Powering Smarter Construction Finance

Construction Loans, Interest Reserves + COVID-19

Posted by Jim Fraser on Jun 11, 2020 at 9:03 AM

As COVID-19 continues to evolve, impacts to commercial real estate loan portfolios will become more apparent. Lenders and borrowers are engaged in deal-by-deal negotiations, including application of the CARES Act which gives lenders the ability to defer interest, modify and extend maturity dates, and forebear defaults if needed. 

Real estate secured construction loans cannot generate positive cash flow and are typically capitalized with an interest reserve budget to pay monthly interest accruals. Established and estimated at the origination of the loan, interest reserve budgets are not always sufficient to cover the loan term. Given Covid-19 related construction halts and supply chain disruptions reported by general contractors and material suppliers, a condition of insufficient interest reserve has potentially emerged that may threaten construction loans nationwide. Delay impacts extending construction loan terms and absorbing interest reserve balances is partially offset by Fed interest rate policy. Lower rates mean lower monthly accrual, helping to extend the coverage of interest reserve balances.

Commercial real estate construction lenders on Built Technologies are able to access Insight Reports to identify and measure individual transactions, where interest reserves are currently insufficient based on remaining balances, estimated months to completion and scheduled maturity. A similar, aggregated portfolio sufficiency report is also available to see global exposures to this key risk indicator.

Informal regulatory feedback is promoting additional interest reserve stress testing for lenders with impacted portfolios. Built Technologies is working closely with current clients to help develop interest reserve sufficiency tests under stress scenarios. Each portfolio is unique in composition and market exposures. Property use types and re-opening schedules are likely to affect sufficiency tests.

Stress tests will be critical in the coming months and quarters. Shortfalls identified and confirmed through borrower and lender negotiations will need to be funded. In most cases, the shortfall will be subject to additional equity or borrower funds requirements of the construction loan agreement. In the case of very low leveraged transactions, lenders may find credit support to provide an additional advance to fund any shortfall. 

Contact Built Technologies for more information on how our interest reserves sufficiency reporting can help support your commercial real estate portfolios and prepare for future regulatory reviews that are specifically targeted at commercial portfolios where deferrals, extensions, or modifications may have occurred affecting interest reserve balances.

Topics: "Construction Finance", covid-19

Jim Fraser

Jim Fraser

Jim Fraser has over 30 years of experience in financial services, with an emphasis in construction lending and real estate development. Fraser currently works at Built Technologies as Lending Channel Manager, overseeing Built's construction lending origination and loan administration platform solutions. Built’s platform has supported over $68B in construction commitments as of 2020 and is used by more than 130 of the nation’s leading construction lenders. Prior to working at Built, Fraser was EVP of Commercial Lending at Axos Bank [NYSE: AX], where he was responsible for commercial construction lending, income property, lender finance, equipment leasing and factoring, with a combined portfolio of $5 billion. Previously, Fraser was Managing Director at Banc of California [NYSE: BANC], managing $500 million in residential and CRE construction, including FNMA and FHA renovation lending programs under Banc Home Loans national mortgage lending brand and third-party, fee-based services under RenovationReady, a division of Banc Home Loans. He brings his banking expertise to the Built Technologies team as they build the leading solution for the entire construction finance ecosystem.

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