This policy will serve as a broad statement of the Bank’s standards, guidelines, and limitations that senior Bank management and loan officers are expected to adhere to when making a real estate loan. These policies will refer to specific underwriting guidelines for various project types. Additionally, this policy will refer only to commercial real estate loans.

There are provisions to real estate lending found in the Consumer Credit Policy and Small Business Lending Policy. Any provisions within those policies that conflict with this policy shall be considered superior (for example: those policy provisions should be considered to rule in the case of differences).

The Bank is owned by its shareholders, which elect the Board of Directors to oversee its interests.  The Board has many responsibilities including ensuring that appropriate plans and policies are adopted and adhered to, and that operations are effectively monitored.  Additionally, the Board is charged with analyzing and determining that the credit needs of the community the Bank serves are met.

The Board is accountable for the Bank’s credit policies.  It reviews the policy annually and reviews reports on the Bank’s loan performance at each meeting.  The Board has designated the Chief Credit Officer as having responsibility to administer the credit policy.  Administering the policy includes editing the policies and procedures and monitoring compliance thereof.
 

The loan policy is a dynamic document that is to be constantly reviewed.  As such, there will be times when the policy needs to be reviewed to assure that it continues to harmonize with the Bank’s Mission Statement, Lending Philosophy, and long-range plans and strategies.  As a lender you should recommend changes as you feel the need.  The changes will be reviewed and implemented when appropriate.  Note, however, that all changes to policy will be distributed through the Credit Administration Department.  No changes are to be made other than those published by Credit Administration.
 

Credit risk is the risk to earnings or capital arising from an obligator's failure to meet the terms of any contract with the Bank or otherwise fail to perform as agreed. Given the volatility in the commercial real estate markets, the financing of commercial real estate projects is subject to an exceptionally high degree of credit risk. 

In the context of commercial real estate lending the Bank's credit risk can be affected by one or more of the following risks that imperil the borrower: 

• A real estate project can expose the borrower to risk from competitive market factors, such as when a property does not achieve lease-up according to plan. 
  • Initial projections of demand may have been overly optimistic. A high volume of distressed property sales that can drive the value of other properties down compounds competitive market factors. 
• Interest rate sensitivity is an important consideration when originating loans secured by commercial real estate. 
  • Given the floating rate of most debt and the fixed rates on many leases, increasing interest rates are detrimental to the future repayment capacity of most real estate projects. Higher interest rates also reduce the market liquidity of real estate by making alternative investments more attractive to investors. 
• Rollover of leases is another risk to the borrower that is present in most commercial real estate projects. 
  • In depressed economies, leases have been broken as tenants go out of business or simply move out unless their leases are re-negotiated. The value of fully leased buildings can decline when leases must be rolled over or extended at lower market rates. 
• Changes in the regulatory environment can greatly affect commercial real estate developers. 
  • Changes in zoning regulations, tax laws, and environmental regulations are examples of local and federal regulations that have had a significant effect on property values and the economic feasibility of existing and proposed real estate projects. 
• Developers face construction risk that a project will not be completed on time, or that building cost will exceed the budget and result in a project that is not economically feasible. 

Interest rate risk is the risk to earnings or capital arising from movements in interest rates. Our primary interest rate risk arises from differences between the timing of rate changes and the timing of cash flows (re-pricing risk).  

We also incur interest rate risk from changing rate relationships across the spectrum of maturities (yield curve risk). In general, most of our amortizing real estate loans will be priced on a floating rate basis with a maximum fixed rate period of three to five years. On occasion, for very desirable credits, we will fix the rate on the loan for a longer term. Exceptions to this practice include promotional pricing, where the loan is funded by a fixed rate funding source such as an advance from the Federal Home Loan Bank, or where the loan fully amortizes over a period that does not exceed 7 years.

Liquidity risk is the risk to earnings or capital arising from the Bank's inability to meet its obligations when they come due without incurring unacceptable losses. Liquidity risk includes the inability to manage unplanned decreases or changes in funding sources. 

In the context of commercial real estate projects financing liquidity risk is a function of the Bank's inability to convert the book value of its loan asset to cash. To mitigate this risk we will limit the percentage of the Bank's loan portfolio that will be in commercial real estate projects. 

Transaction risk is the risk to earnings or capital arising from problems with service or product delivery. Transaction risks will be mitigated through the establishment of policies and procedures that address all aspects of the origination and servicing of real estate loans. 

Compliance risk is the risk to earnings or capital arising from violations of, or non-conformance with, laws, rules, regulations, prescribed practices, or ethical standards. 

This risk exposes the institution to fines, civil money penalties, payment of damages, and the voiding of contracts. Compliance risk can lead to a diminished reputation, reduced franchise value, limited business opportunities, lessened expansion potential, and lack of contract enforceability. The Bank has a full-time Compliance Department that is responsible for monitoring our adherence to laws, rules, and regulations. The Compliance Department also works with the Bank's training delivery department (StarU), to ensure that training materials are up to date. It is the overall goal to have loan delivery process designed to ensure regulatory compliance is followed. 

Capital City Bank is desirous of supporting the communities in which it operates. The Bank will aggressively seek loans from within our primary trade area, which will be defined as the counties in which our offices are located. We will also make loans within our secondary trade area, which is defined as counties adjacent to those in which our offices are located.

Real estate lending is a highly specialized lending area and requires a detailed knowledge of market conditions impacting the property. Loans made in the secondary trade area are to be made to borrowers with risk ratings above 4-Watch List¹ and which have other relationships with the Bank. There may also be instances in which we might make loans to borrowers with a current banking relationship that reside in our trade area where the real estate serving as collateral is located outside of our trade area. A common example of this would be the financing of a vacation home. Loans of this nature will only be to top tier clients in terms of both repayment capacity and banking relationship. The requirements of using a banking partner is defined in the the Loan Approval Process > Business Partners section of the General Credit Policy apply. There will also be occasions when we partner with another financial institution in a loan participation that will involve the pledge of real estate located outside of our defined trade area and the principal may be domiciled outside of our trade area as well. These participation transactions will typically be with existing clients of the participant bank with whom that financial institution has had an ongoing and positive relationship. Finally, there will be other instances whereby we might purchase a loan or loan portfolio from another financial institution where the collateral for the loan(s) will be outside of our defined trade area.

¹See Asset Classification Policy > Appendix for details on risk ratings.

Concentrations of credit generally represent excessive risk. Such concentrations typically take the form of a significantly large volume of economically related loans to specific industries, specific types of businesses, specific geographic area, or to individuals. Concentrations of credit are specifically defined in the General Credit Policy.

The Bank’s management recognizes that the economic environment of its trade area might cause concentrations of credit due to a lack of alternative lending opportunities. When this happens, the Credit Risk Oversight Committee will consider the nature of the concentration and the Credit Administration Department will give the Bank’s loan officers specific written guidance concerning these concentrations. The specific guidance will address credit criteria for loans in the concentration and any other additional controls to be used to minimize Bank exposure caused by the identified concentration.

To further limit concentrations of credit, the Bank maintains an in-house limit of $10.0 million to one individual or to a related group of individuals if there is a common business bond. All concentrations of credit and exceptions to the in-house limits will be reported to the Credit Risk Oversight Committee quarterly.

The Bank's Credit Risk Oversight Committee will determine and monitor loan portfolio composition on a quarterly basis. Revisions to the Bank's credit policies will be made as needed depending on existing portfolio mix and economic conditions, local demand, profitability, and concentrations. 

Staying within the limits established in the General Credit Policy enables the Bank to maintain a diversified loan portfolio that will hopefully perform consistently under all economic conditions. The use of participations, loan acquisitions, and loan sales will be encouraged to properly manage the portfolio mix. 

The Bank looks to the income-producing potential of the underlying collateral or of the business for owner-occupied commercial properties. The loan officer needs to fully understand the business and its strategic plan or the economics of the income-producing property. For income producing properties, the focus of the approval consideration will be the ability of the collateral to generate cash flow adequate to service the loan without relying on owner/guarantor support to make up the difference. 

The loan officer must consider the local economic conditions and current supply of product. Additionally, the officer must determine that the cash flow expected to service the debt is sustainable, or if projected, attainable. The loan officer must also understand and be able to opine on the reasonableness of the feasibility study or appraisal to the reviewing associate.

Before becoming seriously involved in discussions regarding a commercial real estate loan, the loan officer is to inspect the property. If it is a proposed project, the officer should carefully review the proposed construction budget and plans for the building. The inspection accomplishes the following:

• Allows the Bank to terminate discussions if the loan is obviously ill advised because of unrealistic income assumptions, poor project design, or an undesirable project location.
• Prepares the officer to communicate specific input to the associate engaging the appraiser.
• Facilitates a preliminary environmental assessment.
• Enables the officer to make comparisons with information provided by the borrower, adding insight to the loan being requested.
• Helps identify other business opportunities.
• Helps assess market area demand and growth prospects.

The Bank has discretion when making loans on real estate which are inconsistent with the neighborhood/market area or identified as legally non-conforming uses. This creates heightened risk to the Bank due to the inability to aptly measure value and marketability (for example: value conclusion is weakened due to like-kind sales or other data). Examples of inconsistent use would be a home with airstrip, residence with commercial gymnasium, or warehouse located in a residential area. 

There are also locations within the Bank footprint which have no zoning/land use restrictions or neighborhoods where the Restrictive Covenants have expired, are not enforced/inactive, or do not exist. As such, these examples could be legally conforming uses but are inconsistent with neighborhood trends, market acceptance, and reasonable marketability. Properties which do not meet current code, but are grandfathered in as it was an allowable use at the time of construction (legally non-conforming) could include properties which do not meet setback requirements, contain insufficient parking. Loans which have inconsistent use or are legally non-conforming uses may undergo additional review. As it relates to insurance for legally non-conforming properties, refer to the documentation files in Synergy.

Although the value of the real estate collateral is an important component of the loan approval process, the Bank does not place undue reliance on the collateral value in lieu of an adequate assessment of the borrower's ability to repay the loan. The assessment factors differ depending upon the nature of the loan, such as income-producing commercial property loans or development loans. 

We establish the creditworthiness of borrowers, co-makers, and guarantors by analyzing their backgrounds to see whether they have a history of fulfilling their obligations and paying their debts. Any derogatory information must be fully explained to the satisfaction of the Bank and sufficiently documented in the credit and/or loan file. 

As a matter of policy, we require that stockholders owning 25% or more of a corporation and general partners of partnerships guarantee or personally sign for the debts of the borrowing entity. On rare occasions there may be willingness to make loans with limited guarantees, burn-off guarantees, or without requiring personal guarantees at all. These instances will generally be limited to where loan to value ratios are very low and the collateral provides cash flow that services our debt with substantial excess margin. We may also impose financial covenants such as limitations on leverage and minimum debt coverage to help mitigate the lack of personal guarantees.

While our commercial real estate loans should be made primarily based on the income-producing capacity of the project itself or of the business entity occupying the collateral, there are times when guarantors or co-makers are considered to be the primary source of repayment. In these instances the Bank needs to have all the current financial information as outlined in the General Credit Policy. The financial information must reflect high amounts of liquid assets and other independent sources of cash flow. Where guarantor liquidity is crucial to the loan decision, we should request bank / brokerage statements to verify its existence. Also, it is important to consider the number and liability amount of guarantees currently extended by the guarantor or co-maker and the capacity to not only service our debt, but global obligations as well to help ensure there will not be the obvious potential to neglect our credit in favor of a separate obligation to another institution.

The following table provides the general guidelines required in funding commercial real estate loans at Capital City Bank.

***One extension for up to 3 months can be made to gather appropriate documentation or financial information. All extensions and renewals require authorization from the associate or committee with appropriate loan authority. All renewal notes must be documented through Loan Doc Prep and must be supported with appropriate loan authority. Use of the Extension Agreement is not appropriate for renewing loans.

1. Maximum term allowed only in certain conditions. 
   • See specific underwriting guidelines for detail. 
2. May be structured with annual payments for row crops. 
   • Land must be committed to ongoing management and agricultural production; otherwise it is considered raw land. 
3. Can be interest only for the first 18 months.
4. Speculative construction loans where the collateral is not sold within 9 months of completion, or within 15 months of loan origination, are to be curtailed by a minimum of 10% of the fully funded loan amount.
5. For loans to purchase real estate, value is defined as the lesser of acquisition cost or appraised value. 
6. Some loans may qualify for a longer period based on construction timing and size of the project. 
    

The following generally represents real estate loans that Capital City Bank does not desire maintaining or approving for its portfolio:

• Loans on real estate where there is no legal access.
• A loan specifically for the purpose of a borrower to pull equity out of a property from a purchase money transaction that occurred within the last year.
• There is an excess of similar projects under construction.
• The loan type has met the maximum percentage of portfolio loans outstanding as described in the Portfolio Mix section of the General Credit Policy.
• Loans with minimal or no borrower equity.
• Loans to develop property when the borrower has no previous development experience.
• There is no sound expectation or analysis that reflects current and reasonably anticipated market conditions.
• The loan is for property that is improperly zoned and is dependent on future rezoning.
• Renewals, extensions, and refinancing that lack credible support for full repayment from reliable sources and that do not have a reasonable repayment schedule.
• Loans to finance purchases of, or construction of, real improvements on leased property. 
  • The allowable exception is when the lessor subordinates its lease to the Bank and the term of that land lease not including renewal options exceeds the amortization period of our loan by some margin. Any exception to this policy requires prior approval of the Credit Committee.
• Loans on real estate that has a recognizable environmental condition and is not in a State or Federally funded cleanup program.

This list is not all-inclusive, and from time to time mitigating circumstances may warrant an exception. Loans being considered that meet the above characteristics will be discussed with the Credit Administration Department prior to approval. 

Investment property loans improved with a structure to be maintained in the Bank’s portfolio shall amortize over no more than 25 years when they meet our underwriting requirements as found in the Appendix to this policy. In some cases, the Bank may approve a loan participation with a term up to 30-years when well supported and approved by Credit Committee. In underwriting this loan, the borrower’s net income is adjusted by the amount of net cash flow that will result from income and expenses associated with the property. If the borrower owns more than 4 units, the debt coverage ratio (the number of times net operating income covers annual debt service) should be at least 1.20X. Expenses vary depending on the property type but should not be less than actual with adjustments for a management fee and an allocation for replacement reserves. The loan to value is not to exceed 80% and the borrower must have at least 20% equity in cash or other collateral.

Mobile home loans made to finance units to be rented are generally against Bank policy, with exceptions occasionally made for very creditworthy borrowers. However, we will consider financing mobile home parks where the source of repayment is rent of the land on which the mobile homes are affixed.

The Bank extends 1 - 4 family construction loans only to experienced local builders who have a successful track record either with the Bank or with a local competitor, and then only when the construction will be in our market as defined in this policy. These loans will typically be made as guidance lines of credit with a pre-determined maximum outstanding balance. The Relationship Manager must approve individual construction starts within the line unless Credit Committee requires designation of this responsibility to Credit Administration or Construction Loan Administration.

Loans of this type are to be managed by the Construction Loan Administration Department to ensure the proper funding, inspection, and other required steps are completed in a controlled manner. All residential construction loans, regardless of origination source, are subject to this requirement.

Residential construction loans will be limited to 80% of the appraised value or 90% of cost of construction, whichever is less. If the loan is for a speculative home, our maximum LTV will normally be 75% or lower for significant exposures to a single property. For loans to purchase real estate, value is defined as lesser of acquisition cost or appraised value. The appraiser must be on the approved appraisers’ list as per the Bank’s Appraisal Policy. Each loan will be for a period of one year to allow for construction and marketing. If the home is not sold after having been completed for 9 months, or within 15 months of loan origination, the principal balance of the associated loan shall be curtailed by 10% of the outstanding balance.

There may be instances when our borrower, an individual, is not the contractor on the job. In these cases, because of the risk of time and attorney’s fees, the Bank must approve the builder. This is not a credit decision on the builder, but rather due diligence to ensure that our borrower has chosen a reputable builder and that the possibility of the construction being completed timely without outside liens is maximized.

To approve a builder that is not already on the Bank’s approved builders list, a Builder Data Sheet must be submitted to the Construction Loan Administration Department who will verify the trade references, pull and review a credit bureau and search public records. Approval or declination will normally occur within 2 days. The Construction Loan Administration Department may request additional financial information depending on the results of its initial review and/or subsequent to its initial approval when deemed necessary. Such instances may include situations in which a certain number of houses are under construction, or when an unusual number of lien notices have been filed. Failure to provide financial information when requested will result in the removal of the builder from the approved builders list.

These are loans secured by real estate that will be repaid from the borrower’s business operations or from personal assets or cash flow of the principals. Although the primary collateral for the loan is real estate, the real estate is not the source of repayment.

For credit-based loans, the primary analysis focuses on the business’ operations and its ability to create cash flow sufficient to exceed debt service requirements by a pre-determined margin. Additionally, other non-financial considerations must be made including industry analysis, management capacity and depth, collateral value, and personal financial condition of the maker.

The required debt coverage ratio of owner-occupied real estate loans is 1.50X. This means the cash flow generated from the business should exceed all principal and interest payments by 50%. The traditional cash flow is determined by adding net income, depreciation, amortization, and interest expense on long term debt. Debt service requirements include principal and interest payments on long term debt. Cash flow should be adjusted for non-recurring expenses or income.

If the cash flow does not exceed debt service requirements by 50%, the loan may still qualify. If the principals are personally liable, their personal cash flows and debt service requirements must be considered. Oftentimes, the business income is low because of large salaries paid the owners. In this case and when the owners have other independent sources of revenue and low personal debts, the loan may still be considered.

The debt coverage requirement may be lower than 1.5X if the business is not cyclical. Cyclical is not to be misconstrued as seasonal. Cyclical means the business’ success tends to be influenced by the general economy. Most retailers and service providers are cyclical. Businesses are non-cyclical when its operations are minimally affected by economic cycles. Medical facilities are non-cyclical. The debt coverage requirement may be as low as 1.20X to non-cyclical businesses. Confer with Credit Administration when underwriting a loan at less than a 1.5X debt coverage ratio.

The maximum loan to value for credit-based real estate loans is 80%. For loans to purchase real estate, value is defined as the lesser of acquisition cost or appraised value. The typical amortization term is up to 20 years. However, the Bank will consider a term of up to 25 years when for the 5 most recent consecutive years, the business produced operating cash flow adequate to create a minimum DCR of 1.70x and the loan to value (LTV) does not exceed 70%. Any 25-year loan must have a 5-year call option and should be reviewed by Credit Administration. 

These are loans made to purchase income-producing real estate. Project financing relies on the cash flow currently being produced (or anticipated) from existing or future improvements to real estate. Because of the complexities and additional risks relative to project financing, the Bank has a Commercial Real Estate department that focuses strictly on these types of loans. Refer to the Loan Approval Process > Business Partners section of the General Credit Policy for direction on when to refer clients to, or collaborate with the Commercial Real Estate Department in underwriting specific loan types. The Credit Administration Department will also seek assistance in underwriting those loans described in this section.

In considering project-financing loans, the Bank’s loan officers must understand the relationship of the actual borrower to the project being financed. The form of business ownership varies for commercial real estate projects and can affect the management, financial resources available for completion, and the ultimate repayment of the loan. The credit memo must fully address the ownership structure of the property. Oftentimes, the owner(s) structure limited partnerships, limited liability companies, or other structures to limit personal liability. While guarantors and co-makers are less likely to perform under this type of financing, the Bank will still require personal endorsements or guaranties from any partner or corporate entity that holds a 25% or more interest in the project. All general partners of a limited partnership will be required to be personally liable. If the borrowing entity is different from the one presented in the credit memo, a notification of such should be made to address the change and the reason therefore.

The credit memorandum should address the past and current projects constructed, rented, or managed by the potential borrower to assess the borrower’s experience and likelihood of the proposed project’s success. The loan officer, in conjunction with the Credit Administration Department, will also conduct credit checks of the borrower and all principals involved in the transaction.

All financial statement information, including applicable personal and corporate tax returns, as well as rent rolls of major projects will be analyzed as part of the underwriting process. This analysis is done to assess the borrower’s financial strength to determine if the principals of the project have the necessary working capital and financial resources to support the project.

In underwriting any loan for income-producing property, the loan officer must quantify the degree of protection from the collateral’s cash flow. The protection from the collateral’s cash flow is determined by calculating the debt coverage ratio. The rental revenue is to be supported by an existing or projected rent roll. Variances between projected and expected rents should be fully explained. The debt coverage ratio is the number of times the stabilized net operating income from the property exceeds debt service requirements. Net operating income is defined as the cash left over to service debt and reward the owner after all non-debt related cash operating expenses have been paid. The expenses used should reflect the underlying leases. Even if the project is fully leased, a vacancy allocation should be included in the underwriting to reflect potential tenant turnover and/or default. The vacancy factor used in the analysis should be the greater of actual or market. 

In calculating the debt coverage ratio, the underwriting should consider the project’s sensitivity to the potential impact of changes in key economic variables, such as interest rates, vacancy rates, or operating expenses. An interest rate sensitivity test should be done on all project financing loans if the rate is not fixed to determine what rate movement could occur and determine the resulting impact to the debt coverage ratio. Additionally, a sensitivity analysis will be done to assess performance if vacancy rates or operating expenses increase by 10% over the normal or expected rates.

Finally, the value of the underlying collateral must be closely considered in underwriting loans on income-producing property. The Appraisal Policy details when appraisals are required.

The adequacy or appropriateness of the appraisal is an extremely important process in commercial real estate underwriting. Because the income approach is used most often, the value ultimately depends on the assumptions of capitalization rates, rental rates, vacancy rates, and operating expenses. The value of an income-producing property changes quickly when there are significant changes in the original assumptions used. Because of the potentially rapid change in value, the secondary source of repayment, which is used in cases where cash flow generated is insufficient to service the debt, is oftentimes insufficient to pay off the debt in liquidation. It is therefore imperative that the original assumptions used to establish value are supported by existing market conditions and are not unreasonable or overly optimistic.

When acquiring an appraisal for real estate which is encumbered by a long term lease, the values requested should include the Leased Fee Estate as well as the Fee Simple Estate. Depending on the terms and conditions of the lease as well as the strength of the tenant, both analyses may be needed for the lending decision.

A particularly important piece of the appraisal is the direct capitalization (cap) rate used to arrive at value. The cap rate estimates the present value of a property by discounting its stabilized net operating income. The cap rate is to reflect reasonable expectations about the rate of return that investors and lenders require under normal, orderly, and sustainable market conditions. Stabilized net operating income is the net cash flow derived from a property when market conditions are stable and no unusual patterns of future rents and occupancy are expected. Direct cap rates are only appropriate to use in valuing stabilized properties.

In addition to direct capitalization rates, the reviewer should consider the following in assessing the reasonableness of the assumptions used in the valuation of the commercial real estate: 

• Current and projected vacancy rates 
• Lease renewal trends and the remaining lease term of tenants using the property
• Volumes and trends in past due leases 
• Effective rental rates and sales prices taking into account concessions 
• Historical operating performance of the property 
• Economic conditions related to real estate supply and demand 
• Age and condition of the property 

A final credit decision and loan closing may not occur until an appraisal has been received when applicable and an appropriate review of the appraisal has been made. 

There are many different types of projects that Capital City Bank will loan against. Each property type has unique risks and therefore different underwriting requirements. In Appendix I to this policy, a detailed grid of underwriting requirements provides a summary of the Bank's required terms and conditions by property type. Additionally, within the Bank's Knowledge Management tool, HelpU, there are a number of supplemental guides by property type that should be followed when originating these loan types.

The following provides specific underwriting details by property type:

These loans include those for owner-occupied buildings, project-financing or income-producing properties. Construction loans for owner-occupied properties should be underwritten as described above in Credit-based loans. All non-residential construction loans should be originated with a loan-in-process account sufficient to fully fund the construction contract.

For owner-occupied properties, it is critical that the borrower hires a contractor that has expertise in building this particular project. The Bank must know the character, expertise, and financial standing of the contractor which requires the approval of the builder by Construction Loan Administration. The major sub-contractors should also be reviewed. Cost overruns, which are often created by contractors, can prevent a project from cash-flowing determined during the underwriting process and result in a criticized loan.

Construction/permanent loans for owner-occupied properties will include an interest only period, paid monthly, for a period of up to 12 months. The loan is to convert to a permanent amortizing loan after the initial construction period with terms as stated previously.

Construction loans for income-producing properties are much more risky than those for owner-occupied properties. Construction loans are vulnerable to a wide variety of risks. The following risks must be addressed in approving a construction loan: 

• Failure to complete the project by the agreed take-out date could void a permanent funding commitment. 
  • Likewise, not completing the construction as projected could void a lease agreement between the owner and a tenant  thus jeopardizing our course of repayment. 
  • For student oriented properties, it is imperative that construction is completed in time for the fall lease-up. Failure to do so could result in lower first year occupancy rates providing for cash flow that is insufficient to accommodate debt service. 
• Cost overruns occur. 
  • This can occur because of inclement weather, poor budgeting, increasing labor or material costs during construction or any number of occurrences. 
• Completed project is an economic failure. 
  • Progress payments may have been diverted by the developer and mechanics' liens may be filed for non-payment.
• General contractor may file for bankruptcy before completing the project.
• Failure of major subcontractors. 
• Uninsured destruction of completed work or work-in-process.
• Underfunded project-review construction to confirm a guaranteed maximum price contract. 
  • Cost plus contracts often lead to underfunded projects and could result in a problem asset. 

Construction loans for income-producing properties, even when a take-out commitment exist, must be underwritten to the standards included in Project Financing loans above. It is acceptable to enter into an open-end construction loan in which there is no pre-committed source of repayment. These loans entail additional risk, however, and more due diligence is required. 

When assessing construction loans with no pre-committed source of repayment, the loan officer and the Credit Administration Department must consider whether the project will be able to attract permanent financing from another source or whether the project can create a stabilized net operating income within an acceptable time period. Under such an analysis, the loan officer uses the expected net operating income generated from the property when completed in determining how large an amortizing, permanent loan the property could support using the underwriting requirements for the applicable property type. Sensitivity analysis to interest rates, occupancy levels, and operating expenses are extremely important. 

As a complement to the above underwriting requirement, the loan officer should determine the feasibility that the project will either lease up or sell out as believed by the borrower. Such analysis should include a marketing plan for the project and information about the project’s anticipated absorption rate based on future supply and demand conditions. A formal feasibility study may be required on any single project when deemed appropriate. If the project will result in completed units that will be sold, the feasibility study should consider proposed sales prices as well as absorption rates.

In cases where projects are being constructed in areas where demand has not been established, or there is a supply of similar projects in the area, pre-construction sales commitments or pre-leases may be necessary prior to funding the loan. This will typically be required when the project is over $2.5 million or the developer does not have substantial financial strength to carry the project for an acceptable period after construction, typically twelve months.

The loan to value requirements are outlined above by various property types. All construction loans will require at least 10% equity in the cost of the project, exclusive of interest reserve and contingencies. If the appraised value of the property and the cost are materially different (>10%), the variance must be explained in the credit memo. The 10% equity must be either in cash or in equity value of other assets included with the real property. The cash must be collected at closing, with the borrower’s funds being disbursed prior to the Bank’s funds.

The construction loan budget should include an interest reserve to carry the project from its origination to completion, including the projected lease-up or sell-out period. A sensitivity analysis should be performed to determine what the outcome would be based on the borrower’s financial strength if interest rates increased significantly during construction, or if the absorption rates were lengthened. In situations where the budgeted interest reserve is exhausted before the project is completed and lease-up is achieved, the borrower is responsible for providing additional cash to cover the interest payments. If the borrower is not expected to pay interest out of pocket, the economic projections for the project must support additional advances by the Bank. 

As with any commercial property financing, the appraisal must be assessed for reasonableness when determining the loan amount. The key considerations should include the absorption rates, or proposed lease amounts, current and projected vacancy rates, and projected sales price. Also, construction projects should be appraised on a net present value basis. This method is used when the project has not reached a stabilized net operating income. 

These are those loans made for the purpose of preparing land for future construction. These loans are typically made to purchase and grade the property and install streets and utilities. The source of repayment is the sale of improved lots, or the rollover into a construction loan. Due to the complex nature of hotel/motel lending, refer all financing requests to the Commercial Real Estate Department for review.

The Bank extends land development loans only to experienced local developers on projects within the Bank’s market area. The developer should submit a plan describing each step of the development. The development plan will detail the projected costs, including costs for obtaining zoning permits, environmental impact studies, and any other associated costs, such as improvements required by local regulations.

For large residential tract developments, the funds should be advanced in stages to prevent an oversupply of developed lots. Subsequent stages should be advanced against only after there has been sufficient pay-down on the initial stage and acceptable demand has been established.

The loan to value ratio is limited to 75% on a discounted value approach and the term of the loan is not to exceed 18 months. However, if the development is large, the loan should have a term to match the development and estimated sell-out period. The appraisal must be completed by an approved appraiser and the appraisal must be based on the value of the finished lots. The appraisal should not be based on the gross market value of the individual lots. It must be based on a net present value basis using the discounted cash flow method (for example: unit absorption). The appraisal must be based on appropriate absorption rates, developer’s profit, operating expenses, and discount rates.

The release price for lots should be set to ensure that the loan is repaid when 2/3 of the lots in the project have been sold. It is important to consider that lots within a development are typically not homogenous and as such have values that vary. Therefore, it is critical that the release requirements for each lot is directly correlated to its worth.

These loans are to purchase undeveloped land for the purpose of future construction or development. Raw land loans for speculative purposes are not allowable unless the borrower can support monthly payments that will pay off the loan in fifteen years or less. The source of repayment must be from income other than the expected resale of raw land.

The Bank extends raw land loans to experienced local developers with whom the Bank has a track record, but only when the land is being inventoried for development into lots or future construction. The LTV is limited to 65%. The development or construction should be scheduled to begin within 18 months. If lot development does not begin within 2 years, the loan should be moved to an amortizing or similar curtailment basis.

These loans are to purchase or finance land being actively used for farming, timber or related purposes. The source of repayment must be from income generated by farming or similar operations and not from the expected resale of the land itself (for example: crop proceeds, timber sales).

The Bank extends agricultural loans to experienced operators. Loans should be limited to an LTV of 80% when amortizing over 15-years and 75% when amortizing over 20 years. Crops and timber are to be further secured by a UCC filing (for example: mortgage on land by itself is not sufficient to secure timber or similar).

The pricing of loans is dependent on several factors, including:

• The level of credit risk
• The overall Bank relationship maintained by the client
• Competition 

The solution to all pricing problems is charging an interest rate for Bank funds that is sufficient to reward the Bank for the risks it assumes and to cover costs incurred in providing the loan. The costs include cost of funds, direct non-interest expenses, overhead support costs, and a risk premium to fund the loan loss reserve.

Pricing guidance is routinely issued bank-wide on a regular basis and determined with a risk-based approach in mind. Pricing for all commercial loans is based on guidance issued by Credit Administration and evaluated as part of the credit approval process; described further below.

Prices for commercial real estate loans are negotiated. Construction loans are typically priced using the prime rate as an index. Amortizing loans are priced using a Treasury bill as the index with a margin added. Margins of less than 3.00% may be considered for premium client relationships. Any loans originated with margins below 3.00% must include 5-year call options. Call options allow the Bank to assess the relationship not only from a credit standpoint, but also on the basis of client profitability. If the client is not maintaining the original relationship, or has not delivered the relationship promised at closing, the margin should be adjusted. All loans having variable rates shall have an interest rate floor.

Loan fees are charged to cover overhead costs of loan delivery and to enhance yields. The Bank has a standardized fee structure for construction loans and non-construction loans. Refer to the price guidance on netinterest. Proposed fees that are below this standard are considered exceptions and require adequate justification documented in the credit memo.

To mitigate interest rate risks, it is against policy to price loans outside of the pricing guidance published by the Bank. From time to time the Bank may provide a source of funds with a matched maturity to make fixed rate loans. The requirements for fixed rate loans will be published as they become available.

The overall yielded of a lender's portfolio is a determinant of performance. The Bank must yield a return on equity sufficient to warrant our stockholders' ownership of the company. 

The high volatility commercial real estate (HVCRE) regulation within the Basel III capital requirements mandates that, in order to be exempt from an HVCRE designation, clients who originate commercial acquisition, development, and construction (ADC) loans must meet a 15% equity requirement (for example: cash equity), and the leverage on such loans cannot exceed Supervisory LTV requirements of the estimated completed value of the project (for example: LTV equal to or less than that allowed for Supervisory LTV monitoring on an as-completed basis). If these conditions are not met, the loans will be subject to a 150% risk weight requirement. Additionally, the rule dictates loans that are required to stay designated as HVCRE until the credit facility is converted to permanent financing, sold, or paid in full.

The Bank will seek to identify loans as HVCRE for capital estimation purposes through a review and completion of a checklist during loan origination and underwriting in the loan origination system. Additionally, loans that qualify as HVCRE will be identified in the core system for regular reporting on an on-going basis.

Documentation files are maintained to provide information on the essential details of the loan transaction, the security interest in the real estate collateral, and the appropriate collateral protection. The Bank has developed checklists for all business purpose and consumer purpose loans that we typically originate. All required documentation is itemized on the checklist. 

The documentation files for real estate will generally include: 

• A recorded mortgage or deed of trust that may be used to foreclose and take legal possession of the collateral.
• A title insurance binder and policy issued by a recognized title insurance company on the approved title company list. 
  • The title company conducts a thorough title search and issues a title commitment to insure the Bank’s mortgage or security deed through the issuance of a title insurance policy which insures against Bank losses due to prior claims on the property, lack of validity or effectiveness of the bank’s lien, and lack of enforceability due to improper or unauthorized execution of the mortgage or deed. 
  • A title commitment may include exceptions that must be cleared prior to loan closing. The only exceptions allowed are in those instances where the Bank has knowledge of and acceptance of a priority lien to remain in place (for example: a first lien holder’s interest is considered in the loan decision). 
  • It is the Bank’s policy that the title agent must conduct the loan closing, clearing all required exceptions through oversight and funding based off the title agent’s settlement statement. 
  • Title policies should be updated or endorsed for additional coverage with each additional advance unless the title policy is issued for a revolving line of credit loan, and title policy includes a revolving credit endorsement.
• Collateral insurance policies showing that coverage is in effect, and in an amount adequate to cover losses to improvements, and evidencing the Bank as mortgagee. 
  • The policy should cover liability, hazards, and when appropriate, floods. 
  • A wind damage endorsement must be included, and will be forced-placed when not purchased by borrower. 
  • The Bank maintains a separate Hazard Policy, through Credit Administration, as well as a Flood Policy through the Compliance Department. 
  • If the loan will encumber a property which has been identified as a legally non-conforming use¹ sufficient insurance replacement cost verification is required in the event the property is damaged more than 50%. 
  • Options for documentation include acquiring a Replacement Cost New Estimate from an approved appraiser or contractor. 
• An appropriate appraisal or evaluation as required by the Bank's Appraisal Policy. 
  • A survey certified to the Bank evidencing the legal description, including dimensions, size and boundaries (if not platted) of the property, must evidence legal access, and be free from encroachments or encroachments on adjacent properties or public roadways or easements. 
  • A prior survey, up to 20 years old may be acceptable for residential properties, provided that no improvements have been placed, made or attached to the structure or boundary lines since the date of most recent survey, if the closing title company will insure survey matters using the prior survey in conjunction with an executed survey affidavit by the borrower or owner of collateral.
• A borrowing resolution, which empowers a representative of the borrower to enter into the loan agreement on behalf of the borrower.
• Environmental site assessment for commercial related loans as required by the Bank's Environmental Policy. 
• Evidence of good standing for business entities, including copies of their entity documents, as such is required in underwriting a legal entity borrower.
• Flood certification.

Construction loans require additional documentation in the file in addition to the above. These documents include: 

• Documentation of builder approval. 
• Documentation and approval of construction change orders by the loan officer and construction loan administration.
• Construction contract. 
• Project plans and construction budget showing the development plans and project costs. This documentation should include a detailed cost breakdown for the land and hard construction cost, as well as indirect or "soft" costs for the project. 
  • Soft costs include administrative cost, architectural, engineering, legal fees, and interest costs. 
• The architect's certification that plans comply with all applicable building codes, zoning, environmental protection, and other government regulations. 
• The construction loan agreement that sets forth the rights and obligations of the lender and borrower, conditions for advancing the funds, and events of default. 
  • The loan agreement should specify the performance of each party throughout the course of construction. 
  • The Bank and take-out lender, if applicable, should approve any changes in the borrower's plans representing more than a 5% increase in the cost of construction where applicable. 
• The take-out commitment from the permanent lender, when applicable. 
  • The take-out commitment should clearly document the loan terms and any conditions specified by the take-out lender that must be met in order for the take-out to occur. 
• A completion or performance bond when applicable. 
• Any environmental surveys deemed necessary given the location and type of project. 

As construction loans are completed, the documentation files are transferred to the Loan Servicing Department from the Construction Loan Administration Department. Once the documentations files are sent to the appropriate servicing area, a review is performed using the documentation checklists. Any exceptions are noted, and exception reports are distributed to all loan officers routinely. It is the lenders' responsibility to clear all exceptions. 

¹A use that was lawfully established and maintained, but no longer conforms to the use regulations of the current zoning in the zone where it is located. The Dictionary of Real Estate Appraisal, Fifth Edition p. 112

All real estate loans should be closed using the appropriate mortgage produced by our Loan Document Preparation Department or the mortgage prepared by a Bank approved law firm. The loans should be closed by either a title company or by a law firm unless the loan does not require title insurance in accordance with the checklist. 

The following loans are required to be closed by an attorney: 

• Church loans
• Commercial construction loans 
• Development loans or any other loans requiring partial releases
• Commercial loans to be secured by an interest in leasehold property 
• Loans where hazardous substance contamination exists (these are to be closed or reviewed by the Ausley law firm.)

Law firms should be considered when there are specific loan agreements or customized covenants. Any attorney closing a loan for the Bank must sign a formal agreement to represent Capital City Bank in the transaction. The law firm should maintain its trust account with the Bank with the loan disbursement checks drawn from this account. 

To be on the Bank's pre-approved list of closing attorneys, the specific attorney closing loans for the Bank must have at least 5 years of experience in real estate law and have a good reputation in the community. Additionally, the attorney must have a Martindale-Hubbell rating of B-V and use an insurance underwriter with a Demotech rating of A.

Title companies may be used to close non-complex real estate regardless of size. Commercial real estate loans closed by title agents should generally be restricted to those involving a transfer of title on existing improved real estate or unimproved land. 

The title company must be on the Bank's NetInterest Vendor List for closing agents maintained by the Credit Administration Department. There are occasions when the buyer agrees to utilize the seller's title company, and these situations are addressed on a case-by-case basis through Credit Administration. Prior to utilizing a title company not on the Bank's approved list, a Closing Protection Letter must be issued from the title company's underwriter. Approved title companies must agree to follow the Bank's closing instructions, policies and procedures. Additionally, the title company should maintain an escrow account at the Bank with loan disbursement checks drawn from this account. 

To be on the Bank's pre-approved list, the title company must be licensed by the Florida Department of insurance and have a good reputation in the community. An errors and omissions policy must be provided annually, and is monitored through Credit Administration. The insurance underwriter must have a minimum Demotech rating of A.

When selecting a pre-approved attorney or title company for loan closing, the lender obviously needs to consider the client's preference of closing agents. Other key considerations should be the service level provided and the amount of corporate business the firm or title company conducts with the Bank. 

Loan proceeds will typically be disbursed by the closing agent. The exception is when the loan is for construction. The Bank has a Construction Loan Administration Department that is responsible for administering all construction loans, both residential and commercial. All construction loans must be administered in this department regardless of point of origination. 

The Bank will disburse construction funds in accordance with either a standard disbursement plan or a progress disbursement plan. The standard disbursement plan is normally used for residential construction loans, and sometimes for smaller commercial loans. This plan uses a pre-established schedule for fixed disbursements at the end of each specified stage of construction. Disbursements will not be made that are not commensurate with improvements made to date unless a decision has been made to advance unsecured credit to the builder. All disbursement made under the standard disbursement plan are to be made only after an inspection of the property has been made. All notice to owners or mechanics' liens must have been cleared prior to progress disbursements. The final disbursement is made only after the legally stipulated period for mechanics' liens has expired. 

The progress disbursement plan is used for commercial projects. Under this plan, the Bank will release funds only as the borrower completes certain phases of construction. All requests for construction disbursements will be accompanied by an independent certification, typically from the architect and the Bank approved inspector, that the work to that date has been completed according to the plans and specifications. It is the responsibility of the Construction Loan Administration Department to confirm that all suppliers and subcontractors have been paid to date for materials or work performed. A retainage of 10% will be withheld from each draw to cover contingencies on commercial loans and 5% of 1-4 family residential loans.

The final disbursement usually included all retainage to date. Before releasing the final draw, we will confirm that the borrower has obtained all waivers of liens or releases from the project's contractors, subcontractors, and suppliers, proof of insurance, and a final survey of the improvements. Additionally, the Construction Loan Administration Department must obtain and review the final inspection report to confirm that the project is completed and meets building specifications. They should also confirm that the builder has received a certificate of occupancy. 

The Bank may enter into agreements with the title agents under promotional product offering, whereby title insurance is purchased, however, the loan closing and disbursements may occur in-house, without the title agent present. 

It is not the policy of this Bank to require corporate clients to escrow taxes and insurance on commercial real estate except where noted in this policy. However, all lenders are encouraged to establish escrows. There can be instances when borrowers fail to pay property taxes when the taxes are not escrowed. Even though this is an event of default, the Bank may be forced to advance funds to pay delinquent taxes to protect the Bank’s lien. If the Bank advances funds to bring property taxes current, the loan officer is required to initiate an escrow account for taxes and insurance (if applicable) from that date forward. Also, when reserves for capital improvements are set as a condition of approval, these reserves must be escrowed as well. Prior to disbursing reserves to the borrower, the loan officer should review all invoices and confirm by site visit that work has been completed.