FinXTech’s Need to Know: Construction Lending

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Demand for housing hit a high unlike any other during the pandemic. While demand grew, the number of acquisition, development and construction (ADC) loans in bank portfolios grew parallel alongside it. Construction and development loans at community banks increased 21.2% between the first quarter of 2021 and the first quarter of 2022, according to the Federal Deposit Insurance Corp.’s Quarterly Banking Profile.

As a subset of the commercial real estate (CRE) lending space, banks are accustomed to the timely process that construction lending requires. But are banks prepared for the influx of risk that can accompany this growth?

Mitigating construction risk is a bit like attempting to predict the future: Banks not only have to evaluate creditworthiness, but they also have to predict what the project will be worth upon completion. With another interest rate hike expected later this month, being able to accurately price projects is becoming more complicated — and more vital.

Here are three ways financial technology companies can help banks in their attempt to fund more ADC projects.

Software can automate the drawing process. Construction lending features the unique ability for builders to “draw” cash from their loan throughout the project. Spacing out the draw schedule protects banks from losing large amounts of money on projects that go cold, and also allows proper due diligence and inspection to be on rotation.

CoFi — formerly eDraw — specifically focuses on this process. Bank associates access all budgets, invoices, approvals and construction draw records in one web-based system. The bank’s borrowers and builders also can access the software through customer-facing accounts. A builder requests funds by uploading invoices, and CoFi then notifies the bank that their approval is required for the funds to be disbursed.

Once the bank approves the disbursement, the borrower is notified. Banks can also dispatch inspectors to the property using CoFi. After confirming that construction progress is in line with the draw requests, the inspector can upload their report directly into CoFi. With all of the proper approvals in place, the bank can release funds for the payment request. All actions and approvals are tracked in a detailed, electronic audit trail.

CoFi also has a construction loan marketplace banks can plug into.

Multiple parties and industries can collaborate in real time through web-based solutions Nashville-based Built Technologies operates as a construction administration portal, coordinating interactions and transactions between the bank, the borrower, the contractor, third-party inspectors and even title companies in one location. 

Legacy core banking technology wasn’t designed to completely support construction loans, which moved the tracking of these types of loans into spreadsheets. Built’s portal eliminates the need for these one-way spreadsheets. The moment a construction loan is closed, instead of a banker creating a spreadsheet with a specific draw budget, they can design one digitally in Built and reconcile it throughout the duration of the project.

Builders can even request draws from their loan through their phones, using Built’s mobile interface. 

Fintechs can better monitor portfolios, identify errors and alert banks of risk areas, compared to manual review only. ADC loans are fraught with intricate details, including valuations that fluctuate with the market — details that can’t always be caught with human eyes.

Rabbet uses machine learning and optical character recognition (OCR) when reviewing documents or information that is inputted to its platform, the Contextualized Construction Draw format (CCDF). It also continually monitors and flags high-risk situations or details for borrowers, including overdrawn budgets, liens or approvals. Any involved party — developer, builder or bank — can input budget line items into the platform. Rabbet then links relevant supporting documents or important metrics to that item, which is information that is typically difficult for lenders to track and verify.

Storing loan calculations and documents in one place can translate to faster confirmations for borrowers and easier reconciliation, reporting and auditing for the bank.

In July 2022, Built announced the release of its own contractor and project monitoring solution, Project Pro. The technology helps banks keep track of funds, identify risk areas such as missing liens or late payments, and stay on top of compliance requirements.

Banks with a heavy percentage of construction loans on their balance sheet need to keep notice of all elements attached to them, especially in a rapidly changing economic environment. Technology can alleviate some of that burden.

CoFi, Built Technologies and Rabbet are all vetted companies for FinXTech Connect, a curated directory of technology companies who strategically partner with financial institutions of all sizes. For more information about how to gain access to the directory, please email [email protected].

Five Critical Mistakes to Avoid in Any Headquarters Project

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headquarters-5-15-19.pngCorporate headquarter projects are likely one of the biggest investments a bank will make in itself.

With a lot of time and money on the line, it is no surprise that these massive projects quickly become an area of major stress for executives. Most management teams have limited experience in executing projects of this kind. The stakes are high. Bad workplace design costs U.S. businesses at least $330 billion annually in lost efficiency, productivity and overall employee engagement, according to Facility Executive.

A lot can go wrong when planning a corporate headquarters. Executives should use a data-based approach and address these issues in order to avoid five critical oversights:

1. Overpromising and Under-delivering to the Board
You should feel confident that every decision for your planned headquarters is the right one. The last thing you want to do after you get the board’s approval on the size, budget and completion date for the project is go back for more money and time because of educated guesses or bad estimates.

Avoiding this comes down to how you approach the project. Select a design-build firm that considers your needs and asks about historical and projected growth, trends and amenities, among other issues. This will help mitigate risk and create a plan, budget and timeline based on research and deliberation

2. Miscommunication Between Design and Construction
Partnering with a design-build firm helps alleviate the potential for miscommunication and costly changes between architects and construction crews. Look for firms with a full understanding of costs, locally available resources and current rates, so they can design with a budget in mind. Some firms offer a guaranteed maximum price on a project that can eliminate surprises. 

3. Missing the Mark on Efficiencies and Adjacencies
The way employees work individually and collaborate with others is changing. Growing demand for work areas like increased “focus spaces,” more intimate conference rooms and other amenities should not to be ignored. Forgetting to consider which departments should be next to each other to foster efficiency is also an oversight that could dampen your bank’s overall return. Look for a firm that has an understanding of banking and how adjacencies can play a role in efficiency that can guide you toward which trends are right for your bank.

4. Outgrowing the New Space too Soon
I have witnessed a project that was not properly planned, and the board was asked to fund another project for a new, larger building only five years after the first one. As you can probably imagine, the next project is being watched and scrutinized at every turn.

Most architectural designers will ask you what you want and may look at whatever historical data you provide. Beyond that, how will you know if the building will last? A good design-build firm should incorporate trends from the financial industry into your design; a great one will provide you with data, projected growth patterns and research, so you can demonstrate to the board that the bank is making the right investment and that the new space will last.

5. Forgetting the People Piece
Not communicating with your employees or leadership on the reasons behind the change or how to use the new space often means leaving money and happiness on the table. The design and the features of the building frame the company culture, but the people complete the picture.

Make sure to show your workforce the purpose of the new space. Help get everyone excited and on the same page with the use, process and procedures. Do not drop the ball after the hard work of building the headquarters.

When it comes to any project—especially one of this size and magnitude—always measure twice and cut once.

Part II: The Inspection Process – Compliance Lessons from the Construction Industry

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quality-guarantee.jpgIn the first article of this series I compared the optimal compliance program to a well-built house. You may recall that the construction of a house and a sound compliance program share three key elements: the blueprint, foundation and framework. In this installment, we’ll talk about two more elements that compliance and construction have in common: inspections and maintenance. For the staff involved, this work can be painful to endure, but altogether necessary.

Just like a home inspection, a banking inspection ensures the safety and soundness of the structure. An overlooked mistake can spell a failed inspection, or worse, a structural collapse—and perhaps liability. Even after a passed inspection, periodic maintenance is required. Prompt detection, and swift and thorough remediation of the problem areas, can halt concerns before they worsen, thereby protecting your institution.

So how do you know whether your institution is ready to pass inspection? How do you determine whether you’re conducting the proper periodic maintenance check-ups and routines to keep your compliance programs as effective as possible? The answer is simple: By exercising proper oversight of these programs at the board level. This oversight is carried out by reviewing the right reports with the right content at the right times. 

Boards of directors must ensure that they gather solid intelligence to carry out their fiduciary duties and make informed decisions. One way to do this is to demand high quality reports at predictable intervals. Reports that are flawed or delivered too infrequently may conceal weaknesses that should be addressed. Reports should occur at three basic intervals:  monthly, quarterly, and annually.

Monthly Report

Monthly reports should focus on tactical execution, delivering performance data and metrics. These reports, typically delivered by the compliance team, should cover frontline activity and demonstrate whether the day-to-day work of compliance is being done on time and accurately. Monthly reporting should shine a bright light where weaknesses may exist, and should state the measures being taken to remedy the deficiencies. 

Quarterly Report

Quarterly reports should focus on trends and analytics that demonstrate whether risk exposures are increasing or decreasing. The quarterly report gives insight into how the compliance program is functioning over time. This report should contain information about regulatory trends, upcoming or changing rules and should consider the environmental and operating conditions that could affect the institution’s progress and performance.

These reports should also summarize the results of compliance monitoring activities that occurred during the quarter and which activities are planned in the quarter ahead. This data allows directors to conclude what, if any, internal events or changes will influence the institution. In general, these reports show the up-to-the-minute state of preparedness for exams and audits.

Annual Report

Finally, annual activities such as audits or reviews generate reports on the program’s effectiveness. This annual look-back reflects how well the institution kept its risk exposures to acceptable levels. These types of reports often opine on the overall capabilities of the executive team and compliance management group in carrying out their responsibilities. These reports take an independent look at the program to gauge its effectiveness, efficiency and performance over a historical period.  

Indicators of Poor Reporting

Good intentions can nonetheless produce bad results if the content of reports is inadequate.  When reviewing your institution’s reports, keep in mind these signs of flawed reporting:

  • Reports that are too long or too detailed. Key points cannot be extracted when the volume of information presented obscures the meaning. 
  • Reports that state only facts but provide no evaluative statements. The board needs to understand whether the data being presented is positive or negative.
  • Reports that fail to identify the root causes of weaknesses. Failure to identify the root cause delays implementing corrections. 
  • Reports that identify the root causes of deficiencies, but do not suggest appropriate corrective action. Solutions should be offered in reports. 
  • Reports that only emphasize weaknesses and ignore strengths. Focusing only on the negatives may inappropriately exaggerate the scope or materiality of an identified problem. 
  • Reports that do not reflect the materiality or severity of an issue. Treating every issue uniformly is a sign that perspective may be lacking.

Financial institution boards have a tough assignment: Overseeing the construction of a stable structure that can withstand not only regulatory scrutiny, but the storms of changing economic and regulatory conditions. Maintaining this structure after it’s built is equally daunting. It requires vigilance toward the review and interpretation of quality data, and applying that information to managing risks in an ever-changing climate. Proper reporting ensures proper maintenance of the compliance program, and a well-maintained program that can be clearly articulated to examiners is the key to passing future inspections. 

But, what if, during the inspection process, you realize that something has gone wrong? In the next article of this series I will go over the corrective steps and actions the board should take to repair the compliance program.