Business LOC - does a newbie have a chance?

Question

Hello - a friend suggested tonight that my business partner and I apply for a Business LOC with a local bank and is connecting me with a person there to speak with. I'm concerned, however, about whether we have a chance at qualifying.

My partner's LLC has been in existence a long time but she wasn't very active the past 2 years and is essentially coming out of retirement to do rehabs full-time (a r.e. broker, she used to primarily list properties while doing a few investments here and there). Thus, there isn't much to show in the way of assets for the LLC. As for me, I'm pretty new to the rehab business so I understand I still have a lot to prove.

However, my partner's personal credit is 810 and she has equity on her personal home (about 60k). And the project we have under contract - the one for which we'd use the LOC - has good numbers. We'd look for a maximum  of 150k, which includes purchase price and a chunk of the rehab, and the ARV is 250k. Hell, we'd be happy with anything the bank could provide for a LOC b/c it would still be cheaper than hard money and private money!

What else do I need to know? What else will the bank want for info, and what can we do to make our case?

Thanks!

Chris Martin · Answer

Yes, there are differences. First I want to back up a couple steps. There are a couple ways to find out what your bank wants. The first one is obvious - just ask. The second method is to find the bank's historical lending via reports from the FDIC. The third method, which is sometimes the best/most revealing, is to read their SEC statements.

In SEC filings, you want to find their underwriting criteria. Here is an example of what a bank in my area wrote in their last annual report (10-K): "Residential mortgage loans represent one-to-four family loans originated through NSB Mortgage and selected by the Company to be retained in its portfolio. These loans are subject to strict underwriting standards which are at a minimum per the FREDDIE MAC guidelines and typically have terms within 10 to 15 years with moderate loan-to-value ratios, typically less than 70% and with credit scores typically exceeding 740." From county recorder's records, this bank lends to LLCs and on property that is price and loan dollar-wise similar to what I invest in.

Back to their SEC filing, now that I know that what they call a "Residential mortgage loan" is what I need information about, I can see that in Table E they are making loans. Why? The summary of loans segregated by loan category chart for "Residential mortgage" for December 31, 2011 shows $40.4M in loans, or 8.3% of their total loans. June 30, 2012 for the same loan category shows $63.8M in loans, or 13.2% of their total loans. This is a bank worth talking to.

Use this same process for every bank in your area. Some banks don't give out great details on their underwriting. Here's another bank in my area that spells out details very clearly at the top of page 33.

There are good hints in many of the documents. "The limited lending opportunities and the aggressive problem loan resolution program has reduced the loan portfolio by $212.9 million..." This means your chances of getting a loan are probably not as good. Maybe you put this bank at the bottom of your list. Other bad phrases: "Losses ... have further eroded the Bank’s capital levels, and the Bank is now significantly undercapitalized.... Reduce the real estate credit concentrations in the Bank’s loan portfolio..." Hopefully you get the picture.

Kevin Yeats · Answer

I would make VERY careful consideration as to whether you and/or your partner want to put the equity in your personal residence at risk to fund your investment property.

This strategy is doable but certainly contains risks.

Brandon Hughes · Answer

If you are applying for lending at a big bank they are going to want to see a "track record" for your LLC.  You said it hasn't been used in 2 years?  Had it been generating money prior to that?  Most large banks are going to want to see 3-5 years in business generating profits.  (Most businesses fail in the first 3 years)  Also, you will gradually have to grow your credit lines for your business. Your credit will have to grow incrementally unless secured by assets (residence, cash, CD's, equipment).

This is what you will find at most large banks.  Unless you can find a local community bank which can possibly offer different terms, this is the problems you will encounter.

Jim Lien · Answer

Great points Chris Martin.  I'm a call report junkie so I like to look at construction loan and commercial real estate exposure as a percentage of the portfolio to see what the bank's appetite is for real estate.

Karin DiMauro don't discount the ability to use the asset you are rehabbing as collateral!  When you present a deal to a banker just make sure that you are providing concrete evidence, i.e. comps supporting why the collateral will be worth what you think it will be worth.

Karin Crompton · Answer

Thank you, Chris Martin, that's fantastic info and I will use it to research the local banks we're considering.

And Jim Lien, thank you for suggesting the construction line - I will research those as well and see what shakes out when comparing the two. You touched on exactly the challenge I figured we'd face: not enough assets in a rehab company to support a business LOC (especially when you can't use the property you're rehabbing as any type of collateral). We will build up reserves as we go, but it's not like we're going to have tons of money in there; our overhead is extremely low.

Thanks again!

Jim Lien · Answer

Hi Karin, I've underwritten plenty of properties like this and I'm not necessarily sure that you want a business line.  The bank is going to want to have sufficient collateral, a good plan with clear market support for the proposed project, and a secondary source of payment, i.e. your other sources of cash flow.  The assets of the company if it is a rehab type of company are not likely to be significant enough to support a business line.  I'd start out with a construction line specific to the project and be willing to pledge equity and personally guarantee the loan.  As you grow and have several projects under your belt then you might graduate to a construction line of credit that is supported by multiple projects at the same time.

Kevin McGinnis · Answer

In my area I've found the small "local" banks more willing to work w/you.

Gene Hacker · Answer

I know in my area business lines of credit have all but vanished.  Local business that depended on lines have had to adjust.  Huge changes starting in 2008/9...things are starting to loosen up but not much yet.

Karin Crompton · Answer

Thanks again, Kevin Yeats. A LOC is a bit different from a loan, though, right? Ultimately we'd be doing the same thing, paying money back, but I thought the initial approach and application was different, no?

Kevin Yeats · Answer

Karin, bankers worry every day until the loan is repaid.  Generally speaking, lenders want to see a clear path to repayment of the outstanding loan.

Your partner's credit score certainly is high enough.  The next issue is collateral.  Bankers will also look at how long it will take for you/your partner to repay the loan.  This is not only how long it will take to perform the rehab but how "hot" your market is.  The big what if question is "what if you find more problems with the property and it does not sell very quickly?"

The good news is that there are plenty of very experienced people here on BP that you can turn to for help.

Business LOC - does a newbie have a chance?

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