Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.
Issue link: http://cire.epubxp.com/i/143044
FINANCING FOCUS Off Balance Do commercial borrowers benefit from bank relationships? "w by Steve Zorich "We are looking for a relationship." "We are a relationship bank." Often borrowers hear these phrases when requesting a commercial mortgage loan from a bank; however, in these circumstances, relationship is really just a marketing-friendly code word for compensating balance. Compensating balances are funds that a borrower is required to keep on deposit in a bank to satisfy the terms of the commercial real estate loan agreement. Depending upon the stipulated agreement, the deposit may be held in a checking account, savings account, or certifcate of deposit. Tese are cash-restricted funds, and the balance required is usually a percentage of the committed loan amount. Te amount is negotiable and can vary widely. bank loan ofcers to their clients — is that if the commercial real estate borrower enters into a compensating balance arrangement with the bank, the borrower will beneft from a lower interest rate on the loan. While this certainly sounds like a good idea, keeping liquidity on deposit with the lender in exchange for a lower rate is in fact just the opposite. As we see in the example below, agreeing to a compensating balance arrangement significantly increases the efective rate on the loan. Let's take the following example: A borrower obtains a $5 million loan at an interest rate of 4.5 percent. Te annual interest payments are $225,000. Te bank's compensating balance requirement is $2 million. In actuality, the borrower is borrowing $3 million ($5 million loan less $2 million compensating balance). Tus, the efective interest rate is 7.5 percent. Te two most prevalent types of compensating balance arrangements banks use are the average balance and minimum fixed amount. Te average balance arrangement is most commonly used in commercial banking lines of credit and is calculated on the average maintained account balance over a set period of time, typically a 30-day average. Normally when insufcient balances go below the agreed-upon average balance, the interest rate on the loan will increase. Who Benefits? The common belief in commercial real estate finance — especially espoused by 14 July | August | 2013 2013 0 Commercial Investment Real Estate