Bank Term Loans
An ordinary term loan is a business loan with an original or final, maturity of more than 1 year, repayable according to a specified schedule. For the most part,
these loans are repayable in periodic installments quarterly, semiannually, or
early. The payment schedule of the loan usually is geared to the borrower's
ash flow ability to service the debt. Typically, this schedule calls for equal perio
dic installments, but it may specify irregular amounts or repayment in a lump
am at final maturity. Sometimes the loan is amortized in equal periodic install¬
ients except for the final payment, known as a "balloon" payment, which is larger
than any of the others.
Most bank term loans are written with original maturities in the 3 to 5 y
ear
range. Some banks are willing to make longer term loans, but only rarely will a bank make a term loan with a final maturity of more than 7 years. The final maturity of a term loan does not always convey the length of time the loan is likely to remain outstanding. In some cases, the bank as well as the company expects the loan to be renewed successively with maturity. These evergreen loans are typically characterized by credits to companies in growth phases. Despite the expectation of evergreen refunding upon maturity, the bank is not legally obligated to extend the loan. As a result, most requests for extensions and additional credit are analyzed afresh, based on changed conditions from the time of the original loan. What was thought to be an evergreen loan may turn out to be a "deciduous" one if the financial condition and performance of the borrower deteriorate.
Generally, the interest rate on a term loan is higher than the rate on a shortterm loan to the same borrower. If a firm could borrow at the prime rate on a short term basis, it might pay .25 percent to .50 percent more on a term loan. The interest rate on a term loan can be set in one of two ways: (1) a fixed rate that is effective over the life of the loan may be established at the outset or, as is more usually the case, (2) a variable rate may be set, to be adjusted in keeping with changes in the prime rate. Sometimes a ceiling or a floor rate is established, limiting the range within which the rate may fluctuate.
In addition to interest costs, the borrower is required to pay the legal expenses that the bank incurs in drawing up the loan agreement. Also, a commitment fee may be charged for the time during the commitment period when the loan is not taken down. For an ordinary term loan, these additional costs usually are rather small in relation to the total interest cost of the loan. A typical fee on the unused portion of a commitment is .50 percent, with a range of .25 percent to .75 percent. This means that if the commitment fee were.50 percent on a commitment of $1 million, and the company took down all of the loan 3 months after the commitment, it would owe the bank $1 million X .005 X 3/12 = $1,250. In addition to the commitment fee, the need to maintain compensating balances, discussed in Chapter 16, is an indirect cost to the borrower.
The principal advantage of an ordinary bank term loan is flexibility. The borrower deals directly with the lender, and the loan can be tailored to the borrower's needs through direct negotiation. The bank usually has had previous experience with the borrower, so it is familiar with the company's situation. Should the firm's requirements change, the terms and conditions of the loan may be revised. It is considerably more convenient to negotiate with a single lender or a reasonably small group of lenders than with a large number of public security holders, who are involved with a bond issue. The borrower can deal confidentially with a bank or, for that matter, with any private lending institution and does not have to reveal certain financial information to the public.
In many instances, bank term loans are made to small businesses that do not have access to the capital markets and cannot readily float a public issue. The ability to sell a public issue varies over time in keeping with the tone of the capital markets, whereas access to term loan financing is more dependable. Even large companies that are able to go the public market may find it quicker and more convenient to seek a bank term loan than to float a public issue. A term loan can be arranged in several weeks, whereas a public issue takes longer.
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