By: Bob Bramlette
In June, the Federal Reserve increased the prime rate by 0.25%. The Fed also announced that that it will start allowing about $10 billion in Treasury securities and mortgage-backed securities to mature every month, and eventually the amount is expected to increase to $30 billion a month in Treasury securities and $20 billion in mortgage-backed securities. Many economists are forecasting that the Fed will have an additional 0.25% rate increase before the end of 2017 and as many as three 0.25% rate increases as we move through 2018.
As we enter a period of rising interest rates, borrowers may want to consider entering into a Forward Starting Swap agreement with their lender. This strategy will permit a borrower to enter into a term loan whereby the interest rate will continue to float until a specified date. The fixed rate can start in a few months or a few years.
Some banks are currently offering the following:
10/2/17: 5 year swap rate: 2.22%
Plus credit spread: 2.50 – 3.50%
All in rate: upper 4%s – upper 5% range
10/2/17: 7 year swap rate 2.34%
When to Measure Loan Covenants
In commercial real estate finance, Debt Service Coverage Ratio (“DSCR”) is an important measure to determine if a property will generate enough cash to pay principal, interest, and other amounts due under the loan. The general formula for commercial real estate is: DSCR = Annual Net Income + Amortization + Depreciation / Principal Repayment + Interest payments. Currently, lenders are generally requiring a DSCR of at least 1.15. The rate may change up or down depending on the amount of equity in the project and credit worthiness of both the borrower and the tenants.
Bankers continue to analyze the Loan to Value Ratio very carefully. Bankers are hiring their own appraisers, and in some cases loan committees are requiring two appraisals for the same transaction. Some community banks manage their exposure by limiting the amount they are willing to loan to a single borrower. In these situations, some borrowers are looking to develop relationships with new banks that have a larger lending capacity.
No matter what ratios are imposed by the lender, it is imperative that borrowers look at the timing of the measurements of these ratios. Many businesses are cyclical, thus negotiate the right time of the business cycle to calculate the ratios. Also, minimize the number of times that the ratios are calculated.
Have Regular Meetings
Keep your banker up to date on your business performance and future borrowing, treasury management, and other banking needs. If you anticipate needing additional capital or you want to expand your line of credit, start discussing your needs with the banker in advance. Tell your banker how much and when you will need the additional funding. If the banker requires additional information, then you can provide it in advance. When the need actually arises; then the process should proceed smoothly.
If you anticipate that your business is likely to have some “bumps in the road”, then let your banker know as soon as possible. Share your plan as to how you anticipate dealing with the issues. Your banker may be able to provide financial advice, leads to new customers or suppliers, and counsel regarding consultants with experience in similar situations. If you have a plan to address a challenging situation, then the banker may have flexibility to re-structure your loan in a manner that will be acceptable to both parties.
If you go into the meeting with no plan and your loan is not performing or you are having difficulty meeting a covenant; then the banker will be more likely to transfer the loan to the workout group.
Carefully Review and Negotiate
When you are entering into or re-negotiating a loan agreement, carefully review each provision with your advisors. Whether you have been a long time or new customer of the bank, many provisions of loan agreements can be negotiated to meet current conditions.