Term Loans

Term loans generally share three common characteristics: they (1) have maturities I of one to 10 years, (2) are repaid in periodic installments (such as quarterly, semiannual, or annual payments) over the life of the loan, and (3) are usually secured by either a chattel mortgage on equipment or a mortgage on real property. The principal suppliers of term credit include commercial banks, insurance companies, and to a lesser extent pension funds.

Maturities

We will consider briefly some of the more common characteristics of term loan agreements. Commercial banks generally restrict their term lending to one to five year maturities. Insurance companies and pension funds with their longer term liabilities generally make loans with five to 15 year maturities. Thus, the term lending activities of commercial banks actually complement rather than compete with those of insurance companies and pension funds. In fact, commercial banks very often cooperate with both insurance companies and pension funds in providing term financing for very large loans.

Collateral

Term loans are almost always backed by some form of collateral. Shorter maturity loans are frequently secured with a chattel mortgage on machinery and equipment or with securities such as stocks and bonds, longer maturity loans are frequently secured by mortgages on real estate.

In addition to collateral the lender in a term loan agreement will often place restrictions on the borrower that, when violated, make the loan immediately due and payable. These restrictive covenants are designed to maintain the borrower's financial condition on a par with that which existed at the time the loan was made. Thus, the lender seeks to prohibit the borrower from engaging in any activities that would increase the likelihood of loss on the loan. Some commonly used restrictions are discussed below.

One such restriction involves maintaining a minimum amount of working capital. Very often this restriction takes the form of a minimum current ratio, such as 2 to 1 or 3/2 to 1, or a minimum dollar amount of net working capital. The actual requirement would reflect the norm for the borrower's industry, as well as the lender's desires.

Generally this type of restriction requires the lender's approval before any additional debt can be issued. Furthermore, the restriction is often extended to long term lease agreements, which are discussed later in this chapter.

A standard covenant in most term loan agreements involves requiring the borrower to supply the lender with financial statements on a regular basis. These generally include annual or perhaps quarterly income statements and balance sheets.

Term loan agreements will sometimes include a provision requiring prior approval by the lender of major personnel changes. in addition, the borrower may be required to insure the lives of certain key personnel, naming the lender as beneficiary.