The Credit Committee, sometimes called the Investment Committee, is a panel of individuals ubiquitously found in financial institutions, pension and endowment funds, credit unions, banks, insurance companies and the like. This paper will focus on the role and inner workings of the Credit Committee of an Exempt Market Dealer offering real estate products to the public.
What is an Exempt Market Dealer (“EMD”)?
An EMD is a strictly regulated firm that has been licensed to distribute investment securities that are exempt from the rigours of a prospectus normally required by the Canadian Provinces in which it is registered to carry on business.
EMD’s may act as dealers for prospectus exempt securities sold to qualified clients. Typically an EMD offers products covered by an Offering Memorandum (“OM”) which need not be pre-cleared by a Securities Commission. An OM is an Issuer prepared document purporting to describe its business and that has been prepared primarily for review by prospective purchasers to assist in their decisions of whether to invest in the securities being offered by the Issuer.
What is a Credit Committee?
The Board of Directors of an EMD normally establishes the Credit Committee comprised of senior management individuals with authority and relevant skill and experience.
They will typically meet regularly to consider new investments and approve, amend or turn away investment opportunities being brought forward under the auspices of the EMD.
General duties and responsibilities
The Credit Committee has a broad range of general duties and responsibilities as part of its mandate. These include the obligations to:
- Ensure regulatory compliance for each investment;
- Review regularly investment policies and recommend to the Board of Directors changes in policies, procedures, internal controls and underwriting guidelines;
- Promote wise investment and credit management;
- Rule on investment opportunities, taking into account credit, market, operational and legal risks; and
- Ensure any investment is consonant with the EMD’s published investment criteria and policies.
The Loan Officer (Underwriter)
The Loan Officer assigned to any proposed transaction is typically an experienced underwriter charged with presenting the investment opportunity to the Credit Committee, including all the supporting research.
An underwriter’s main task is to assess the quality of an investment, its sponsors, and its inherent risks. You might ask why it is called “underwriting”. The term’s genesis is found in the historical practice of Lloyd’s of London Insurance of requiring each risk taker (often for a sea voyage with risks of shipwreck) to put their “written” signature “under” the total monetary risk they were willing to assume in return for a fee. Hence the term “underwriting”.
Often times, the Loan Officer’s presentation to the Credit Committee will have been previously vetted and endorsed by the Loan Officer’s supervising manager.
Credit Committee Adjudication – The “nuts and bolts”
Over and above its general obligations, the Credit Committee on an everyday basis is charged with the specific evaluation of any potential investment opportunity falling within the EMD’s jurisdictional orbit.
The starting point for its review is, of course, the Loan Officer’s discussion paper, which will include a profile of the people behind the deal as well as its proposed terms, detailed analyses and recommendations.
Due Diligence will usually cover, as applicable, a myriad of items, such things as:
- The credentials of an Issuer or Sponsor;
- The financial details of the proposed deal, including principal amount, yield, duration and other salient features and conditions;
- Creditworthiness of the borrowers and/or guarantors, including credit checks, financial statements, personal references and net worth statements;
- Third party reports such as valuation appraisals, architectural certificates, environmental; reports, building condition assessments, geotechnical appraisals and quantity surveyor reports;
- Leases, rent rolls and estoppel certificates;
- Development budgets and construction schedules;
- Ability of the originator to fund budget shortfalls and need for a Deficiency and Cost Over Run Agreement;
- Zoning and building permits;
- Details of prior and subsequent encumbrances and availability of lender consents, if necessary;
- Assessment of loan to value ratios and other compliance with the EMD’s investment criteria;
- Evaluation of current competing market conditions for similar deals, including prevalent offerings by competitors;
- Timing of advances to the borrowers;
- Availability of collateral security;
- Builder’s risk and liability insurance;
- Validity of repayment schedules, as well as feasibility of exit route through refinancing or sale of underlying property;
- Evaluation of originator’s track record and project’s progress to ensure continued sustainability in case an extended term is needed;
- Location of the property – marketability, condition and value based on Multiple Listing Service history over previous 5 to 7 years and approved appraisals;
- Contemporaneous assessment of general economic and societal forces, including state of financial markets, existing and proposed government policies, local issues, force majeure conditions, such as emergency measures related to an epidemic or pandemic;
- Review of commitment administrative and all incidental expenses and fees;
- Legal structure and supporting documentation; and
- Such other matters may arise in the course of the due diligence research and reviews.
Thumbs “UP” or “DOWN”
Having deliberated over the Loan Officer’s underwriting report and upon completing any follow up interviews, the Credit Committee is in a position to approve, amend or disapprove of the investment application at hand.
If it’s turned down absolutely or with amendments, then the Loan Officer will take carriage of so advising the applicant. If it’s approved, then a letter of intent will normally be sent. Upon acceptance by the applicant, a term sheet and commitment letter prepared by the Loan Officer and approved by the Credit Committee is ordinarily forwarded to the applicant for signature and acceptance. The Loan Officer then will confirm all due diligence and funding requirements are in order and arrangements are put in place to fund the transaction. The EMD’s Legal Counsel will be retained to prepare and register the mortgage and/or any other security documents and ensure all conditions have been satisfied before funds are released. Barring the need for an extension down the line, the basic work of the Credit Committee is now done.
As this juncture, the EMD moves on to fulfill its regulatory obligations and attends to matters related to Know Your Client, Know Your Product, qualification of investors, suitability, conflicts of interest, disclosure, etc. The full treatment of these tasks is beyond the scope of this paper.
The Credit Committee does much of the “heavy lifting” for investors in evaluating the underlying merit of any investment opportunity. It serves as a natural buffer or safeguard against an overly enthusiastic promoter. An essential part of its mission is to protect the ultimate consumer of products offered to the public under the umbrella of an Exempt Market Dealer.
Fundscraper Capital Inc. (“FCI”) is an online platform using modern technology and best of practice compliance standards to facilitate direct real estate investments by a wide range of Canadians into residential and commercial real estate projects. FCI also offers government compliance services and solutions to a variety of third party mortgage syndication and investment organizations which in some cases have published their own OM’s.
All investments and third parties offering securities on the FCI platform are vetted by its Credit Committee made up of seasoned experts in the real estate industry. They all pride themselves in staying current with political and legislative events, industry trends and everyday scuttlebutt.
FCI is registered in Ontario, Alberta, British Columbia, Prince Edward Island and Quebec as an Exempt Market Dealer (NRD: #53460) and with the Financial Services Regulatory Authority of Ontario as a Mortgage Brokerage (FSRA: #12859).