Complex Challenge, Careful Approach

Our board has been discussing how best to fund several large capital improvement projects. One of the options under consideration is refinancing our building’s underlying mortgage. One of our newest board members moved from another building where a refinancing took six months! Is that what we should expect?

Absolutely not! However, without visiting your building, discussing your planned improvements, and reviewing your cooperative’s financial records, I hesitate to give you a specific time frame. Nonetheless, I can’t imagine a scenario that would take anything like six months.

Refinancing an underlying mortgage is a complex process, one that requires thorough planning and careful execution. My guess is that your new board member’s former building failed on one or the other, or both. While I have completed transactions in as little as three days, most take around two months. Assembling all of the necessary information, deciding on the amount, term, and amortization schedule, and then sorting through the various lenders and loan offers will consume at least half of that time. Reviewing the commitment and closing your new loan will take up the balance.

Virtually all lenders have a formal loan approval procedure that starts when a signed application is received, then passes through “underwriting,” and culminates in the issuance of a “commitment.” Each lender has its own set of forms that comprise the “application.” These help organize all of the information that the lender needs to determine whether the proposed loan makes economic sense. None of the information requested is that complex, although you might have to call a few of the shareholders who have lived in the building for a long time and/or several of your building’s advisors to get some of it.

Some forms require no more than a date and the signature of one of the co-op corporation’s officers. Typically, these are authorization forms that give the lender permission to verify certain information. For example, a loan verification form asks your existing lender for information regarding your co-op’s current loan (lender, address, loan number, contact person, phone number, etc.) and your payment history. You should be ready to explain any late payments or other credit issues. Deposit verification forms allow the new lender to confirm that the checking, savings, money market, and investment account balances that the co-op reported are accurate.

Some lenders also send an environmental questionnaire that helps them determine whether the co-op’s property presents any environmental risks. While board members and managing agents may not be able to answer every question on such a form, they should be as complete and honest as possible. If the co-op’s questionnaire provides enough information, the new lender may waive any further environmental investigation (thus saving the co-op substantial time and expense). If not, the lender most likely will order a follow-up inspection by a licensed environmental engineer to evaluate potential hazards.

The next step in the loan approval process is “underwriting.” During this phase, the loan officer and other lender personnel evaluate all of the information that the co-op supplied on its application and various accompanying forms, as well as any other facts provided. Annual accounting statements paint a picture of the co-op’s financial condition and indicate whether the co-op can carry the new debt and ultimately pay it back. Additional supporting information will come from a credit report, appraisal, engineering inspection, and environmental assessment that the lender might order from third parties. The co-op’s credit report is much like what would be requested for an individual. It lists the co-op’s outstanding loans, liens, judgments, and other obligations as well as its corresponding payment histories. All lenders want to be sure that potential borrowers pay their bills on time.

An appraisal (if required) will determine three hypothetical values for your co-op: its replacement value (the cost to rebuild the building today on the same or similar lot), its sale value (based on recent sales of “comparable” properties), and its investment value (based on the income stream your building would produce if it were a rental). Lenders consider all three values, but they give the most weight to your co-op’s value as a rental because, if your co-op doesn’t make its payments and the lender must foreclose, your co-op would revert to rental status. The appraisal forms the basis of the lender’s loan-to-value ratio (LTV) calculation. Each lender has a maximum LTV limit, usually around 65 percent.

Many lenders also hire a professional engineer to thoroughly inspect the co-op’s property to make sure that no significant repairs are needed. Serious defects and building department violations must usually be corrected before (or very soon after) the new loan closes. Some lenders even escrow (hold back at closing) funds until such repairs are completed. In addition, the lender may insist that the co-op establish a special “replacement reserve” to pay for major repairs that the engineer thinks may be needed during the term of the new loan.

An environmental assessment (if required) will determine whether the co-op’s property contains any hazardous substances (asbestos, lead paint, oil spills, etc.), whether any substances that were found pose a risk to co-op residents or adjoining properties, and (if so) what steps may be required to eliminate or reduce those risk(s).

Once a loan officer has evaluated this information, he or she usually summarizes the findings in a report to the institution’s loan committee. The committee’s members typically evaluate each application in light of the others under consideration. If the co-op’s application presents an attractive lending opportunity with relatively low risk, it will be approved. If the co-op’s application is deemed to be higher risk, it may be approved with special conditions, rescheduled for further discussion, or rejected. If the application is approved, the loan officer will send out a commitment.

Since the commitment letter is the document that everyone has been waiting for, its arrival does justify a small celebration. However, much important work remains to be done. If the board has not discussed its planned refinancing with the co-op’s attorney before this point, it must do so now. Under no circumstances should a co-op return a loan commitment to a lender before reviewing it with its attorney. Every refinancing has myriad business and legal issues that must be handled carefully to avoid future problems for the co-op. The right time to address these issues is in the commitment (or even in the application, as some attorneys suggest), and the right person to address them is the co-op’s legal advisor.

While every commitment is a contract between lender and borrower that contains all of the terms of the proposed transaction, most commitments contain one or more conditions that must be satisfied within a reasonable time period before this contract is binding. If even one of these conditions is not met, your deal can fall through. Conditions in a commitment usually relate to documents or other information that must be supplied by the co-op’s attorney.

For example, every loan requires a new title insurance policy to protect the lender’s security interest. Most lenders want a report from the secretary of state certifying that the co-op is a corporation in “good standing.” They also request an “opinion letter” from the co-op’s attorney testifying that your co-op was properly formed and continues to operate as a bona fide cooperative. Most lenders require assurances that your property does not have any serious building code violations, mechanic’s liens, easements, or other encumbrances. As soon as all of this information has been reviewed by the lender’s attorney, a closing will be scheduled.

The closing is the final step in most refinancings. The closing is a meeting (attended by at least one co-op officer, the co-op’s attorney, the lender’s attorney, a title company representative, and others) at which the old loan (if any) is paid off and all of the documents describing the new loan are signed. It also is when all of the expenses of the refinancing are paid and the new loan proceeds are disbursed to the co-op.

A properly organized closing should take about two hours. However, if there are unresolved issues, a closing can last all day – or longer! Thorough preparation makes a big difference.

If you and your fellow board members plan carefully, stay focused, and involve all of your co-op’s professional advisors from the beginning, your refinancing should be completed within 60 days. It will be a very busy time, but a very important and rewarding one as well. I wish you every success!