Zero Coupon Bonds as Loan Guaranty

[Zee]

I have a client that has an bank underwriting commitment for $95 million, it includes a loan guaranty reserve amount of $14 million to be invested in a 20 yr US Govt zero coupon bond for the $81 million amount. The beneficiary is the lender. Does this mean the lender receives an additional $81 million at maturity in addition to the interest paid throughout the loan? I'm not familiar with the practice. Is this typical for large loans? It seems awfully expensive.

[erchess]

No Idea

Beyond the fact that your client took out a loan or line of credit I am not sure I understand your post. For example did your client pay $14 Million for a bond that will pay off 81 million in 20 years? If my math is right that works out to about 1.1 percent interest per year.(I thought even US Treasuries paid better than that.) And is regular payment of interest on 94 million plus the $14 million for the bond all this is going to cost your client? And if the business your client invests the loan proceeds in and the rest of his financial life goes badly enough will be be able to go bankrupt and perhaps pay the bank nothing except some of the interest and the 14 million that bought 81 million in 20 years? My initial reaction is that your client must have an established track record of making money and paying debts to have gotten such a sweet deal - but I am not at all sure I really understand the deal.

[Zee]

I'm looking for help from someone with commercial lending expertise

Nope. He has no track record.

I'm trying to determine how good/bad this loan commitment is. My initial reaction is it is far too expensive. And, I don't understand how the use of the US Strip Zero Coupon bond works as a guaranty. I assume it's purchased from the loan proceeds with the lender named as beneficiary. I'm not sure whether that means the bank gets the proceeds at the completion of the loan, or only at default. Post note: I've been told the lender gets the proceeds of the zero coupon bond.

My calculation of the rate of return is much different than yours. The FV of $13,915,000 invested at 8.796% for 20 years is $80,895,000. I didn't realize US Strip Zero Coupon Bonds paid that much.

The terms of the $95 million loan (including the strip bond purchase) are:

1. It's a ten (10) year term with a 20-year amortization schedule. I'm not sure how that works? Post note: I've learned that means a large balloon payment at 10 years, and smaller payments during the term.

2. Interest rate 250 BP over Term Treasury, fixed rate, principle and interest payable in arrears.

3. Interest only, monthly in arrears from reserves for the 1st 24 months, P&I monthly in arrears therafter from cash flows.

4. Loan points 2% of the gross loan.

I haven't seen any amortization schedules, etc. just the commitment letter.

I'm hoping someone here has experience in evaluating loans and the fairness of the terms, etc. can provide some guidance. I do know the interest on the strip loan is taxable income each year which will create substantial "phantom" income.