1. Loan Request
1.1 Purpose
The Borrower is Hills Construction, owned by Hugo Cruz with a 51% ownership and Carlos Reyna with a 49% ownership, requesting new money in order to purchase a vacant tract of land located in Brownsville, TX. The land will be used for the future construction project planned for the next two years. Financing includes the acquisition of the land tract, development, and construction of a residential apartment complex. The tract of land has an appraised value of $1,000,000 and according to speculation, the property will increase its value and there will be plenty of rental opportunities once the building complex is constructed and the project is completed.
Besides the acquisition cost of $1,000,000, the projected cost for construction and improvements will add another $800,000 towards the total amount needed. Construction costs will be held low, due to the three companies being able to operate without instructing and involving other companies. This results in the estimated costs for the entire project being $1,800,000. The construction will start immediately after loan approval.
Hills Construction is requesting a Commercial loan of $1,440,000 which would be granted to the company as well as to the other two business entities, Remote Homes, and Fast Construction in order for the acquisition of the land and the construction of the planned building.
The value of the requested loan accounts 80% of the total estimated cost of the project. The other 20% of the cost will be covered by Hills Construction by contributing $360,000 of its equity towards the project. The money will assist to purchase the land as well as to cover the operating costs.
1.2 The project plan
• Location: 7000 Post Oak Cir, Brownsville, TX 78526
• The planned one-complex apartment building, located in Brownsville, Texas, will consist of 6 apartments. The current, median list price per square foot in Brownsville is $83, which reasons the price of the land tract to be acceptable.
• The land tract for the planned project has a gross area of 12,000 sq./ft and the residential building will be built on 60% of this area which comes down to a living are 7,200 sq./ft.
4 apartments in each of the 3 floors are planned and a green yard is surrounding the apartment complex which is supposed to be an attractive offer for families, but also couples looking for a modern flat located in this popular living area of Brownsville. The estimated rent will be $1,200 for the 8 apartments in the first and second floor. The third floor allows to create 4 flats with a roof terrace which increases their values, plus it enables to charge 20% more rent which will result in $1,440 per apartment.
The borrower is confident that the project will generate high profits and once the loan is received, further work on getting the final approval will be done so that the project will be completed within the next 2 years. The estimated revenue that the rental income will generate is going to be $15,360 over 12 months for a total revenue stream of $184,320 per year.
1.3 Terms
The mortgage is an amortizing loan with a monthly payment until maturity. A portion of the monthly payment satisfies the interest, while the other portion reduces the principal balance. One final payment of all remaining principal and accrued interest on the loan will be made on maturity date. The company will be given a 12 months interest only period at loan inception to allow for the construction period. After the 12 months they will start the principle and interest payments.
The 7.25% of interest results in a monthly payment of $8,820.83, equal to the annual, total payment of $105,850.
The principle and interest payment will start right after this 12-months period, which is on December 1, 2019. The terms will call for 360 monthly payments of approximately $9,823.34 which is based on a 30 years amortization. This results in a yearly payment of $119,062.55. The last payment will be made on Nov.1, 2048.
1.4 Pricing
• The loan will be priced at a fixed rate of 7.25%. This rate is a couple points over prime rate
which is justified by the fact that that instead of a floating rate, a fixed rate is used that protects the customer from rising rates in the future.
• An origination of fee 1.0 % will be assessed for processing the loan application. This results in in a total of $14,400.
• Also, an appraisal fee of $300 is going to be charged.
1.5 Collateral
Regarding the collateral, a mortgage is used. This form of collateral secures the bank in case of the project being a failure and not generating the expected return so that the loan cannot be paid back to the bank. 80% of the property, which is the land tract serves as collateral for the borrower which lowers the risk for the bank. Additionally, the 80% of the building complex will be a collateral once the constructions are finished. This consequences in a collateral worth $1,440,00, so that the LTC is 100%. In case that the borrower stops making the promised loan payments, the lender can seize the collateral to recoup its losses. This claim of the bank to the borrower's collateral is a lien, which is the legal right of the creditor to sell the collateral property if Hills Construction and its business entities fail to meet the obligations of repaying the loan.
1.6. Guarantee
The loan will be personally guaranteed by Hugo Cruz and Carlos Reyna will provide an additional corporate guarantee.
1.7 Sources of Repayment
• The primary source of repayment is directly connected to the purpose of the requested loan. In this case it will come from the cash flow of the planned construction project which is supposed to generate high income. Due to the fact that it will provide plenty of rental opportunities, enough rental income will be generated in order to cover the loan.
• Secondary sources of repayment will be hard assets of Hills Construction in form of
manufacturing equipment which will be sold in case that the primary sources cannot cover the loan repayment cost.
• The tertiary source of repayment is the office of Hills Construction which is used as a collateral in case of failure.
2. Recommendation
2.1 Reasons for Approval
I recommend approving the loan request for Hills Construction due to the following reasons:
• Collateral value: Security for the bank due to the loan being used for the acquisition of the land tract. Meaning that the bank has the collateral because the land is the mortgage. 80% of the project, which includes the land tract as well as the apartment complex is used as collateral, which results in 100% Loan-to-Collateral securing the bank in case of the company’s failure.
• Liquidity: The property is in good location which makes selling easier and decreases the liquidity risk in case of the borrower defaulting to pay back the loan.
• Relationship: Positive Relationship with the client in the past years and regarding prior loans which were granted to Hugo Cruz. Hills Construction is a customer of the Bank of South Texas since 1988.
• Income & Cash Flow: High Cash Flow compared to the amount of total debt which leads to a 40.45 x Debt Coverage Ratio. The company seems to be stable enough in order to ensure the repayment. Also, the DTI is pretty low which qualifies the borrower for the loan.
• Experience: Success over many decades which includes managing rents, tenants, contractors, and knowing how to successfully deal with day to day activities
• Loan-to-Value: The project is financed by only 80%, so that equity of Hills Constructions is contributed which increases the project’s value for the guarantors, Hugo Cruz and Carlos Reyna. The down payment accounts $360,000 of the company’s equity.
• Credit Score: 729, which is considered to be a good credit score
• Positive Trends: The real estate industry continues to trend in a positive direction, benefiting from over all long economic expansion.
• Other: The fact that the loan was requested by a construction company enables the construction costs to be low and secures that no overpriced charges by other companies are involved.
Note: I recommend using an interest rate of 7.25% which is based on the fixed rate. Additionally, Hills Construction contributing equity towards the acquisition of the land lowers the risk of the bank and reasons to approve the loan.
2.2 Exceptions/Items Requiring Attention
Missing financial statements for Fast Construction:
• No US Return for Partnership Income was provided
• No Profit & Loss Statement was provided for the year 2017 also one for the first 3 months of 2018 which is on accrual basis
Other missing financial statements
• No balance sheet for 2017, only for the year 2018 and 2016 for any of the companies
• No balance sheet for 2017 for Hugo Cruz or Carlos Reyna
2.3. Sources of Cash
Sources of Cash
Loan $1,440,000
Equity Contribution $360,000
Totals $1,800,000
2.4 Banking Relationship
The relationship of Hills Construction and the Bank of South Texas is remarkably positive. Hills Construction has shown loyalty in the past by choosing this institution for prior projects. Hills Construction is a customer of the Bank of South Texas since October 1988. 5 years ago, the company with its business entities, Remote Homes, and Hills Construction received a loan for constructing an educational complex. The repayment went off without any issues. Besides this, both, Hugo Cruz and Carlos Reyna are loyal customers of the Bank of South Texas with long-lasting relationships.
3. Company Description
3.1. About the company
Hills Construction was founded in 1959 by the business man, Leonard Cruz. Since then, the company is known for its excellence and quality performance which showed long-term success and stability over decades. The company is a family firm with important values that have been transmitted over the past years. Over half a century of industry-leading excellence, Hills Constructions offers general contracting, construction management, and design-build services to private and public companies for projects of a variety of sizes. Furthermore, Hills Construction has shown high achievement with own projects such as several rental property
projects. Through detailed planning and coordination, Hills Construction ensures that project deadlines are met. Decades of experience to rely on and consistently delivering quality are one of the main goals to achieve and focus on.
This allows the company combining innovative construction methods and accountable project management to get the job done, and to get it done right. In order to do so, Hills Construction works closely with architects, engineers, subcontractors, and clients at every stage of the process.
3.2 Ownership
3.3 Related Entities
• Remote Homes is a real estate company which was founded in 2001. The firm’s principal business activity is rentals. Hills Construction and Remote Homes cooperating is an advantage for the project since it enables to keep operational costs low. Remote Homes is owned equally owned by Hugo Cruz and Carlos Reyna with the practice of a general partnership.
• Fast Construction is a is a commercial general contractor and construction company which was founded in 1998. The firm is equally owned by Hugo Cruz and Carlos Reyna with the practice of a general partnership.
4. Financial Analysis Borrower: Hills Construction
Hills Construction presents financially stable numbers regarding the balance sheet as well as the profit and loss statements. This results in a debt coverage ratio of 40.45x and allows to assume that the company has been operating successful in the past and has the sufficient income to cover current debt obligations.
4.1 Quality of Financials
The borrower provided a U.S. Return if Partnership Income (Form 1065) for the year of 2017. Hills Construction also provided company prepared financial statements; a balance sheet as of March 31, 2018 and a Profit and Loss Statement for 2018. Regarding this information, it was difficult to prepare the cash flow statement. The profit and loss statement for the year 2018 was used and the 3-months period multiplied by 4. Also, the balance sheet for 2017 was missing so that the balance sheet of March 2018 was used. This was problematic since this financial document is on an accrual basis, not on a cash basis.
4.2 Balance Sheet
From the balance sheet, total assets of $1,656,286 and total liabilities of $1,355,421 can be seen. This results in the company’s net worth being $300,865.
4.3 Profit and Loss
From the Profit and Loss Statement, the total cash flow available for debt service accounts $ 337,792 and the total debt is $8,352 which results in a net cash flow of $329,440.
4.4 Debt Service Coverage
The borrower’s debt coverage ratio is 40.45x which was calculated by dividing total cash flow available of $337,792 by the total debt of $8,352. This ratio is considered to be high and gives the bank security regarding the credit risk, Hills Construction not being able to repay the loan.
5. Financial Analysis Guarantor: Hugo Cruz
With reference to the numbers provided, it seems that Hugo Cruz is stuck in debt. He has a debt service coverage ratio of 0.31X which is due factors such as loans within his personal obligations which include three Auto loans, credit card loans, a mortgage, etc. There is a need to decrease household expenses in order to avoid more debts.
5.1 Quality of Financials
Hugo Cruz has a reported income of $34,946 with household expenses of $49,104. There is a significant difference between these two numbers that normally, off the bat, would let a loan officer know that this person is facing troubles to pay a loan because he spends more than he earns. Also, automotive expenses are abnormal high which should be reduced in order to lower debts.
5.2 Balance Sheet
No balance sheet for 2017 for Hugo Cruz was provided.
5.3 Profit and Loss
Hugo Cruz reported Salaries & Wages which account $10,268. Adding taxable interest and ordinary dividends, this results in a total income of $10,877. The total income reported comes down to $38,663. This number is compared to the total debt of $125,271 low which results in a negative net cash flow of 86,608.
5.4 Debt Service Coverage
Hugo Cruz’s debt service coverage sits at 0.31x which is found by dividing the total cash flow of 38,663 by the total debt of $125,271. This indicates that the borrower’s financial position as an individual is not stable enough to pay back a loan.
6. Financial Analysis Guarantor: Carlos Reyna
Based off of what Carlos Reyna reported, Mr. Reyna too is in debt. Hugo Cruz, shows a debt service coverage of 0.39X. A high mortgage along with 2 auto loans and a credit loan is what is keeping Mr. Reyna in this category.
6.1 Quality of Financials
It is clear that Carlos Reyna has household expenses of $46,260, slightly less than his total income reported of $49,737. This is not necessarily bad as he still is able to easily provide resources for his purchases without heavy interrogation and less worry by any loan officer.
6.2 Balance Sheet
No balance sheet for 2017 for Carlos Reyna was provided.
6.3 Profit and Loss
The total income of Carlos Reyna comes down to $49,737 and the total cash flow is $21,828. Comparing this number to the total direct debt of $55,500, this results in a negative cash flow of $33,672.
6.4 Debt Service Coverage
Carlos Reyna’s debt service coverage sits 0.39X which is found by dividing the total cash flow of $21,828 by his total debt of $55,500. Attempting to pay back a personal loan would be considered to be fairly difficult. .
7. Market Analysis
7.1 Collateral Analysis
• Description of collateral:
For the collateral, 80% of the land tract as well as the apartment residence will be used and serve as security for the bank.
• Loan to Collateral Value:
The loan-to-collateral is 100% which is a good security for the bank.
• Market Analysis:
Due rental property being used as collateral, the current US Rental Vacancy Rate was considered and analyzed. The vacancy rate shows the percentage of available units within rental properties, such as apartment complex’, hotels, etc. that are vacant or unoccupied.
The current US Rental Vacancy Rate is at 6.80% which is compared to last quarter (7.00%), and last year (7.30%) and the long-term average of 7.36%, really low. The decreasing trend of the vacancy graph is a positive for the collateral of the project. Low vacancy rates indicate that the residential real estate market is doing well, and the rental sector is thriving.
• Quality of Collateral:
The perceived marketability in the event of liquidation is rated as, due to following reasons:
• Collateral location:
7000 Post Oak Cir, Brownsville, TX 7852
• Floor plan of projected apartment complex:
• Projected cost break-down of collateral:
Project Costs
Construction Costs
I. Pre-costs/ Site Work $ 20,000.00
Building Permit Fees
Other Fees
Architecture, Engineering
II. Foundations $ 80,000.00
Excavation, Foundation, Concrete, retaining walls, and Backfill
Other
III. Framing $ 120,000.00
Framing (including roof)
Trusses (if not included above)
Sheathing (if not included above)
General Metal, Steel
Other
IV. Exterior Finishes $ 100,000.00
Exterior Wall Finish
Roofing
Windows and Doors (including garage door)
Other
V. Major Systems Rough-ins $ 90,000.00
Plumbing
Electrical
HVAC: Heating, Ventilation, Air Conditioning
Other
VI. Interior Finishes $ 300,000.00
Insulation
Drywall
Interior Trims, Doors, and Mirrors
Painting
Lighting
Cabinets, Countertops
Appliances
Flooring
Other
VII. Final Steps $ 60,000.00
Landscaping
Outdoor Structures (deck, patio, porches)
Driveway
Clean Up
Other
VIII. Other $ 30,000.00
Total Construction Costs $ 800,000.00
Add:
Land Purchase Costs $ 1,000,000.00
TOTAL COSTS PROJECT $ 1,800,000.00
• Cost per square feet:
– Gross Area: 12,000.00 sq/ft
– Living Area: 7,200.00 sq/ft
– Total Cost: $1,800,000
– Cost /fqft: $250.00
– Loan /sqft: $200.00
7.2 Key Risk Factors
1. Credit risk:
The potential that Hills Construction will fail to meet its obligations in accordance with the agreed terms.
2. Operational risk:
The risk of loss due to the bank making mistakes regarding internal processes. Potential losses can occur due to a human error, system failures, programming errors, and lacking information.
3. Liquidity risk:
The risk of the collateral’s marketability, meaning that the collateral can’t sold quickly enough in order to prevent losses.
4. Risk of collateral losing its value:
a. Market risk: The possibility of a decreasing need for apartments and changes in
occupancy rate and other factors in the market.
b. Damage or injury of the collateral: The collateral can be damaged in case of environmental catastrophes or other incidences.
c. Commodity risk: The chance of the collateral losing value because of fluctuating prices regarding construction commodities.
5. Credit weaknesses:
The business entities of Hills Constructions; Remote Homes and Fast Construction, both score remarkably lower in their debt coverage ratio than Hills Construction. With a comparable amount of Cash available for debt services, Remote Homes and Hills Construction show quiet different numbers for net cash flow due to higher debts of Remote Homes. Additionally, both guarantors; Carlos Reyna and Hugo Cruz show debt coverage ratios below 1.0.
7.3 Mitigations
1. Credit risk:
The Borrower, Hills Construction in the case of failing to generate the expected profits with the project has the secondary source of repayment, which is manufacturing equipment, as well as the tertiary source, the company’s office.
Also, the financial analysis of the company showed Hills Construction’s stability over the past years and the debt coverage rate which is really high results in the estimation of the company being financially stable.
2. Operational risk:
The loan request is processed by several people and will be doublechecked by the director of
the Bank of South Texas to avoid possible errors and prevent overseeing or miscalculating any financials.
3. Liquidity risk:
The land tract which is going to be purchased has a good location and an attractive neighborhood. Researches and ratings have shown that the demand for apartments, located in this area in Brownsville is high. Furthermore, the bank will ensure this factor by inspecting and examining the land tract. The planned apartment-complex will be constructed newly so that there is no need for renovations for the first couple years.
4. Risk of collateral losing its value:
a. Market changes: Analyzing the current vacancy rates and comparing the data to the
past years, the occupancy level increased which is positive for the real estate market.
According to experts, the risk of a decreasing demand in this market is considered
low.
b. Damage or injury of the collateral: The terms will require the borrower to transact several insurances regarding the apartment complex to prevent major damages and value losses of the collateral.
c. Commodity risk: Considering the current market changes and the increasing prices regarding commodities such as metal and steel, the trend results in the estimation of the collateral value not being at risk in regard to commodity risk.
5. Credit weaknesses:
The borrower is Hills Construction which presents stable financial statements and has been a loyal customer in the past without any negative incidences in prior loans. The company has high debt coverage ratio, high credit scores and the risk grade is low.
7.4 Global Cash Flow
The global cash flow analysis results in a recommendation to approve the loan request. The consolidated Cash Flow of the borrower, Hills Construction with its’s business entities; Remote Homes and Fast Construction, as well as of the guarantors Carlos Reyna and Hugo Cruz illustrate a debt coverage ratio of 2.54. This result leads to the estimation that there is enough cash flow available to pay current debt obligations. The repayment of the loan should not be at risk according to the global cash flow. The total cash available of the global cash flow is $823,245, while the total debt sums up to 323,957. The debt coverage ratio being way higher than 1.0 means that the there is a sufficient income to repay the loan. Additionally, it is important to mention the risk grade being low.