As with any investment, GROUNDFLOOR's loans aren’t risk-free. Instead, exposure to risk must be approached thoughtfully and managed carefully. That’s a shared responsibility -- for us as an issuer of securities and for our investors as well.
By way of introduction, my name is Rich Pulido. I’m the Senior Vice President of Lending, Capital Markets and Risk Management at GROUNDFLOOR. My 30-year real estate career includes leading the Special Servicing group of Prudential Mortgage Capital Company during the Great Recession of 2008-10.
As a professional who’s had a front-row seat to several up cycles and down cycles in real estate, I’ve observed first hand how important asset management is to controlling risk. With fix-and-flip loans for acquisition and renovation such as those we offer here at GROUNDFLOOR, there are two aspects of risk to consider: The extent of loan repayment and the timing of it. At GROUNDFLOOR, our highest priority is maximizing the repayment of principal and interest. Minimizing the time to achieve repayment runs a close second.
How have we done? On our first priority, we’re 94-for-94, with 100% of principal and interest successfully returned on the loans we’ve repaid to date, as of the reporting period ended December 8, 2016 (Note: In the same report, we have identified several loans currently in workout that may return less than the expected rate of interest or principal. We produce this report monthly, and the number of loans in workout will change month to month depending on results). On our second priority, 82% of repaid loans have returned principal and interest prior to the due date, while 90% of our outstanding loans were on-track to repay on time. Under the circumstances for the type of lending we do, we’re proud of this record.
Here’s an inside look at how we manage to do it.
Step 1: Underwriting
The term “underwriting” refers to the assessment of risk in relation to certain criteria.
GROUNDFLOOR employs a team of professionals who apply decades of real estate investing and lending experience to this task. We added new leadership in this area and expanded our depth of expertise significantly throughout 2016. Our underwriting team carefully screens borrowers, quantifies the value of loan collateral presented, and assesses the feasibility of completing proposed project works.
In addition to our people, we’ve also added more data, tools and policies to support our underwriting process. For example, we introduced more robust appraisal standards, including full interior inspections where relevant. We also added more extensive sources of valuation data and analytical tools to our arsenal. All loans are now subjected to more rigorous business case analysis and stress testing. GROUNDFLOOR's closing documentation has also been revised to incorporate stronger, industry standard lender protections.
Step 2: Monitoring
Once we make a loan, GROUNDFLOOR employs proactive asset management practices to protect your investments. We monitor progress against the borrower/principal’s stated plan and budget, as well as compliance with loan requirements. This helps us to identify or anticipate problems sooner and more reliably than we could without that monitoring. Once a deviation from plan or another concern becomes apparent or is detected, we promptly contact the borrower to understand the situation.
Most of our loans fund renovation work to prepare a property for sale or lease-up. The borrower typically pays for the renovation work and then requests a draw for reimbursement. Experienced professionals independently assess the quality and scope of the work completed against all reimbursement requests to assure reasonableness. In addition to tracking a budget, we measure the project against the original schedule. Any significant deviation from schedule prompts a phone call from our asset management team to discuss project progress. GROUNDFLOOR's loan documents require the borrower to maintain sufficient insurance coverage, remain current on all real estate tax obligations and keep the property free of any liens (other than GROUNDFLOOR's first lien). We diligently monitor all these conditions. Problems with these requirements may indicate financial stress or insufficient focus.
A key element of proper loan management is focusing the borrower on upcoming loan maturity. We contact the borrower 90, 60 and 30 days prior to maturity to remind them of the upcoming maturity and understand how they plan to pay off the loan. These discussions allow us prepare a payoff statement, coordinate with the closing agent or new lender, etc. These communications allow us to get ahead of a situation that may result in a payoff occurring later than the stated maturity date.
If the situation warrants it, we or a designated third party may meet with the borrower at the project and conduct a property inspection. It is critical to mitigating risk and minimizing loss to understand the property’s condition and hear directly from the borrower what the plan is to ensure any problems are resolved promptly and with minimal impact to GROUNDFLOOR.
Step 3: Recovery
In some situations, rigorous underwriting and proactive asset management are not enough. That’s where the real art of asset management comes into play: Recovery. The real measure of how effective we are at protecting your investment is the loss ratio on loans that have experienced trouble. While we have certainly had loans that paid off later than anticipated, realized cost overruns or even faced foreclosure, we’ve successfully recovered and repaid all principal and interest due on 100% of the 94 GROUNDFLOOR loans repaid to date (as of December 8, 2016, as reported in our SEC regulatory filing of December 8, 2016).
As a lender secured by a first mortgage, we always have the right to foreclose on a troubled loan. However, we seek to resolve problem loans in a manner that is quicker, more cost effective and ultimately economically better than a foreclosure.
Here are two actual case examples of our recovery efforts:
Example 1: We had a loan on a project on which the principal had apparently become distracted by other concerns not related to the project. The project was also experiencing cost overruns. After inspecting the property and meeting with the borrower, we decided it would be preferable to exit the investment quickly than continue to work with the borrower. We worked through our professional networks to identify a lender willing to purchase our loan position so they could make another, larger, loan to the borrower. The loan sale, achieved at a price that fully recovered all principal and interest, was completed in about 2/3 of the time that would have been required to complete a foreclosure.
Example 2: Sometimes a problem loan requires multiple workouts before achieving a final resolution. A Georgia borrower was behind schedule, experiencing cost overruns and facing an imminent maturity on his project. We determined an additional $8,000 would be required to complete the project. The borrower agreed to deposit $8,000 in escrow in exchange for a short-term loan extension. The borrower struggled to complete the work and in fact only drew down $4,000 from the escrow. It was clear the borrower would not be able to complete the project. We explained to him why he would definitely lose the property in a foreclosure and why giving us the property immediately would be to his advantage. He agreed and voluntarily transferred title to GROUNDFLOOR. Anticipating we would secure title to the property, we proactively began working with a broker to identify a buyer for the property. This action reduced GROUNDFLOOR's total holding period to only 45-days while yielding net sale proceeds sufficient to cover all carrying costs and to return full principal and interest due to our investors.
We invite questions, comments and feedback on how we manage risk at GROUNDFLOOR, as well as any other aspect of our company. Comment below or write to me anytime at rich@groundfloor.us.
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