We talked to our resident loan experts about the most difficult aspects of abstracting a loan, and one of the biggest issues was a bit of a surprise. Sometimes, your lender makes a mistake in the loan docs! Sometimes the mistake is small, but other times it can create some confusion with your loan.
It is possible for a lender to make a mistake. Your loan documents were drafted up by humans, and humans aren't perfect. We're not knocking lenders, but we do encourage borrowers to check for some of these things that our abstractors see.
1. Incorrect or Vague Prepayment Dates
Your prepayment terms can be of critical importance if there is any chance of disposition before maturity, and strategizing can become harder when you get confused in the prepayment schedule.
For example, say you had a flat percentage prepayment January 1, 2021 through January 1, 2024, and no prepayment from January 1, 2024 to maturity... what is the prepayment on January 1, 2024 when it is both a flat percentage and no penalty? This is one example of a confusion which you may have to go back and clarify with your lender.
We've also seen schedules switching around the years of prepayment. They've said something to the effect of "2.00% Flat Percentage for the 1st, 2nd, and 4th years. 1.00% Flat Percentage for the 3rd, 5th, and 6th years." It's an oddball, but we would absolutely clarify this with the lender, as the 3rd and 4th years are usual points of disposition for a lot of shops.
2. Prepayment Calculation Methodology
By far, the most commonly confused prepayment calculations are between Yield Maintenance and Make Whole. Yield Maintenance first calculates the difference between the value of all future interest payments at the note rate and today's market rate - this difference is then PV'd back to today and summed to arrive at the Yield Maintenance penalty. Make Whole first calculates the present value of all future payments that would be made on the loan (PV'd using the replacement rate), the outstanding balance is then subtracted from that amount to arrive at the Make Whole penalty.
At a high level, there is minimal effective difference, so mixing up these prepayment types and methodologies won't result in a number off by more than a few bps in most cases.
Where your business decisions can be affected, however, is all in the replacement rate. If your doc's language misses an open period or additions to the replacement rate, you may find you've drastically under-calculated your prepayment penalty upon exit. Aka you'll pay more than you planned to.
Missing open periods in the calculation methodology (typically the last 3 periods), you'll end up getting a replacement rate higher than you actually need for an accurate calculation, since there are additional periods you're accounting for. Higher reinvestment rate for the lender = lower prepayment for you. But what if you've used the doc's methodology and find you've significantly underestimated your penalty when you go to exit?
If the lender accidentally leaves in language tacking on an addition to the replacement rate, say T+50 for instance, you'll end up significantly underestimating your prepayment penalty. While missing open periods will tack on a few bps, missing that 50bp addition can have you thinking your prepay is a number that is hundreds of thousands under-calculated. Not a fun discovery when you go to exit.
When loan documents get up to hundreds of pages, it's no shock or scandal that there are templates lenders work off of when closing a new loan. But, with a document that long, sometimes pieces of language are missed while the terms are shifted. We've seen quite a few that have resulted in an inconsistency on a floor.
One section might simply say "Under no circumstances will LIBOR be below 0%", writing in a 0bp floor. And another section will say "If LIBOR falls below 0.25% then LIBOR for that period is 0.25%", introducing a floor much higher than 0%.
In this case, what is the actual rate for your monthly debt service when LIBOR is 10bps?
4. Different Maturity Dates
Last but not least, some Notes and Loan Agreements are typed up with two different maturity dates. It's just a typo, but it makes your life a bit harder. Now you have to recognize that you don't have a clear maturity date and you have to reach back out to your lender to clarify.
All in all, it's human error. But we encourage borrowers to double check that there's no confusion in their critical terms and calculations.
Here are some Loan Abstract Questions You Should Be Asking.
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