One battle currently waged in the banking industry is amortization terms and interest-only (IO) periods. Borrowers often have legitimate needs to extend the principal repayment on term loans to 30 years. Banks prefer 20-year amortization terms on real estate-secured loans, but most banks are willing to extend to 25-year amortization terms. Some banks will offer 30-year amortization periods for specific borrowers, and there are a few banks that will provide 30-year amortization terms with interest-only periods for the initial one to three years. A few months ago we were involved in a full 10-year term IO loan (a 40% LTV real estate-secured loan, 10-year interest-only payments). We have a novel structure that allows banks to maintain a 25-year amortization period but offer borrowers a much longer effective principal repayment schedule.
Real Estate-Secured Reducing Revolver
A revolver is a credit facility that can be drawn and repaid multiple times. A “reducing revolver” has the same multiple draw and repayment feature, but the maximum draw amount declines over (or amortizes like a term loan if the facility is fully drawn). While we often associate revolvers with the financing of short-term assets such as inventory and receivables, revolvers can also be secured by real estate. A real estate-secured reducing revolver can also be coupled with a term loan. This is the essence of our solution.
We received a request from a borrower to adjust his existing term loan from a 25-year amortization to a 30-year amortization. The borrower also asked if we would consider an amortization longer than 30 years. The borrower is motivated to reduce monthly payments to increase cash flow from his investment property that is being used to finance his retirement.
Specific numbers for this loan are as follows:
Appraised real estate value - $7.5mm
Loan balance - $4.45mm (59% LTV, with no cash out except for closing costs)
The borrower would like to preserve cash flow, and the bank does not want to offer amortization periods longer than 25 years.
The bank writes a single note composed of two tranches:
Tranche A - $1.1mm RE-secured reducing revolver
Tranche B - $4.45mm RE secured term loan, 25-year amortization, 10-year term
The combined loan amount of $5.55mm is 74% of the appraised value (within the bank’s policy guidelines). The borrower will draw Tranche B ($4.45mm) at closing and has the option to draw and repay Tranche A in the future. The loan will amortize the combined principal of Tranches A & B over 25 years (again within the bank’s policy guidelines). However, if the borrower does not draw Tranche A, the principal can remain outstanding based on the combined balance of Tranche A (as if it were drawn) and Tranche B.
The structure is demonstrated graphically below.
Loan 2 (the blue line in the graph) shows the LTV over time if the borrower draws the RE secured reducing revolver (Tranche A) from day one. Loan 2 is a standard 25-year amortizing, initial 74% LTV term loan. Loan 1 (the red line in the graph) shows the LTV over time if the borrower does not draw the RE secured reducing revolver. If the revolver is not drawn the starting LTV is 60%, and principal reduction is not required until the principal outstanding on Loan 2 approaches the balance on Loan 1 – in this case, if the borrower draws zero amount on the reducing revolver, then principal payments are not made until month 88. While the borrower does not make a principal payment under Loan 1 until month 88, the lender has lower exposure for Loan 1 than Loan 2.
While Loan 1 has the lower credit exposure for the bank if the reducing revolver is not drawn, Loan 1 also has a longer average life (9.85 years for Loan 1 vs. 8.74 years for Loan 2). Interestingly Loan 1 is the more secure credit for the lender and meets the borrower’s need of preserving cash flow. In positioning Loan 1 for the borrower, the bank explains that the average life of Loan 1 is the equivalent of a 65-year amortizing loan – a big selling point for this specific borrower.
The real estate-secured reducing revolver can be an interesting option under certain circumstances where the initial LTV is low, the borrower does not require cash out but does want to preserve cash flow. The structure is contractually a 25-year amortizing loan that permits the borrower to preserve cash flow and still keep regulators comfortable.
Submitted by Chris Nichols on July 25, 2019