How any potential borrower requesting the same type of credit may manage exposure to interest rate risk? Identify the alternate tools available to management.
Hellenic National Bank has decided in favor of the loan request to Garda Investment Associates, Ltd. for the construction and development phase and mini permanent financing of the strip shopping center in Romania. In recognition of the growth opportunities in Eastern Europe, the bank has established a representative branch in Bucharest, Romania which will help service the request with the Boston-based institution. However, the loan will be booked in the United States and denominated in U.S. dollars. This will create an additional opportunity to capitalize on the depreciation of the Romanian currency.
The construction and development of the shopping center is expected to take 15 months to complete at a (dollar-equivalent) cost of $3,928,250 including interest. Monthly payments against the mini perm financing may run at $27,141 based upon a 25 year amortization and a 6.75 percent fixed rate, with a balloon payment due in 5 years. The balloon payment of $2,299,790 will then be funded by a takeout commitment in the form of a 15-year mortgage loan from a German pension fund(see calculations below).
Based on our analysis, Garda has submitted all the necessary documentation for the loan request. The documentation includes the credit enhancements used to determine whether to underwrite the real estate loan such as surveys, permits, insurance, contractors’ completion bond, and an environment impact study. The performance bond is written by an insurance company on behalf of the building contractor to construct the strip shopping center in the case where project completion is not guaranteed and takes longer to complete than expected. In addition, Garda has included lease commitments from the tenants in this package which has been crucial to support our decision in favor of the loan request.
In our financial analysis to approve the Garda loan request, we needed to determine whether the income generated from the strip shopping center would adequately service principal and interest on the debt. This is measured through the “debt service coverage” ratio. As stated in the case, net operating income in 2020 and 2021 is $499,172 and $540,645, respectively. If growth continues to be at 8% as the pro forma income statement given in the case suggest, our analysis suggests that debt service coverage is likely to continue to improve(See chart below).
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