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6.1.1 Description of the Transaction

The loan is intended to provide part of the necessary capital for an investment in an income producing property. The buyer's strategy is to hold and lease the property for five years and then to divest. Proposed figures for the real estate investment are shown in Figure 6.1.

The income generating investment

FIGURE 6.1 The income generating investment

It is assumed that rental payments, operating costs, and the OMV of the property will increase by 2.5% per annum in line with projected inflation. A summary of operating cash flows is extrapolated on the basis of the previous figures, which will be carefully analysed by the lender in order to ascertain their reliability and feasibility. Moreover, the OMV of the property for each period will also be estimated; in the example the OMV is estimated by Direct Capitalization Approach[1] (constant rent on entry yield[2]), consequently the OMV will grow over time by the rate of inflation. Free operating cash flows are shown in Figure 6.2.

6.1.2 Term Sheet for an Income Producing Property

The bank's due diligence for structured real estate financing operations concerns the economic and financial equilibrium of a specific real estate investment which is legally and economically independent of the other assets of the equity investor, e.g. the sponsor of the deal. For this reason the loan is usually granted to a newly constituted SPV or to a legal subject which

Free operating cash flows

FIGURE 6.2 Free operating cash flows

is capable of guaranteeing it legal protection (e.g. a real estate fund). This is not compulsory, but ring-fencing the financing enhances the creditor's guarantees.


Acquisition Line is equal to the lowest of the following amounts:

• €100,000,000;

• an amount guaranteeing LTV no higher than 70%, calculated on the OMV, as determined by an independent appraiser appointed by the Bank;

• an amount guaranteeing an ICR no lower than 170%.

Maximum loan amount

FIGURE 6.3 Maximum loan amount

Since the economic scale of the deal may not yet be exactly known at the time the loan is negotiated, and hence as reported in the term sheet, the amount of the loan is not specified at a fixed level, but rather stated with reference to several variables, as shown in Figure 6.3.


The description must be as detailed as possible in order to enable the Property to be identified in such a way as to ensure that it is correctly valued and that it is possible to draft the preliminary notary's/legal report to the loan agreement.


To partially finance the purchase price of the Property provided as security. No finance party is bound to monitor or verify the utilization of the loan.

This is a contractual purpose, not a legal one.


Five years from drawdown.

The term is compatible with the borrower's strategy: purchasing the property, earning income from rents (after deducting the loan repayments), and divesting after five years with capital gain expectations.


In one single instalment following conclusion of the relative loan agreement, conditional on the fulfilment of various conditions precedent. The amount is paid directly to the seller (subject to the issue of an irrevocable mandate to the bank issued by the SPV) at the time the deed of sale and the loan agreement are executed. The guarantees will also be established at the same time.


In one single instalment upon maturity under the loan agreement and, if the property is sold, using the proceeds of the sale of the property.

Full or partial prepayment of the loan will be permitted on any date subject to a minimum of 30 days' notice in writing to the Bank and subject to the payment to the Bank of breakage costs (if any) plus prepayment fee equal to 50 bps for each full year of prepayment before maturity.

The loan is structured to be repaid at property disposal. This provision is aimed at providing financial flexibility to the borrower, in order to be able to sell the property even before the expected holding period. On the other hand, the lender requires a prepayment fee to compensate the need to reinvest the money received in advance.


Acquisition Line: floating 12 months EURIBOR plus margin interest will be payable annually in arrears.

In this specific case the property generates cash flows (rental payments) which are assigned as security and permit to pay interest on debt.

The interest rate may track any EURIBOR rate between 1 and 12 months or, if a fixed rate is chosen, the EURIRS for the period corresponding to the term of the loan agreement. The reference period for the interest rate chosen depends on the intervals between interest payments (monthly, quarterly, half-yearly, or annually), the availability of the funding which the bank must obtain on the interbank market, and the level of the corresponding EURIBOR rate.

At the time the loan is negotiated, the 12 month EURIBOR rate is 0.55%. However, the financial sustainability analysis is carried out assuming a higher interest rate of 1.25% (equal to the Cap which will be bought to hedge interest rate risk), in order to verify whether the operation will be able to service the debt even if interest rates increase.


3% per annum on the amount financed when LTV is under 60%;

3.5% per annum on the amount financed when LTV is between 60% and 70%.

The margin is subject to negotiation and mainly depends on the credit risk of the borrower, on the risk of the transaction, on the cost of funding for the bank, and ancillary on revenues associated for the bank. Obviously, due to the increased financial risk, the higher the leverage (LTV), the higher the spread (and vice versa).


The borrower undertakes at its own expense to hedge interest rate risk fluctuations and this contract has to be approved by the Bank. The hedging rate, excluding the margin, may not exceed an annual rate of 3%, and the rights and receivables under that agreement will be assigned to the Bank as security.

The parties agree on a floating interest rate; the rate at which the Cap is set (excluding the margin) represents a threshold above which the operating cash flows (rental payments after deduction of property operating costs) may no longer be capable of guaranteeing that the contractual commitments will be honoured. It is clear that the interest rate at the time the term sheet is drawn up will be lower than the Interest Cap Rate. The borrower will pay a premium to buy the hedging instrument. Alternatively, the borrower may conclude a Cap & Floor contract or take out a Swap.

The example shown in Figure 6.4 assumes an Interest Rate Cap for five years with an up-front cost calculated as a percentage of the loan amount.

Interest rates for an income producing property lending

FIGURE 6.4 Interest rates for an income producing property lending


Equal to 1% calculated on the Loan Amount, due and payable upon signing of the loan agreement.

This fee partially covers the loan structuring costs and partially remunerates the bank in advance for its lending activity. The fee amount is related to the total commitment, regardless of the drawdown periods.


(a) First ranking mortgage over the Property;

(b) Assignment of the rents and any other rights arising out of any rental agreement in relation to the Property as and when these are entered into and out of any other contracts in relation to the Property and payment into a security escrow account with a pledge in favour of the Bank (Rent Account);

(c) Pledge on 100% of the borrower's shares;[3]

(d) Assignment of rights and receivables related to the all risks insurance policies that cover the Property provided as security issued. This title of insurance should be provided by primary standing insurance companies approved by the Bank. The Bank will have a pledge on them;

(e) Assignment of rights and receivables resulting from the signature of the hedging agreement to hedge interest rate risk.

Also according to the Basel Accords,[4] guarantees have the principal function of covering the credit risk which the bank assumes when granting the loan, which is reflected in the margin. The correct and balanced establishment of the security package therefore makes it possible to moderate the credit risk and, accordingly, to reduce provisions made by the bank in its accounts (beneficial for the bank) and to reduce the spread (beneficial for the borrower).

Various instruments may provide hedging for the credit risk: personal sureties, voluntary mortgages, pledging of receivables in addition, naturally, to the pledging of shares of the SPV.

Whilst the other guarantees merely grant satisfaction, e.g. they are only capable of guaranteeing compliance with all or part of the contractual obligations when a particular specified event occurs, the pledge of shares also grants the lending bank voting rights, permitting it to monitor the financed property more effectively in case of problems.


In addition to the usual conditions for this type of transaction (verification of powers of signature, company resolutions etc.), the signature of the loan agreement will be subject to the following conditions precedent:

• verification of the value of the Property provided as security by an appraiser appointed by the Bank;

• presentation of an all risks insurance policy covering the property provided as security issued by a primary standing insurance company approved by the Bank and pledged to the latter;

• presentation of a true copy of all leases for the Property;

• completion of a legal and tax due diligence, concerning corporate and contractual documentation, that is procedurally and substantively satisfactory for the Bank; completion of a Money Laundering[5] due diligence.

The term sheet is generally drawn up by the bank on the basis of the information provided by the borrower. If it is accepted by the borrower, the Bank must verify these data and perform the technical, legal, tax, and financial due diligence.[6]


In addition to the usual conditions for this type of transaction (verification of powers of signature, company resolutions etc.), disbursement will be subject to the following conditions precedent:

• the legal validity of the Securities;

• a report drawn up by a notary/lawyer attesting:

• the registration of a first-rank mortgage;

• the formalization of the assignment of rental payments;

• that no applications for the initiation of bankruptcy proceedings have been filed against the borrower.

• a declaration by the borrower attesting that there are no further debts in addition to those declared upon conclusion.

These are standard conditions typical of all real estate financing operations and must be met prior to disbursement.


In addition to the standard contractual conditions for this type of transaction (including but not limited to default interest, prohibition on changes in the company object, prohibition on the assignment of rights/obligations vested in the borrower under the loan agreement, obligation on the borrower to send its annual accounts to the bank etc.), the loan agreement will also provide that:

• the loan agreement itself will take precedence over capital repayments of shareholder loans and/or infra-group receivables;

• any legal and/or notary's fee, tax, or duty relating to the property provided as security and the relative insurance premiums will be paid by the borrower;

• the borrower issues a mandate to the Bank to appoint an appraiser in order to assess the value of the property provided as security at regular intervals and at the borrower's expense; further valuations may be requested by the Bank, but will only be borne by the borrower in the event of a breach of financial covenant or a default occurred under the loan agreement;

• the Bank must be informed of any event of a technical, corporate, or fiscal nature which may have a substantially negative effect on the borrower's capacity to comply with any obligation associated with the loan and which may cause substantial detriment to the borrower's economic, asset, and financial situation.

The loan must be monitored during its whole life and all conditions specified at the time it is granted must continue to obtain for its full term. The borrower must support the Bank, and allow it, on verifying whether those conditions continue to apply until repayment in full.


The Loan to Value Ratio (LTV, equal to the ratio between the amount of the loan and the value attributed to the property provided as security by the surveyor appointed by the Bank) may not exceed 70% at any time during the term of the loan.

The Interest Cover Ratio (ICR, equal to the ratio between the total sum of the annual rents generated by the property provided as security and the amount of annual interest due to the Bank) may not fall below 170% at any time during the term of the loan.

Financial covenants may be summarized as follows:

• LTV Default >75%

• LTV Cash Sweep >70%

• ICR Default < 150%

• ICR Cash Sweep <170%

The financial covenants are necessary in order to impose objective limits on the amount which will actually be negotiated in the loan agreement and have the function of monitoring the loan until it is repaid. This has direct effects on the rating of the transaction, and may also have an impact on the Bank's regulatory capital (a downgrading will require increased provisions, whilst for example a revaluation of the property will make it possible to reduce provisions).

The monitoring of the rating also makes it possible to take timely action in order to prevent possible default on the transaction.

In the event that the covenants specified above are not complied with, the borrower must repay the excess amount of the loan and/or provide supplementary guarantees approved by the Bank.

If on an interest payment date a Cash Sweep event is outstanding or no Cash Sweep event is outstanding, but a Cash Sweep event was outstanding on the immediately preceding Interest Payment Date, the borrower must ensure that the entire balance of the rents in excess of the corporate operating costs amount is used to repay the loan.


In addition to the primary commitments and obligations which are typical for these types of transactions, the contractual documentation will contain specific commitments by the borrower whereby, unless it has obtained prior written authorization from the Bank, it is required to refrain from:

• disposal of company assets other than in the ordinary course of business;

• any extraordinary activities such as merger or acquisition;

• incurring any other financial indebtedness;

• granting real or personal guarantees (negative pledge);

• undertaking other loans;

• change of ownership in the borrower;[7]

• disposal of the financed property.

The borrower is a SPV with the exclusive purpose of completing the specific transaction and may not carry out other transactions which may be detrimental to the existing financial equilibrium.


The conditions subsequent stated are those typical for financial transactions of this type. The Bank is entitled to terminate the agreement or, depending upon the circumstances, to request the partial repayment of the loan and/or supplement of the guarantee if:

• the borrower fails to pay one or more instalments of the loan or repeat late payments;

• the borrower does not comply with any obligations imposed on it under the loan agreement with reference to the action required for the purposes of disbursement;

• the assets provided as security are subject to enforcement procedures;

• the borrower and/or third party mortgage guarantor do not promptly comply with one or more of the obligations provided for in relation to the mortgaged properties;

• the borrower carries out any act which reduces its asset level or its financial or economic solidity, or becomes subject to any bankruptcy procedure;

• a breach occurs of one or more of the obligations in respect of which express provision has been made for the full or partial termination of the loan agreement;

• the documentation submitted and the notices provided to the Bank are inaccurate;

• the borrower does not promptly arrange the repayment of tax payable otherwise resulting from the loan or the establishment of the relative guarantees, and such charges will under all circumstances be deemed to be imposed on the borrower even if they are honoured by the Bank;

• the borrower is submitted to a procedure of insolvency.

In the event that the loan agreement expires or is terminated, the lender will be entitled to require the immediate full or partial return of the amounts due for capital, interest (including default interest), and ancillary amounts. The overall amount due will accrue interest on arrears starting from the expiry or termination of the loan agreement.


These are paid by the borrower, which must also reimburse all adequately documented out-of-pocket expenses which may be incurred by the Bank in relation to the conclusion of the financing operation.

These expenses, which may not under any circumstances exceed Euro ..., will include those associated with the preparation of the legal and technical due diligence reports and periodic appraisal.

The Bank excludes any liability occurring from any tax implications at the borrower's end.


The Bank reserves the right to securitize, syndicate, or sell all or part of the loan without prior consent of the borrower. The borrower will assist in any Syndication efforts by the Bank without risk, cost, or expense to the borrower including but not limited to the borrower's legal costs or expenses. The Bank may provide such information relating to the borrower or the Property in conjunction therewith as it is customarily provided by the Bank in respect of such transaction.

The Bank may pool the operation with one or more banks under a club deal or may thereafter assign the receivable to a third party by securitization/syndication post-closing.

Term sheet expiration: 31st January 201x.

Law: ...

Language: English Court of Jurisdiction: ...

Limiting Condition: The above constitutes only a draft outline of the terms and conditions on which the Bank would be prepared to consider making available a facility and is in no way to be construed as an offer to provide finance. Any decision regarding the provision of finance requires the approval of the Bank's credit committee.

Once a certain stage has been reached, the term sheet, initially used in order to facilitate negotiations, will become a summary document and the basis for the final loan agreement. Once the borrower (which will negotiate the various tenns) has accepted, the Bank will initiate or continue the internal due diligence procedure, the results of which will be summarized in the complex proposal to the competent bodies to adopt the decision authorizing the granting of the loan. After this, if the loan is approved, the contents of the loan decision will be notified to the borrower (although these may also differ from those contained in the term sheet) and the loan agreement may be concluded.

Figure 6.5 sets out the Acquisition Financing Line and contains calculations of the agreed LTV, ICR, and Yield on Debt for each of the loan periods as well as the transaction flows (real estate and levered).

The IRR of each cash flow shown in Figure 6.6 represents the return on the transaction or the cost of the loan. It is noted that since the cost of the debt (5.39%) is lower than the return on the real estate investment (9.33%), the final return (final levered cash flow) is significantly higher (16.93%).[8]

Financing line

FIGURE 6.5 Financing line

Summary of cash flows

FIGURE 6.6 Summary of cash flows

  • [1] Please refer to paragraph for details on the Direct Capitalization Approach.
  • [2] Market yield is assumed constant during the holding period.
  • [3] An SPV financing is in place.
  • [4] Please refer to Chapter 8.
  • [5] The term Money Laundering refers to the process, which can be undertaken via various methods, of creating the appearance that large sums of money obtained from illegitimate means and serious crimes, such as terrorist activity or drug trafficking, originate from a legitimate source.
  • [6] Please refer to paragraphs 2.4.4 and 2.4.5 for details on the due diligence process.
  • [7] The lender has to know in advance and/or permit the change of the ownership of the shares (or quotas) of the borrower for several reasons, but in particular for the following: (a) in several jurisdictions, the bank has to record the “beneficial owner” of the transaction due to the anti-Money Laundering law; changing the ownership could change the "beneficial owner” (to be recorded) and therefore the Money Laundering risk; (b) if the borrower belongs to a business group of companies, a change of ownership could change the credit exposure of the group (the old and/or the new one) and therefore their credit risks (furthermore, all the banks have a maximum exposure of credit versus any group of companies); (c) the change of ownership could change the sponsor of the transaction and, consequently, the members of the board of directors of the borrower; therefore, in accordance with the Basel Convention, it could change the rating of the borrower, its credit risk (acceptable or not acceptable to the lender) and the cost of the transaction (the "margin" or “spread”); (d) in several jurisdictions, if the lender has the pledge of the shares (or the quotas) of the borrower, the lender should permit the mentioned transaction.
  • [8] Regarding the effects of financial leverage on the return on an investment, see Chapter 5.
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