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NEGOTIATING WITH LENDERS
PREPARED BY
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This paper provides advice on negotiating with lenders in the operation of Alternative Finance Programs (hereafter referred to as "AFP" or "AFPs"). The paper begins with a definition of terms, and then provides an overview of existing and potential AFP models. What is negotiated with a lender will largely be driven by the nature of the program design. This is because the role of lenders can vary considerably by program design. The final section of the paper highlights program issues, terms, and costs that must be negotiated with lenders, depending on program design.
Terms.
1. "Assistive Technology (AT)". The term assistive technology or AT means any item, piece of equipment, or product system, whether acquired commercially off the shelf, modified, or customized, that is used to increase, maintain, or improve functional capabilities of individuals with disabilities. Assistive technologies range from such devices and modifications as motorized wheelchairs, to computers controlled by voice or other special switches and augmentative communication devices, to cars or vans with hand controls or lifts, to hearing aids and accessibility modifications to homes or offices.
2. "Community Reinvestment Act" or CRA. The CRA is a federal law that was passed in 1977, to prohibit banks from refusing to lend in low and moderate-income communities. CRA was passed to ensure that regulated financial institutions like commercial banks and credit unions have a continuing and affirmative obligation to help meet the credit needs of the local communities in which they are chartered. The Gramm-Leach-Biley Act of 1999 chipped away at CRA, but by no means repealed it. CRA does not require financial institutions to make loans to anyone but rather to demonstrate a record of serving low and moderate-income communities. CRA examinations are performed by federal agencies responsible for supervisory depository institutions and assign CRA ratings-the vast majority of banks have satisfactory or outstanding ratings. When banks apply to buy another bank, or expand, CRA requires the regulators to consider the applicant bank's record of serving low and moderate income communities-by definition, this should include low to moderate-income persons with disabilities.
3. "Debt-to-income ratio". The debt-to-income ratio (how much someone owes in credit card debts and loans compared to how much they earn) is one of the key figures lenders use to evaluate credit-worthiness. Generally, to calculate a debt-to-income ratio: add up total monthly income. This includes monthly wages plus any overtime, commissions or bonuses that are guaranteed; alimony payments received, if applicable; plus all other regular monthly income (SSI, pensions, etc.). If someone's income varies, figure the monthly average for the past two years. Also include any monies earned from rentals or any other additional income. Add up the monthly debt obligations. This includes all credit card bills, plus loan and mortgage payments. Also include monthly rent payments, if applicable and monthly debt service on a proposed loan, such as an AT loan. Divide total monthly debt obligations by total monthly income. This calculation produces the debt-to-income ratio. Generally, lenders look for ratios of less than 36%. In AT loan programs, this ratio should rest on the creation and evaluation of a thorough household budget.
4. "Lender". Pursuant to authorizing legislation, NIDRR requires that a State that receives assistance for an AFP contract with a community-based organization to administer the AFP. The community-based organization must have individuals with disabilities involved in organizational decision-making at all levels. In turn, the community-based organization is required to enter into a contract to facilitate administration of the program with (A) commercial lending institutions or organizations or (B) State financing agencies (i.e. financial administration of the program must be delegated). NIDRR appears to be quite flexible in terms of which organizations qualify under "A" or "B" as lenders. Therefore, as used in this paper, a "lender" means any organization with a demonstrated capacity and track record to originate and service loans the proceeds of which are used for assistive technology. This includes:
1. Commercial Banks
2. Commercial Finance Companies
3. Credit Unions
4. Community Development Financial Institutions (CDFIs). A CDFI is a private sector financial intermediary, ranging from banks to credit unions to non-profit lenders or investors, that has community development as its primary mission and develops a range of programs and methods to meet the needs of low-income communities. A division of the US Treasury Department, which administers a funding program for CDFIs, certifies CDFIs. There are over 400 CDFIs throughout the county. A listing of CDFI's by state is available at: www.ustreas.gov/cdfi . Vermont's program is administered by a credit union that is a CDFI.
5. State Development Finance Agencies. Organizations in this category include government (state commerce or community affairs departments that administer loan programs typically for housing, small businesses, or local infrastructure) or quasi-government agencies or authorities such as state housing finance agencies and state development finance agencies. This latter group includes business finance program and bond issuers like the Finance Authority of Maine that administers Maine's assistive technology loan program.
5. "Loan Term". The maturity of a loan in years or months. Loan terms are especially important in AT finance programs. The term or maturity of a loan often has a far greater impact on the affordability of monthly debt service payments for borrowers than the interest rate charged by a lender. This is shown on the following table.
|
Interest Rate |
3 Years | 5 years | 7 years | 10 Years |
| 3% | $29.08 | $17.97 | $13.21 | $9.66 |
| 6% | $30.42 | $19.22 | $14.61 | $11.10 |
| 10% | $32.27 | $21.25 | $16.60 | $13.22 |
The table shows, for example, that payments per $1,000 on a 10% loan for 10 years are 28% lower than a 5-year loan at 3%. It also shows the difference in monthly payments between a $1,000, five year, 3% loan vs. one at 10% is $3.19 or 15.4% lower.
6. "Loan to value ratio (LTV)". The LTV ratio is the ratio between the size of a loan and the lender's valuation of what loan proceeds will be used to purchase. Many lenders will not approve a 100% LTV, meaning they will require some down payment, such as 10-20%.
Program Alternatives
Direct Revolving Loan Programs
Revolving loan funds can be defined as programs with dedicated equity capital that are capable of recycling lendable funds to finance successive generations of loans over extended periods of time. AT revolving loan funds are capitalized from such sources as state legislative appropriations, general obligation bond issues, and federal and foundation grants such as the NIDRR AFP. AT direct loan programs may be administered directly by a state agency (Arkansas) or contracted to third-party financial institutions such as state development finance agencies (Maine), Community Development Financial Institutions (Vermont), or commercial banks (Connecticut).
Administrative and operational tasks are more numerous for successful AT loan or guaranty programs than many other publicly supported programs such as small business loan or guaranty programs. This is because two administrative entities (in addition to a program board that may approve/deny loans) are often involved in the delivery of programs. Financial assistance should be coupled with extensive consumer support in the delivery of programs. For example, in the Maine program, Alpha One, a center for independent living, markets the program statewide through four regional offices, helps consumers identify their assistive technology needs, locates vendors for clients, and develops loan application packages. They also review medical condition. The Finance Authority of Maine (FAME) provides financial management services for the loan fund and works with Alpha One to present loan applications to the program board once a month. FAME also underwrites, closes, and services loans. The important role performed by Alpha One in the Maine program rests on a large enough program to cover administrative costs, which much smaller state programs find more difficult until they reach a larger scale.
Advantages of Direct Loan Programs
1. Direct loan programs offer the most control and flexibility to meet client affordability needs in terms of loan underwriting standards (e.g. higher debt/income ratios, higher LTV ratios, acceptable income sources) and longer repayment and lower interest rate terms than conventional bank loans. For example, the Maine program is authorized to make loans of up to $100,000 for twenty years and the average interest rate is 3.3%. Direct loan programs, however, that elect to keep underwriting standards and terms close to conventional standards compete with conventional loans and have marginal benefit to customers.
2. Loan capacity recycles with monthly borrower payments.
Disadvantages of Direct Loan Programs
3. No leveraging of public funds, unless a leveraged fund is created;
4. Does not build private sector capacity to make AT loans other than as program administrators;
5. Does not facilitate building conventional credit capacity for clients to the same degree as loan guaranty options;
6. The ability of a direct loan program to sustain itself and be totally self-supporting in terms of covering all costs, particularly administrative costs, depends on the size of its funding base. With smaller programs (less than $500,000 funding base or capitalization) it can be difficult to cover costs depending, in part, on the extent of consumer support services and marketing expenses;
7. Relative to other program options such as loan guarantees, direct loan programs may be more difficult and costly to administer-they require more staffing-loan officer(s), marketing, record keeping and servicing staff, workout specialists, legal, and supervisory staff. Although some of these functions may be consolidated in low volume programs, they still must be performed directly or by third-party administrators like financial institutions.
8. With smaller programs, loan size limitations may prevent meeting customer needs in contrast to larger programs or conventional bank loans-leveraged programs that create larger funds overcome these problems, since larger funds can make larger loans, while also maintaining prudent portfolio diversification standards.
9. Where programs are not contracted to third-party financial institution administrators (contracting is required for NIDRR grant funds), state agencies with little, if any, experience managing loan funds must assume these tasks. Rehabilitation Services agencies are not in business to originate and service loans-financial institutions can perform these functions better.
Leveraged Revolving Loan Program Model
Leveraged revolving loan funds use a fund's equity or income stream as a source of equity to leverage a higher volume of lending financed by borrowing against the fund. The approaches reviewed here would use state and any federal grant funding to help secure borrowings equal to 3-4 times a fund's equity amount. Thus, a $1 million fund would leverage up to $4 million of lendable funds. Depending on the structure of borrowing(s), funds may not revolve or recycle as fast as an unleveraged fund. There are several potential approaches to executing this technique, particularly through bond issues.
Bond Issues
One method of increasing the size of a state's direct loan fund is to explore leveraging state and federal funds with tax-exempt bond issues.
For example, a State Development Finance Agency or State Treasurer could issue revolving fund bonds as a separate series of bonds attached to a governmental bond issue to capitalize the program fund in addition to NIDRR grant funds.
Structure of Leveraged RLF
A leveraged revolving loan fund could use $2 million of NIDRR grant funds to leverage at least $3,000,000 of tax-exempt revenue bonds, providing a 60% NIDRR match, to establish an initial $5,000,000 Loan Fund (hereafter called the "Fund"). The leveraged technique uses a fixed fund (NIDRR federal funds) as a source of equity to leverage a higher volume (at least $3 million more) of lending financed by borrowing against the Fund.
The Revolving Loan Fund is capitalized by NIDRR grant funds (40%) and bond proceeds (60%). The source of funds for each loan to a borrower will always be in the same proportion-40% NIDRR funds and 60% bond proceeds. NIDRR funds are continuously recycled into new loans as borrowers make loan payments. In the case of the bond share of the Fund (60%), loan payments are used to retire outstanding bonds. However, as outstanding bonds are retired, new bonds are issued. Depending on bond structure, the bond-funded share of borrower repayments may also be recycled into new loans until the underlying bonds mature. Thus, the volume of lending over the first 10-15 years of a program modeled after the example given here could be expected to be in the $7-$9 million range. Although the NIDRR funded share of loans (40%) receives loan payments, these payments will be held and invested for a period of one year prior to using them to make new loans. This is necessary to add security support to the bonds. In effect, bondholders will have a first claim on both the NIDRR and Bond share of loan payments to the extent necessary to make bond debt service payments. This technique provides bondholders with 1.6 times cash flow coverage for debt service payments.
There is no provision in the Internal Revenue Code (IRC) authorizing the sale of tax-exempt bonds, the proceeds of which would be used to make AT loans to individuals. In this author's view, however, a tax-exempt issue is still possible if structured along the following lines. States frequently issue governmental, tax-exempt bonds for various purposes such as highways, schools, public buildings, etc., often in large amounts. Under the IRC, a tax-exempt governmental bond would not lose its tax exemption under the Private Loan Financing Test, provided not more than the lesser of 5% or $5 million of the proceeds of an issue are used to make loans to nongovernmental persons; e.g. persons with disabilities. A $10 million governmental issue, for example, could support $500,000 of funding for an AT loan program.
Other sources of leveraged funds include state appropriated funds, foundations, and lenders.
Loan Guaranty Programs
A. Loan-By-Loan Guaranty Programs
Loan-by-loan guaranty programs in contrast to portfolio insurance or guaranty programs (reviewed later) provide loan guarantees on an individual loan basis. The Small Business Administration 7(a) program for small business loans is a loan-by-loan guaranty program. Loan guarantees act to substitute the credit of a borrower, for example, a person with a disability, with the credit of the guarantor, in this instance a state guaranty fund which provides a cash loss reserve to cover any claims filed by participating lenders on guaranteed loans. Many existing state AT programs are loan-by-loan guaranty programs that provide 100% guarantees to lenders. (Most small business guaranty programs provide only 75-85% guarantees to lenders, believing lenders should be at risk for some portion of loans.) Existing state programs do not leverage cash loss reserve funds or program fund monies in terms of increasing loan guaranty capacity by some multiple such as 2 or 3 to one, meaning for every dollar on deposit in cash reserves to honor claims by lenders, $2 - $3 dollars of guaranty commitments are made. For example, 2 to 1 leverage would cover a 50% loss rate, a very unlikely event, since net loan losses among lenders seldom exceed .5-2%.
Loan-by-loan guarantees may act to increase loan-to-value ratios employed by lenders, since all or a portion of the collateral risk is removed as an underwriting concern. For this same reason, they can act to extend loan terms and may also act to lower interest rates and increase debt/income ratios employed by a participating lender(s). Some state programs report their programs are having these effects.
Advantages of Loan-By-Loan Guaranty Programs
10. Builds private sector capacity;
11. Leverages private sector funds, particularly if cash reserves are leveraged by some multiple;
12. Builds lender/customer relationship in terms of credit or other financial services;
13. Financial management costs are lower than direct loan programs, since lenders originate and service their own loans and may be required to handle workouts and liquidations prior to filing loss claims, depending on the terms of loan guaranty agreements;
14. Provides opportunities to facilitate loans with and without guarantees;
15. May act to increase/improve loan terms, rates and make underwriting somewhat more flexible-but still within banking regulator or investor standards.
16. Loan guaranty capacity recycles as loans are paid-off.
Disadvantages of Loan-By-Loan Guaranty Programs
17. Lender interest in participating in an AT loan guaranty program may vary considerably from state to state. Moreover, until loan guaranty capacity increases (even $1-4 million is very small) it makes sense to limit the program to one or two lenders. This is because financial institutions may not devote staff to learn and market a program, if loan/guaranty capacity is very limited.
18. Loan terms, rates, and underwriting are not as flexible as direct loan programs, although they should improve with a guaranty;
19. Although state or contracted financial management tasks should be less with guaranty programs than with direct loan programs, the extent of the reduction is subject to several factors including: (1) the extent of oversight, including whether or not lender credit memos, underwriting, etc. must be reviewed by staff prior to making recommendations to a program board to approve guaranty commitments-this affects staffing needs; (2) whether a program board is necessary to approve guaranty commitments; (3) assuming an approval board, the level, if any, of delegation of guaranty approval authority from board to staff-for example, the finance agency in the Maine program approves all loans less than $2500 for its direct loan program and provides automatic approval in one of its small business guaranty programs, if lenders certify loans meet certain standards; and (4) the terms of loan guaranty agreements. The level of staff review may also be influenced by the percent of loans guaranteed. Programs that provide less than a 100% guaranty put a lender at risk, which, in turn, should reduce the need for "second guessing" lender underwriting. Reducing the percentage of loans guaranteed, however, may also compromise leveraging better rates and terms.
B. Portfolio Insurance or Guaranty Programs
To date, Portfolio Insurance or Guaranty programs, also known as " Loss Reserve or "Capital Access Programs (CAPs)" have been confined to small business lending. Through 1998, 19 states and 2 municipalities operated CAPs, with nationwide cumulative CAP lending reaching $1.2 billion.
Under CAPs, participating banks and borrowers pay an up-front insurance premium, typically 3%-7% of the loan amount at the bank's discretion, which goes to into a reserve fund held at the originating bank. The state matches the combined borrower and bank contribution (the bank portion is typically passed on to the borrower) with a deposit into the same reserve fund. The CAP reserve fund allows a lending bank to make higher risk loans than conventional underwriting, with the protection of the reserve fund for its entire pool of CAP loans enrolled in the program.
CAPs allow banks to use their own underwriting standards for eligible loans, without governmental approval of the loan-making decision. Compared with the staff intensiveness of many loan-by-loan guaranty programs, CAPs require little administrative cost for lenders, borrowers, or the government (State Rehab Departments-community-based organization-contracted financial administrators). States report that CAPs are staffed by .5-1.5 full-time equivalents, assuming active programs enrolling over 50 loans annually. A state's up-front payment of 3%-7% of the loan amount into a Bank's CAP Reserve fund supports a bank loan that is 14 to 33 times larger than that amount.
The leveraging effect of public funds is large, and the state's investment is certain at the outset. For example, if the state matches a borrower and bank contribution of 5% of the loan amount, its contribution is backing the bank to make a loan that is 20 times larger than its investment (5% premium x 20=100% loan amount). Moreover, the state does not carry any contingent liability for potential future losses on CAP loans, as it would for a loan-by-loan guaranty program.
A participating bank recovers any loss on a CAP enrolled loan from its funded loss reserve, typically by filing a one-page form. Even though a percentage of each enrolled loan is contributed to a lender's loss reserve, a lender may still be able to absorb a 100% loss on an individual loan, since the program operates on a "portfolio" basis. That is, all money in the reserve is available to cover losses on any enrolled loan.
Traditional CAP programs would have to be designed somewhat differently for an AT loan program. For example, the lender and borrower would make no contribution to a lender's CAP Reserve Fund and NIDRR funds would be used to make a 25-30% contribution to the Lender's Reserve Fund; i.e. for each loan enrolled in the program an amount equal to 25-30% of the enrolled loan amount would contributed to the Lender's Loss Reserve. A lender's Loss Reserve Fund is not the property of the lender rather ownership is retained by the entity that makes contributions to the Fund, which a lender can only draw on to honor claims for enrolled loan losses. Investment earnings on the Fund can be retained by the entity that makes contributions to the Fund-community organization in the NIDRR program. Investment earnings can be used to make more contributions to a lender's reserve, fund administrative costs, or provide subsidy features to programs like interest buy-downs.
Advantages of CAP Guaranty Programs
20. CAPs are highly non-bureaucratic programs, with minimal regulations and paperwork for participating lenders, which greatly facilitates use by participating lenders;
21. Gives lenders total discretion as to which loans to enroll and all loan terms but provides an incentive to take more risk and reserve for losses off-balance sheet;
22. The financial management of CAP programs is less burdensome than direct loan and loan-by-loan guaranty programs;
23. Provides access to loans that would otherwise be denied but may not do so to the same extent as loan-by-loan guaranty programs providing 100% guarantees;
24. Compared to 100% loan-by-loan guarantees, CAP programs provide more incentive to banks to underwrite CAP loans prudently, because they must absorb any losses that exceed the CAP reserve account;
25. Good leverage of public funds;
26. Builds private-sector capacity.
27. Works best for lenders who enroll many loans, since this grows their loss reserves and reduces the likelihood of funds in the reserve being inadequate to cover 100% of losses.
Disadvantages of CAP Guaranty Programs
1. Public funds supporting contributions to participating lender loss reserve funds recycle more slowly than loan-by-loan guaranty programs-funds can typically be recaptured only when the principle amount of outstanding enrolled loans exceeds the amount on deposit in the reserve account. In an AT program, depending on lender acceptance, it may be possible to recapture funds when the principle amount of outstanding loans is some percentage of the amount on deposit in a lender's reserve account such as 50%, after the reserve reaches some agreed upon minimum amount.
2. Generally, loan-by-loan guaranty programs, particularly ones providing 100% guarantees, may provide more incentive for lenders in terms of underwriting flexibility and loan terms compared to CAP programs but this must also be weighed against the less bureaucratic nature of CAP programs in terms of getting lenders to participate in the first place.
Interest Buy-downs or Principle Reductions
These are loan subsidy programs under which the interest rate on a loan is reduced, typically by a third-party (e.g. community organization) who makes interest buy-down payments to a lender on behalf of AT borrowers to make a loan more affordable. Principle reductions can accomplish the same thing by providing a grant to reduce the amount borrowed that effectively acts to lower the interest rate. Sometimes principle reductions are made through 0% interest, forgiveable loans. For example, the State of Wisconsin makes $5,000-$6.000, 0% interest, deferred payment, 5-year loans to help persons with disabilities purchase homes and meet downpayment requirements-these loans are forgiven at a rate of 20% per year. The Chicago District Federal Home Loan Bank subsidizes the Wisconsin program.
Loan Participations
Loan participations may be defined as the transfer of an undivided interest in all or part of the principal amount of a loan from a Seller (e.g. commercial bank), known as the "lead", to a buyer (e.g. the state AT loan Fund), known as the "participant", without recourse to the lead, pursuant to an agreement between the lead and the participant. "Without recourse" means that the loan participation is not subject to any agreement that requires the lead to repurchase the participant's interest or to otherwise compensate the participant upon the borrower's default on the underlying loan.
Under this option, AT funds would be used to purchase a portion of AT loans originated, closed, and serviced by a participating financial institution. The state could also purchase subordinated participations and take a lower interest on their share of purchased loans so the borrower would get a lower blended rate. With subordinated participations, the state would have only a second claim on any collateral securing larger (smaller AT loans are often made on an unsecured basis) AT loans (vans, office/home improvements, etc.).
The State of Oregon operates a small business subordinate participation program with reduced rates. It may also be possible to configure a participation vehicle that would act to extend loan terms longer than a lender would otherwise make. This might be done by paying off the lender's share of principal first (the portion of the loan that is not participated) and the state share of principal last-state would get interest only until the lender's principal share is paid-off. In standard participations, principal and interest is paid to a participant on a pro rata basis, based on a participant's share or percentage of the loan the lender is selling.
Negotiating with Lenders
What a NIDRR grant recipient negotiates with a lender is largely driven by the nature of the program, since this affects the role of the lender and terms under which AT loans are made to borrowers. Lenders can perform varying roles in programs from originating and servicing their own loans in loan guaranty programs to performing financial administration services in direct loan or loan guaranty programs. Whatever program design is used, programs should be made as user-friendly for lenders as possible, free of excessive paperwork, regulations, reporting, etc.-in other words, as non-bureaucratic and simple as possible. More than any other factor, this will facilitate lender participation in AT loan programs, the cost of any contracted financial management services, and negotiation of AT loan underwriting standards, policies, and terms and guaranty agreements.
Prepare to Negotiate
Prior to negotiating anything with a lender, the community organization must be clear on what it wants to negotiate. The community organization should first establish its goals, objectives, and strategy (game plan to achieve goals and objectives) for the AFP and define its role and responsibilities in the administration of an AFP-reporting, promotion of program, client counseling services, feeding applications to lender, etc. Program cash flow projections should also be prepared providing estimates of direct loan or loan guaranty activity over a period of years, such as 5-10 years, while also taking into account losses and administrative costs. These projections rest on a number of variables including average loan size, rate and term, loss rates, investment earnings rate, whether a guaranty program is leveraged or not (i.e. the dollar volume of guarantees exceeds NIRDRR grant funds by some multiple), etc. A simple, one-page description of the program should also be prepared, highlighting major features of the program.
The community organization must also establish how its loan product will be distributed to prospects in terms of loan origination. This, in turn, will influence the type of financial institution that is solicited for administration of direct loan programs or participation in loan guaranty programs. Do you want or need a financial institution with statewide coverage where prospects can make application for programs at local branch offices? Alternatively, if it is expected that the vast majority of applications will originate from offices of the community organization or other organizations that provide support services, then the need for a financial institution with statewide distribution capabilities becomes less important.
The goals, objectives and strategy of the program must be responsive to precise needs. Addressing the needs of lower-income borrowers might be accomplished by leveraging higher debt-to-income ratios and loan-to-value ratios, providing interest buy-downs, leveraging longer loan terms, and getting lenders to count sources of income they may not typically include in their underwriting. In loan guaranty programs, these matters must be decided before you talk to lenders, since they may become standards for approving or denying loan guaranty requests later. For example, some people with disabilities live with a roommate and/or attendant. These other "household" members may pay for their share of housing costs. Conventional bank underwriting standards often do not allow for this type of income to be counted when calculating debt-to-income ratios.
The community organization should take as much paperwork and reporting away from lenders as possible and minimize any functions lenders do not normally perform; i.e. provide AT loan counseling services for prospective customers. Any loan packaging services performed by the community organization or other contractor will facilitate lender participation.
General Barriers to Lender Participation .
The barriers and selling points identified in this section are most applicable in the context of loan guaranty programs and to a lesser degree financial contract administrators.
Perception of bureaucracy and red-tape.
Many lenders perceive publically-supported loan and guaranty programs as bureaucratic that can compromise their productivity. Competition among financial institutions has increased as the number of banks shrink in the wake of mergers and acquisitions. This has made financial institutions highly productivity-driven organizations that continuously invest in technology to improve their productivity and reduce expenses. For example, many lenders have invested in credit scoring systems to reduce loan-underwriting costs. Loan guaranty programs need to be non-bureaucratic or they will compromise financial institution productivity objectives, and lenders will not use them. Quick turnaround time on loan guaranty requests is very important.
Relatively small size of programs.
The small size of programs along with small average loan sizes does not justify a lender's involvement in a program in terms of time, cost and profitability.
Uncertainty over the market for programs.
Generally, lenders do not want to invest time, energy, and cost into publically-supported programs with very narrow markets. The market for AT loans is potentially very large but this fact must be demonstrated to lenders with sound market data and information; i.e. given borrower eligibility criteria, how many persons in the state will qualify for the program and what are the numbers for the population most likely to use the program such as lower or middle-income borrowers who can not afford conventional bank financing, down payments, etc.
Branch managers or loan officers generate few loans.
Even when a bank agrees to participate in a program, such as a loan guaranty program, information about the program may not filter down to branch managers or loan officers. As a result, it is not uncommon for a participating bank to do little, if any, program loan volume. It is very important to keep in mind that individual loan officers, branch managers, or staff at central processing centers are the ones who decide whether or not to actually use a program, not bank presidents.
General Selling Points to Overcome Barriers
A lender's (regulated depository institutions only) involvement in an AT loan program will count towards their Community Reinvestment Act requirements.
This and a desire to help persons with disabilities become more productive or live independently are reasons a lender may want to participate. Many AT devices help persons with a disability enter the workforce, which is particularly important in many areas of the country that have critical labor shortages-AT loan programs are also economic development programs that benefit the entire business community.
The limited size of programs can be minimized if programs are limited to just one or two lenders until they reach a larger scale.
Provide sound market information to lenders to demonstrate potential loan volume and cross-selling opportunities for other banking services.
In addition, if the community organization or others will feed borrowers to a bank, explain how this will work and how the program will be promoted to prospective customers.
Assuming the program is non-bureaucratic-- highlight features that emphasize this.
For example, in loan guaranty programs, permit lenders to use all their own forms to originate and service loans and keep loan guaranty request turnaround time to a minimum-5 days or less for verbal approval. Distribute one-page program descriptions to lenders that emphasize program simplicity.
Aggressively market loan guaranty programs to branch managers and loan officers once a lender has agreed to participate.
If the program calls for a review and approval of lender guaranty requests, this marketing should be done by the staff who will review loan guaranty requests and it should be done continuously-loan officers want to meet the folks they will be dealing with and hold them accountable for turnaround times. Since many larger banks have centralized loan processing and approval functions, try to get the bank to designate one or two staff at their central processing center to learn and use the program-applications are submitted to processing centers by loan officers and branch managers; i.e. centralize loan guaranty requests within the bank but make line staff aware of the program.
No cost to lenders.
Most lenders are accustomed to public loan guaranty programs, such as the SBA programs, that charge lenders loan guaranty premiums and other fees to participate. Assuming this is not the case with an AT loan guaranty program, make lenders aware of this at the outset.
Depository or investment accounts.
If the community organization or financial administrator invests its NIDRR funds with a participating, insured financial institution, it provides another incentive for lender(s) to participate in programs.
Negotiating for Contracted Financial Administrative Services
Direct Loan Programs
Contracted financial administrative services will be especially important for direct loan programs. These contractors must perform all of the functions a lender performs when booking their own loans, particularly loan origination, closing, servicing, and loan workout functions. State law may require that a Request for Proposal (RFP) be issued to solicit proposals from lenders to perform these functions. Not all lenders will be interested in this business. Regardless of whether an RFP is issued, the scope of services (loan origination, closing, servicing, work-outs-some contractors may want the community organization to take responsibility for delinquent loans and workouts since these tasks can be costly), roles and responsibilities of program participants (community organization, lender, State Rehab Department, etc), underwriting standards and policies, minimum and maximum loan sizes, description of loan approval process, and other pertinent information should be drafted, since it will later become the basis for a contract.
The community organization should also solicit information on a lender's consumer, housing, or small business loan track record in terms of net annual charge-off ratios or percentages (charge-offs or losses + recoveries from liquidation/outstanding loans). This and other information establishes a provider's capacity to prudently manage direct loan programs. This is also true of participating bank(s) in loan guaranty programs in terms of capacity to originate and service loans the program will guaranty.
Interview at least 3-4 financial institutions to determine their interest in serving as the financial administrator. These interviews should include informal discussions regarding fees-try to get some sense of what a lender will charge based on the information you give them regarding their responsibilities and loan origination and servicing projections. Although only one or a handful of lenders may be interested in serving as the contracted financial administrator, the selection process should be made as competitive as possible.
Once the selection process is narrowed to one or two lenders, there are several ways to negotiate and structure the fees a community organization will pay a contractor for administration of a direct loan AT program. In general, the fee structure should be performance based in contrast to a flat fee paid regardless of loan origination and servicing volume.
Fee Structure Examples
The examples of fee structures presented below are not intended t indicate any maximum or minimum fees paid to financial administrators of direct loan programs but rather how fees may be structured. Fees will vary based on the level of time and effort an administrator must commit to the program. This, in turn, will vary based on program design and operating procedures. For example, if loan approval is delegated to the administrator (particularly for smaller loans within defined standards) in contrast to obtaining community organization approval of every loan, which requires more time and paperwork, this should act to reduce fees. Fees paid for services should be fair. You get what you pay for. You do not want to set fees so low (even if the provider agrees) if this will later provide a financial disincentive for the provider to deliver premium service.
The examples assume originating 100 loans per year and servicing 200 loans annually. They also assume early-phase programs, operating less than a year or two, where loan volume is largely based on projections rather than historical performance-thus, loan volume is uncertain.
A. Origination/Servicing Payment Schedule
| Program Promotion |
$ 5,000 (try to negotiate a matching contribution) |
|
Loan Closings: Loan Size Less than $500 $501-$1,000 $1,001-$2500 $2501-$5,000 $5001-$10,000 More than $10,000 Minimum annual charge Maximum annual charge for Loan closings |
Fees per loan closed $25 $50 $100 $150 $200 $250 $10,000 $ 20,000 |
|
Loan Servicing
: Current loans Delinquent Loans (60 days past due) Minimum annual charge Maximum annual loan servicing charge |
$15.00 per month $40.00 per month $10,000 $25,200 or $2,100 monthly |
| Foreclosed Loans |
Up to $10,000 annually for legal and other costs pre-approved by community organization. |
| Maximum Contract Amount | $60,200 |
This structure is largely performance based and has built-in upside cost protection. Servicing charges assume the administrator mails borrowers a monthly payment notice. Minimum annual charges shown in this example and the next should be avoided but may be necessary to attract providers in start-up programs.
B. Application Fee and Percentage based on Outstanding Loan Balances
Application fee : $25 per loan. Maximum annual charge: $2500
Outstanding Loan Balance Charges : 2% charged annually on a pro-rated basis on the total of outstanding program loan balances at the end of each quarter, with a minimum annual charge of $25,000 and a maximum annual charge of $50,000.
Maximum Contract Amount: $52,500
The 2% charge may be higher or lower depending on assumptions made with respect to average loan size, the average term of a loan, and the average interest rate charged on loans. Origination and servicing costs on a loan are generally the same for a lender, regardless of the loan size. As a result, smaller average loan sizes are less efficient or cost-effective and should command somewhat higher pricing to service relative to larger average loan sizes.
C. Hourly Charge
The provider charges an hourly rate such as $15-$25 but also agrees to a maximum annual amount, regardless of time spent managing the program. Hourly charges can be difficult to monitor and review (second-guess) and put an additional administrative burden on providers in terms of tracking the time staff spend on programs.
Loan Guaranty Programs
The cost of contracted financial management services for AT loan guarantee programs should be less than direct loan programs. This is because loan origination, closing, and servicing functions do not have to be performed, since a participating lender(s) performs these functions for their own loans, which the program guarantees. The tasks performed by contractors have to be clearly delineated. Tasks will vary by the type of program.
For example, loan-by-loan guaranty programs are more costly if the program requires staff review of lenders' guaranty requests prior to submission to program boards for approval since this requires more staff. Costs are lower for loan guarantee programs modeled after portfolio insurance or guaranty programs where loan approval is automatic if borrowers meet eligibility requirements-no "second guessing" of a lender's underwriting.
Other factors affecting cost are policies regarding timing of claims payment. Will claims be paid before a lender is required to liquidate any collateral securing loans or only after collateral is liquidated and the amount of any deficiency is known? Will the administrator or the lender be responsible for foreclosing or liquidating loans?
Will a loan loss reserve fund on guaranteed loans be maintained, particularly if guaranty capacity is leveraged by some multiple or if the guaranty will cover up to 60 days of accrued interest plus principle due the lender? Will there be an interest buy-down feature to the program, which will require the administrator to make periodic payments to the lender? Will the administrator be responsible for signing up a participating lender(s)? Many of the tasks an administrator must perform are purely administrative in nature that do not require staff with loan underwriting skills such as maintaining and updating loan status reports filed by a participating lender(s), establishing and maintaining loan insurance files, among others. Similar to direct loan programs, all details and procedures of the program must be known prior to negotiating for contracted financial management services.
Fee Structures
A variation of "B" above probably makes sense for guaranty programs, except the charge on outstanding balances would be less and maximum annual compensation would also be lower.
Negotiating The Guaranty Agreement and Loan Terms In Loan Guaranty Programs
Loan Insurance and Participating Bank Agreements
Loan guaranty programs enable lenders to book loans that have substantial merit but fall short of normal credit policy guidelines or standards (debt to income ratio exceeds standard, lack of collateral value, etc.). A guaranty may also act to provide better terms to borrowers than would otherwise be the case-lower interest rate, higher loan-to-value ratio, longer loan term).
Most Loan-by-Loan and Portfolio Guaranty Programs are effected with lenders through a Master Loan Insurance Agreement (loan-by-loan guaranty programs) or Participating Bank Agreement (portfolio guaranty programs) which a participating lender signs once. These agreements describe respective roles and responsibilities, reporting requirements and claims paying procedures, among other provisions. Loan guarantee commitments on individual loans are effected through a one-page Loan Insurance Authorization, which is subject to the Master Loan Insurance Agreement (loan-by-loan guaranty programs). In the case of Portfolio Guaranty Programs, a lender files a one-page form for each enrolled loan, which is acknowledged by program administrator, who then makes a contribution to a lender's reserve account.
Agreement Provisions
In the case of loan-by-loan guarantee programs, a participating lender(s) will always prefer the payment of guaranty claims prior to liquidation of collateral along with the ability to assign foreclosed loans bank to the administrator for final disposition. In addition, as noted earlier, they will want to know what the guaranty covers-principal only or principal plus up to 60 days accrued interest. Lenders will also be concerned with any provisions that require all loans to be secured, including UCC filings, or whether they can follow their standard practices in such matters. These items are all subject to negotiation.
Loan Insurance Agreements should also indicate the minimum and maximum dollar amount of guarantees per loan, as well as the maximum guaranty percentage; i.e. will you provide a 100% guaranty per loan up to some stated dollar amount limitation such as $10,000 or only guaranty a percentage of loans on a pro-rata basis such as 75-85% (SBA programs provide less than 80% guarantees).
Another key provision is how program guarantees will be secured. The key issue here is whether or not NIDRR grant funds will be leveraged by some multiple to increase guaranty capacity and how this leverage will affect lender participation. For example, loan guarantees can be secured on strictly a dollar for dollar basis-for each NIDRR grant dollar only one dollar of loan guaranty commitments is made. Alternatively, each NIDRR grant dollar could secure up to $2-3 dollars of guaranty commitments-a 2-3 leveraging ratio would still absorb an extremely high 50-33% loss rate on guaranteed loans. The guaranty, however, becomes more conditional-the guaranty is limited to available moneys in the program account (NIDRR grant dollars). A leveraged program is easier to sell when the program is limited to only one or two lenders, until such time that actual loss rates can be documented over a period of years. A leveraged program also helps to overcome the affects of small programs on lender participation.
Another negotiating issue is the interest rate a participating lender(s) will charge program borrowers. A lender may commit to make guaranteed loans at lower rates than is their customary practice on non-guaranteed loans with similar credit characteristics. Although a lender(s) may be willing to do this, there is clear evidence from small business loan guaranty programs that indicate restrictions on rates charged by lenders acts to discourage lender participation in a program, even when they sign-up to participate.
Program policy-makers must carefully weigh the advantages and disadvantages of all the alternatives reviewed in this paper when negotiating lender participation in guaranty programs or in the role of financial administrator.
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