It is 6 o’clock in the evening on Friday of a very tough week. You are in the process of packing up your things to head out of the office when the phone rings. Hesitantly, you answer the phone. On the other line is a client of your bank in an area that you do not support. Your name was provided to him as a backup for a teammate who has already left the office for the day. The customer is in a panic as they have two loans with your bank which are going to mature on Monday. He has previously arranged for refinance for both loans with your bank, but now has a counter-proposal for you to consider.
The customer is located in Greenville, South Carolina, and his firm has two loans with your bank which are up for renewal currently. Both are secured with a medical office building located in Greenville. The first mortgage consists of a term loan with a current balance of $3,821,435, while the second mortgage consists of a line of credit. The line of credit has a total commitment of $1 million, with a current balance today of $974,000.
The client informs you that his current refinance offer from your bank requires him to pay down the balance on the line of credit to $800,000. The line of credit will then be renewed for 1 year on an interest only, variable rate basis. The line will be priced at 1 month contract LIBOR plus 300. The loan is to be renewed on a 3 year term based on a 15 year amortization. The rate is 6% fixed. The customer would like to instead pay down the term loan by $250,000, and keep the line of credit at $1 million for the next year.
The client says that he can save over $2,100 per month in loan payments on the first mortgage, and says that this would be a “win-win situation” as he would be saving money on his payments, and the bank would have less total outstanding exposure than under the current arrangement.
You inform the client that you will have to further research this issue, and promise to give him a call in the next hour with an answer to his question. Once you hang up with the client, your mind quickly thinks of how a timeline might materialize in order for this loan to close on Monday should you agree to the changes that the customer proposes. “If I agree to this, then I would have to inform the documentation preparation department of the changes before I leave the office today, so that the documents can be redrawn and provided to the client for the Monday closing.”
As you are mentally going through the feasibility of this timeline, you are also researching the client’s relationship with your bank. Upon reading the underwriting analysis for the client in the bank’s customer database, you see that your teammate who had left for the day had the primary aim of getting the line of credit balance paid down when they structured the current refinance proposal. The line of credit balance has been frozen for the last 8 months, thus you doubt that the client has a lump sum source of repayment to pay the line balance down over the next year.
As you read through the information in the customer database, you see that the client who called you is the sole owner of the borrowing entity for both loans. He is also the sole guarantor for both loans. As you review his personal financial position, you see that he has $100,000 in personal liquidity, and a personal net worth of $2.5 million, not including assets held in the borrowing entity. The individual is contingently liable for total indebtedness of just under $6 million, including the two loans under consideration here.
The subject property which secures both loans consists of a single tenant medical office building. The local hospital has leased out the entire building with a lease which runs for 15 years. At the current level of indebtedness (i.e. before any principal curtailment) the property supports the debt on the 15 year amortization proposed for the term loan at a debt coverage ratio of 1.26x. The loan to value is also reasonable, coming in at 71%. You conclude that the property is self-supporting, but the issues of concern are the fact that a portion of the debt is floating, and the low level of personal liquidity for the guarantor.
Quickly, you jot down the following table in order to collect your thoughts:
As you ponder your decision, you consider the competing aims of this situation. The client would like to lower his monthly principal payment on the term loan, but apparently has no ability to decrease the line of credit over the next year. The bank would like for the line of credit to be paid out in the next year, and this represents the first opportunity to curtail some of that exposure. Given the level of personal liquidity, the bank’s desire would be to curtail the total indebtedness to the borrower, something which the customer’s counter-offer does provide. Lastly, you think about the fact that the lower payments on the term loan based on the customer’s counter-offer will make it easier for the client to pay the loan, but will also make the client less motivated to find an alternative lender over the next year.
Having completed your research, it is now time to call back the client and let him know your intentions.
Questions for Discussion
Show whether the client’s claim that he can save over $2,100 per month under the reduced term loan is accurate.
Which is the best alternative in this case: lowering the overall exposure to the client, or lowering the commitment on the line of credit?
What specific recommendations would you provide to this client other than what he has proposed (consider the various types of repayment structures covered in Chap. 2)?
Research what 1 month contract LIBOR is today to determine what the variable interest rate would be at the spread noted in the case.
Define the terms “guarantor” and “contingent liability”.