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3.3 AMOUNT OF THE LOAN

The amount loaned depends mainly on three variables:

• the project which the loan is intended to fund, and hence the value and/or construction cost of the property and its profitability;

• the collateral provided;

• the borrower's creditworthiness.

This amount may be granted in one single line of credit, or alternatively through secondary lines such as for example a loan to cover the costs resulting from the acquisition.

For loans intended to pay for the construction costs of a property, the amount will be specified in the agreement, and will be drawn down in line with the state of progression of work (stating the maximum amount of drawdown, subject to the conclusion of supplementary agreements). The amount which is actually drawn down will depend upon the covenants stipulated in the agreement (including in particular LTC, LTV, DSCR, and ICR), as in the following example of clause.

The lenders make available to the borrowers a term loan facility in an aggregate amount equal to the lower of:

• the total commitments;

• 70% of the cost;

• 50% of the value of the properties (as determined from the initial valuation).

The facility can also be drawn down in different tranches when the project requires cash (i.e. development project). Moreover, in countries where a tax on financing is applied,[1] tranches allow deferral of the point in time when the tax is payable.

3.4 INTEREST RATES

The interest rates specified in a loan agreement include the standard rate (base rate plus margin) and the default rate.[2]

Loan agreements may be subdivided into two major classes[3] with regard to the standard interest rate: fixed-rate loans and floating-rate[4] loans.

The type of interest rate and the spread will be negotiated between the parties. It is clear that the more risky the operation, the higher the spread will be: this element must remunerate amongst other things the bank's intermediation services and absorb the credit risk[5] component. The actual interest rate agreed upon will track a reference rate:

• If a fixed rate is chosen, the IRS[6] (Interest Rate Swap) rate is often used (in Figure 3.2 an example of EURIRS rates is presented)

• If a floating rate is chosen, in the Euro countries the reference rate will be the EURIBOR (Euro Interbank Offered Rate), whilst for other major currencies the LIBOR[7] (London Interbank Offered Rate) is used (in Figure 3.1 an example of EURIBOR rates trend is presented).

For fixed-rate loans, the interest rate remains the same for the full term of the loan (or for a pre-set period), and the precise amount of the instalments due is known from the outset.[8]

This type of loan, under which the borrower is not exposed to interest rate rises, does however entail two negative aspects: a greater potential cost (in the event of a fall in interest rates) and generally an interest rate which is higher than a floating rate on a loan with equivalent characteristics.

For floating-rate loans, the interest rate is not set at the start for the full term of the loan, but is regularly reviewed in line with changes in the reference rate (EURIBOR or LIBOR from 1 to 12 months). A floating rate will offer a lower initial cost, but will entail full exposure by the borrower to the interest rate risk.[9]

If the borrower delays any payment a default rate is applied. It is usually determined as the sum of the interest rate and a negotiated overdue margin and calculated on the number of days of delay in the payment. If, for example, there is a 15 day delay on the payment of a €1,000 loan instalment, and the default rate is set at 7%, the amount due is €2.88 (€1,000 * 15 days / 365 days * 7%).

EURIBOR rates trend

FIGURE 3.1 EURIBOR rates trend[10]

EURIRS rates on different maturities on a fixed date

FIGURE 3.2 EURIRS rates on different maturities on a fixed date[11]

  • [1] Please refer to Part Two for details on different countries.
  • [2] Also referred to as the overdue rate.
  • [3] Especially for residential mortgages, there are numerous other valiants, such as for example mixed loans providing for both fixed and floating rates (where changes may be made between one and the other at set intervals) or contracts providing for a variable rate subject to a cap, see paragraph 3.5 for further details.
  • [4] Also called the variable rate.
  • [5] On credit risk please see also Altman et al. (2004).
  • [6] The Interest Rate Swap is conventionally calculated setting the floating side (normally at Euribor or Libor) and then quoting the fixed rate that is payable for that maturity.
  • [7] Benchmark rates of the money market at which interbank term deposits are offered by one prime bank to another prime bank for different periods of time. Loans for property are normally linked to this rate and expressed as a margin over benchmarks, e.g. 50 basis points over Libor or Euribor (one basis point equates to one hundredth of a percentage point).
  • [8] For further details on instalments dynamics please see Chapter 4.
  • [9] Banks usually require hedging on interest rate risk as detailed in paragraph 3.5.
  • [10] Data source Thomson Financial Datastream.
  • [11] Data source Thomson Financial Datastream. Data referred to 8th July 2014.
 
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