Residential development loans are often tied to borrowing bases. A borrowing base is a lending condition incorporated into many revolving credit agreements that limits the Bank’s legally binding commitment to advance funds to the borrower. The borrowing base specifies the maximum amount the Bank will lend to the borrower as a function of the collateral’s type, value, eligibility criteria, and advance rates. The credit agreement also specifies a maximum commitment amount regardless of the amount of the borrowing base availability.
Typically, the borrowing base formula specifies different advance rates for each collateral type, such as land, developed lots, homes under construction, and completed and unsold homes. The amount of collateral in each category and the corresponding advance rates limit the borrower’s ability to draw additional funds. The advance rates are generally higher for collateral with lower development, construction, and marketing risk. For example, the advance rate for developed lots is likely to be lower than that for a completed home. In addition, advance rates may vary among borrower credit agreements. Generally, Banks grant more liberal advance rates to borrowers that have greater financial strength. Collateral must meet specified eligibility criteria to be included in the borrowing base. These commonly include limitations on the number of speculative units and the duration of time a completed unit may remain in the borrowing base.
The loan amount for a revolving line or credit in which a borrowing base sets the availability is the amount of the legally binding commitment (that is, the outstanding balance of the facility plus any availability under the borrowing base). Value is the lower of the borrower’s actual development or construction costs or the market value of completed units securing the loan multiplied by their percentage of completion.
This type of facility enables the Bank to control loan advances and proceeds from home sales. The funds available under the revolver are based on frequent (usually monthly) borrower-prepared reports, commonly referred to as a borrowing base certificate. The borrowing base certificate details and certifies the quantity and value of collateral in each category that meets the borrowing-base eligibility criteria and a total amount of the borrowing base (the outstanding balance of the facility plus any available funds). The Bank periodically performs on-site verification of the information provided by the borrower.