Capital Recovery Notes
Written by: Ryan Strutz
As many Mark to Market (M2M) project owners know by now, their projects are required go through many more painful levels of review than any other HUD project. M2M projects are required to first have an annual financial statement audit completed by a CPA, financials are then reviewed by REAC and HUD, and most recently OAHP has added an additional level of surplus cash review by MBI. These various levels of reviews, and the financial impact to the project if all regulations are not followed, has led many owners to be very conservative with any payments made from these projects.
One payment which has led to many discussions and debates is the repayment of the Capital Recovery Note. Not understanding the requirements around this Note payment leads many to delaying repayment and not receiving the full return on investment or even making payments which are unauthorized and could cause reimbursement to the project.
First, we need to understand how the Note is being amortized and when it becomes due. Typically these Notes are approved for repayment on a monthly payment amortized over 10 years assuming certain preconditions are met. The key is that HUD will not allow any more payments then those based on the initial monthly amortized payment schedule. Most importantly, if the project does not meet the preconditions established for repayment and the monthly payments are not made the loan will not accrue any additional interest. The missed payments can be made once the preconditions for repayment are met and there is sufficient cash flow for payment; however, delayed payments ultimately result in a decreased return on the Note as additional interest does not accrue as the payments are waiting to be made.
Second, it is just as important to understand the preconditions which are required for repayments to be made so we are not delaying and decreasing our rate of return on the Note. These preconditions for repayment consist of the following:
- All project expenses have been paid
- All required payments have been made on the Mortgage Restructuring Note and on any 1st mortgage;
- The most recent REAC physical inspection score is 60 or above;
- There are no outstanding HUD audit or management findings; and
- The owner is not in default under any of the key governing documents such as the Regulatory Agreement.
In summary all these points lead to the requirement that the project must be in a Surplus Cash position based off of the HUD Surplus Cash Calculation to make any payments on the Note. The majority of practitioners have adopted a philosophy of not paying any payments on the Note till the yearend Financial Statement Audit is completed to confirm the project is in a Surplus Cash position to make the payments, or they are completing a Monthly Surplus Cash calculation to support every monthly payment
Finally, there are many specific reporting requirements for classification of the outstanding balance of this Note within the Audited Financials and Surplus Cash Calculation which I recommend confirming with your CPA.