JCH was pleased to participate in a recent Q&A session with a well-known publication in the assisted living and skilled nursing sector. Here are the results of the session.
What are the most basic, yet most essential financing terms and concepts most managers and other non-finance specialists should know, and why?
In my opinion LTV, LTC, Financial Covenants, DCR,BPS, Origination/Exit Fee, Term/Maturity Date, Recourse/Non-recourse,Inter creditor, Collateral, Impounds are the most basic and most essential financing terms every borrower should know. I’ll explain each below
LTV: Loan to Value,this is the loan amount a lender is willing to lend versus the value of the asset. It’s usually presented as a percentage, for example if you have an asset valued at $10M a lender will lend $7M, that equates to 7/10 or 70% Loan to Value.
LTC: Loan to Cost,this is similar to the LTV equation but instead of value the loan percentage is in comparison to the amount paid for the asset or the cost of an asset. This can be different than the LTV. For example, if you are paying $10M for an asset, and a lender will lend $7M, your Loan to Cost is 7/10 or 70%. This is important to track as you might get a good deal and pay $10M for an asset that is worth $11M with a lender providing $7M in debt. Under this scenario your LTCis 70% (7/10) and your LTV is 64% (7/11).
Financial Covenants: These are covenants that a borrower’s operations must adhere to in order for the loan to comply. AN example of this is the Debt Coverage Ratio (DCR). This is a covenant to measure the operations ability to pay the monthly loan payment or debt service. It is derived by dividing the Net Operating Income by the debt service amount. For example, if your current monthly NOI for an asset is $45,000/month and your debt service is$30,000 per month, your DCR ($45,000/$30,000) is 1.5X.
BPS: This stands for Basis Points. Basis points are 1/100th or .01%. You will see this language in reference to your interest rate, especially on floating rate debt.You might see LIBOR plus 300 BPS which would mean the London Inter Bank Offer Rate plus 3% or 300 BPS.
Origination/Exit Fee: these are fees charged by lenders on the funding of the loan and on the retiring or maturity of the loan. They are typically 1-2% depending on the loan type and what is negotiated.
Term/Maturity Date: This is the length of the loan and the date the full balance is due to be paid off. A fully amortized loan will be paid in monthly increments and will be paid in full at the end of the term or maturity date. For example, a 25-year amortization due in 25 years will have monthly payments that pay down the loan in full by the end of year 25. You may see a loan with a balloon payment. This is when the amortization of the loan and the term or maturity date are not the same. For example, a loan could be amortized over 25 years but due in 10 years which would mean whatever balance is left on the loan at year 10 is due in full. This allows for a lower monthly payment,but a shorter term.
Recourse/Non-Recourse: this is the description of the remedies the lender has in the event of default. A recourse loan allows the lender to go after the principals of a corporation for the money owed in the event of default. While a Non-recourse loan only allows the lender to foreclose on the asset and not go after the principals for money owed. Non-recourse is always preferred if possible.
Inter creditor: This is an agreement between multiple lenders using the same asset(s)for collateral. This agreement details the relationship between the lenders and how things are handled between the lenders and the borrower in the event of default.
Collateral: This is the asset pledged as security for repayment of the loan, the collateral is to be forfeited in the event of a default. Sometimes you will see multiple assets used as collateral for one loan, this is known as “cross collateralizing” or crossing for short. This is typical in portfolios where some assets may not qualify for a loan on their own, but when other, better performing, assets are cross collateralized it allows the borrower to obtain the loan by spreading the risk among multiple assets.
Impounds: These are monthly payments received by the lender or debt servicer in addition to the debt service amount. These are typically done for real estate taxes and insurance. This allows the lender to be in control of the taxes and insurance, which creates a greater level of comfort for them knowing the asset is current on taxes and properly insured.
What are some of the most misunderstood terms and concepts that lenders would like their potential LTC partners to know before coming to the table?
I think LTC vs LTV is a common argument between the borrower and lenders as well as the interest rate calculations and financial covenants or default provisions.
- In your experience, ignorance of what terms would tip you off a borrower is seriously in need of homework?
Not having a firm grasp of the basic terms outlined in the first question.
What loans get confused for one another? What terms get misused or wrongly used interchangeably?
I think Agency/Fannie Mae, Freddie Mac vs HUD debt is often confused, while both are insured loans,they are insured by various sources. LTV and LTC can get confused for each other as well as amortization and maturity date, these can be two different dates.
What advice can you provide readers about the best, most reliable ways to better understand the lexicon of lending?
The NIC (National Investment Center for Senior Housing) conference is an excellent resource, in fact they have an entire evening devoted to “meet the lenders” at each and every conference. A good lender will take the time to educate their borrowers on what they are entering into. A well-educated borrower is much more likely to succeed with the loan, which is what every lender wants.
- Are there resources specific to long-term care that would be most suitable?
Bankrate.com is anexcellent resource for loans in general, there are multiple calculators anddefinitions on the site for all types of loans.