an infusion of cash from a source other than assessment revenue, i.e. a legal settlement, cash form sale of assets or maturing investments. In these situations, a loan with structured principal reductions over time, or a balloon payment at the end of the loan may lessen the strain on association finances. A creative lender will be willing to work with the association to design the best loan for its needs.
THE APPLICATION PROCESS
Loan procedures will vary from lender to lender as will particulars of what information is requested from the association. Typically, the lender will want copies of the association’s governing documents (Articles of Incorporation, Declaration of Covenants and Bylaws) including all amendments. Lenders will also request a copy of the current year budget and current financial statements (Balance Sheet, Income Statement and Delinquency Report). A copy of the association’s last audited or reviewed financial statement and a copy of the current reserve study may also be requested. Some lenders may also ask for a copy of the association’s written collection policy as disclosed to the unit owners and minutes of recent board meetings. Before the loan is funded, lenders will require a Borrowing Resolution properly certified by the association’s Secretary. This document establishes the board’s authority to negotiate a loan.
Associations are well advised to involve their attorney at the early stages of loan negotiations. Before proceeding with a loan application, most lenders may require a written statement from the association’s attorney certifying the association’s authority to borrow and pledge assets as collateral. The lender may also request that the association’s attorney statement also include verification that the borrowing resolution, certified by the secretary, was passed in accordance with the governing documents and applicable law.
Before closing a loan transaction, most lenders will require another opinion letter from legal counsel stating that counsel has reviewed final loan documents and all details of the transaction on behalf of the association. The attorney will be asked to certify that the loan documents are legal, binding and enforceable and that all resolutions passed and actions taken by the board and/or the unit owners, relative to the loan transaction, were taken in accordance with the association documents. Even if the lender does not require such an opinion letter, a prudent board would be wise to seek the advice of counsel for its own protection. Another reason for involving the association’s attorney early in the process is that the association’s governing documents may include requirements, which will affect how the loan is structured and how resolutions are to be drafted. The association’s attorney is the person best able to advise both the association and the lender how to structure the transaction to fit the requirement of the governing documents. If the association has special requirements or restrictions which effect the loan transaction, much time and trouble can be saved if they are defined early in the application process.
LOAN DOCUMENTS
Loan documents will vary form lender to lender. In every case, however, association officers will be asked to sign a note, which is the association’s promise to pay. Unless the loan is made on an unsecured basis, a security agreement will be required pledging association assets as security for the loan. When assessment revenue or personal (non real estate) assets of the association are use as security for the loan, the association will also be asked to execute a financing statement. This document specifies collateral pledged by the association and is recorded as a public record of the lender’s claim.
In addition to the standard loan documents, some lenders may draft a special loan agreement to be executed by the association. The purpose of the loan agreement is to specify in detail the exact terms and conditions of the loan. Typically the loan agreement will include definitions, conditions for disbursements, insurance and compensating balances requirements and similar matter. When assessment revenue is pledged for the loan, the loan agreement may include an assignment of assessments and enforcement clause. Terms of the loan agreement are negotiable and will vary with each loan.
LOAN CONDITIONS
Many association loans will be approved subject to conditions required by the lender. Specific conditions are subject to negotiation between the lender and the association and can include virtually anything mutually agreed upon which is lawful and not in conflict with the association governing documents.
Most banks will require that the association move its deposit relationship to their institution as a condition of the loan. Periodic updates of association financial information are another common condition required by lenders. Depending on the complexity of the renovation project being financed, the lender may impose conditions relative to disbursement of loan proceeds. In highly complex situations the lender may require that a construction manager, approved by the lender, be retained by the association or that the bank make periodic inspections of the work in progress. Lenders may place restrictions on the association’s authority to amend documents during the life of the loan and may require that the association obtain prior approval of the lender before changing a management firms. Generally, however, lenders are reluctant to involve themselves too deeply in affairs of association’s, which are properly, and responsibility of the association board or its managing agent. Loan conditions will increase in complexity depending on the complexity of the repairs being financed. Before agreeing to loan conditions the association should consult with their attorney and managing agent to be sure that ongoing operations of the association are not unduly disrupted.
Obviously, a decision to seek a loan to finance major repairs can have a major impact on the association board and the community as a whole. No one likes to borrow money, however, associations like any other business, often have legitimate needs and responsibilities which can best be addressed through prudent borrowing. An association board, faced with major repairs and a funding shortage, will be meeting its responsibilities and serving its community well if. In addition to the more traditional alternatives, it also considers the feasibility of financing repairs with a loan.
