The Evolution of the End Loan The Lending Industry's Relationship with Shareholders

The Evolution of the End Loan

Remember the early 1980s? Reagan was president, the national economy was strong, property values

were skyrocketing and co-op sponsors were converting multi-unit residential buildings in the New York area faster than you could say offering plan. If you wanted to purchase a co-op apartment in Manhattan, all you had to do was walk into a savings bankthe few commercial banks that are now making cooperative end loans didn't enter the picture until recentlyand apply for a loan. Of course, back then you weren't applying for a co-op loan, because co-op loans didn't exist. In those days, you applied for a personal or consumer loan. And, in most cases (assuming you were creditworthy) you got it.

Then, as the decade neared its close, dastardly events began to unfold. Unable to sustain their unprecedented inflated levels, real estate values plummeted. And the wave of co-op conversion activity was replaced by defaulting sponsors and shareholders. Lending institutions, increasingly saddled with non-performing loans, began to realize that they had better start looking more closely at the cooperative landscape. For a timewhile some lenders pulled out of the cooperative market altogether and others analyzed it to become more familiar with the intricacies of the cooperative lifestyle and its attendant lending risksit seemed almost impossible to get a loan to buy a cooperative unit.

But, the economy is traditionally cyclical and a snapshot of the city's cooperative market today reveals stabilized pricing, an increasing number of owner residents, a marked decline in the roles of sponsors, and a more savvy lending community which is now ready, willing and able to make informed loans to prospective co-op shareholders.

A Complicated Undertaking

The market is pretty much stabilized, explains Jim Banahan, vice president of the New York Share Loans Division of the Washington, DC-based National Cooperative Bank. It's no longer as fearsome an undertaking for someone to buy a co-op because everyone's aware of the negative results of the '80s. Not as fearsome, perhaps; but, significantly more complicated. Today, when prospective shareholders approach lending institutions for co-op loans, the paperwork associated with underwriting the application is formidable, embracing not only the shareholder's creditworthiness, but also the financial condition of the property itself. For lenders, this is the foremost consideration.

In addition to providing information regarding their own personal finances, prospective shareholders also have to wait for most lenders to conduct a thorough underwriting of the cooperative into which they wish to buy. This is true, explains Joseph Fierro, president of First Security Financial Services, Inc., a Manhattan-based mortgage banking firm, because lenders have come to understand the risks involved. When you make a loan to a co-op shareholder, you don't have real property as collateral, Fierro says. What shareholders purchase is shares in a corporation. The bottom line for lenders is this: Would you buy stock in a failing company or use it as collateral? Obviously, the answer is no.

Lenders today have two underwriting jobs with a co-op loan, adds Howard Ackerman, vice president of residential lending in New York for Home Savings of America, the largest savings bank in ffb the country. One is the borrower. The other is making sure that the co-op itself is one that the borrower is going to be happy living in, and that we, as the lender, are secure in knowing is going to hold its value.

The Underwriting Process

According to Ackerman, underwriting the prospective shareholder is comprised of four tenets: security (the property); equity (how much the borrower is putting down); ability (the ability of the borrower to repay the debt as evidenced by work history and personal financial solvency); and willingness (the willingness of the borrower to repay the debt, as evidenced by a positive credit history). Then, says Ackerman, comes the all-important underwriting of the project, or co-op in question.

We take underwriting the cooperative projects themselves from a number of angles, says underwritcr Dan Emanuele, project approval officer for the National Cooperative Bank. We look at the financial statements of the building. We make sure there are reserves in place and that the cooperative corporation is operating with a positive cash flow. If not, we look to see what the reasons are. We also look at the co-op's individual operating procedures and sublet policies. Ideally, we like to see no more than a two year sublet allowed. We're looking to ensure and protect our collateral integrity, and if a sublet policy goes beyond two years, we feel that's beyond the time frame for the changes the market can bear.

Lenders like the National Cooperative Bank and Home Savings of America also look at the original offering plan and subsequent amendments as well as legal contingencies surrounding the property that may signal a red flag. And for properties in which the sponsor still plays a significant role, documentation of his financial activities, not only in the cooperative in question, but in all real estate transactions in which he participates, are examined as well.

Of particular concern to lenders is the amount of the property's underlying debt as calculated according to something called the pro-rata ratio formula. According to Mitchell Steinberg, vice president of correspondent mortgage lending for the National Cooperative Bank, lenders calculate the pro-rata ratio by dividing the underlying mortgage balance by the total number of shares in the building. That figure is then multiplied by the number of shares for the unit in question and added to the sales price or appraised value of that unit. Most banks don't want the debt figure to total more than 30 percent, says Steinberg. Depending on how a property shapes up based on the other criteria, the National Cooperative Bank may accept a pro-rata ratio of up to 45 percent.

But perhaps the most salient figure lenders consider when underwriting a cooperative property is the percentage of owner-occupied units in the building; that is, the number of units occupied by shareholders for whom the co-op is a primary residence compared with sublet units, sponsor-owned units and units that may never be converted because the original offering plan exempted them. In general, lenders are happiest to see an owner-occupancy figure of 51 percent or greater.

No Set Criteria

But, says Kenneth Horn, president of Manhattan-based Alchemy Properties, Inc., a real estate marketing, consulting and developing firm, and vice president of Alchemy Mortgage Financing, There is no standardization in this industry, and each lender's criteria for what constitutes a healthy building are different. Depending on how flexible the institution is, they may or may not deviate from this list of criteria.

For example, Horn cites one bank willing to offer cooperatives with less than 51 percent owner-occupancy a bulk end-loan commitment until the property reaches the ideal figure. The niche between 35 percent and 50 percent occupancy is one that some lender has to fill, says Horn.

In late July, the National Cooperative Bank undertook a program to do just that. According to Banahan, the lender's new Bulk Cooperative Commitment Program provides financing t f4e o projects that haven't quite made it to the 40 percent owner-occupancy level in exchange for a fee and other considerations.

Another aspect of co-op end-loan financing that is undergoing an evolution is the way in which lenders get the information necessary for the project phase of the underwriting process. Traditionally, lenders have relied almost exclusively on a co-op's management to provide this information. According to Horn, Many managing agents don't have the information, aren't cooperative or don't respond to the lender's request. So, boards of a growing number of cooperatives have taken it upon themselves to prepare, provide and regularly update this crucial information package for lenders. Doing so enables these properties to develop ongoing relationships with willing lenders, and streamlines what can often be a frustrating waiting process for both the seller and the prospective buyer. It's a good idea, says Emanuele. National Cooperative Bank would like to see such packages updated semi-annually. Fierro says that First Security Financial Services, Inc. is in agreement with this approach. According to Fierro, It's a service to the property's shareholders.

A More Savvy Market

The foreseeable future of co-op end-loan financing depends overwhelmingly on the willingness of lenders to understand the lending risks associated with the co-op community as it is now, and as it is likely to be in the years to come. Ackerman says, The whole market has become a little more savvy. The future is very strong. As for the sometimes arduous application process, Regulations and requireM-ments need to stay as they are, he adds. It's a good system of checks and balances. And that's what 's best for everyone concerned. "

Ms. Dershowitz is a contributing editor for The New York Cooperator.

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