What is Loan Structure?

Loan structure refers to the different characteristics that a lender can choose from when extending credit to a borrower. Loan structure is also often referred to as credit structure.

Lenders always want to offer their borrower credit that is appropriate based upon the nature of the credit request as well as the perceived risk of the borrower.

As a result, every loan has a variety of characteristics that make it unique from other loans. Examples include, but are not limited to:

• Will the loan payments be interest-only, or will the principal outstanding reduce by way of regular, periodic, or recurring payments?
• Over how many months (or years) will the loan be repaid?
• What is the interest rate of the loan?
• Will the loan have any specific physical assets that can serve as collateral security, or will the loan be “unsecured”?
• What types of reporting (or other behaviors) will be required of the borrower in order to maintain good standing with the financial institution that extended credit?

Criteria that Influence Loan Structure

Loan structure is informed, at least in part, by any underlying assets that are being financed – as in our mortgage loan example above. But there are other factors and criteria, too. These include:

The borrower’s level of default risk

Lenders have complex risk rating models that help them understand the borrower’s likelihood of triggering an event of default. The higher the likelihood of default, the greater the credit risk.

Higher risk scores generally translate to higher interest rates and loan pricing, which compensate the lender for taking on this greater level of risk. Higher risk scores also tend to translate to more restrictive loan structures (such as shorter amortization periods, higher levels of collateral security, or more frequent and more robust financial reporting).

The desirability of any underlying collateral

Credit is generally extended to support the financing (or the refinancing) of an asset. The quality of that asset as collateral will also help to inform loan structure, including loan-to-value (LTV).

As a general rule, the more “desirable” an asset, the more flexible the loan structure is likely to be. Higher quality collateral is generally characterized by how active the secondary market is, how ascertainable its price is, and how stable the asset’s value is likely to remain.

For example, real estate is generally considered more desirable as collateral than intellectual property. As a result, it will tend to have higher LTVs, lower interest rates, and longer amortizations.

Aligning cash inflows and outflows

This is particularly true of corporate borrowers – think about a piece of manufacturing equipment. If equipment is being purchased and it’s intended to produce cash flow for 10 years, it’s not unreasonable to consider a 10-year repayment period.

The upper limit on amortization may be governed by the condition of the asset, but, intuitively, it would be odd to force a company to pay in full upfront for an asset that will generate cash flow for many years into the future.

Mitigating transaction or asset-specific risks

This, too, is mostly true of corporate borrowers. Consider a management team that strips a lot of cash out of the company by way of dividends. A lender may wish to put a covenant in place that would restrict dividends to ensure that a sufficient cash buffer is retained in the corporation to support liquidity (and timely loan payments).

Loan Structure Characteristics

While this is not an exhaustive list, important considerations around loan structure include the following:

• The loan amount, which is generally a function of the loan-to-value (LTV).
• The interest rate, as well as whether it should be a fixed rate or a variable (floating) rate.
• Is it operating (revolving) credit, or will the loan be structured as term financing?
• Will the loan be reducing (amortizing), or will it be interest-only? If reducing, will the payments be periodic, or will it be structured as a “bullet” repayment?
• Is the loan secured or unsecured?
• Will security charges be first ranking (senior), or will the loan be “subordinated” (i.e., first vs. second mortgage) behind another loan or lender?
• How frequently will the borrower be expected to provide financial reporting to the lender, and what quality should that reporting be (i.e., review engagement, audit engagement, etc.)?
• Will there be any specific financial or non-financial loan covenants that the borrower must comply with?
• Will there be any type of secondary (indirect) security taken (ie. government guarantee programs, personal guarantees by owners, etc.)?