Bank customers seeking a commercial loan can sometimes get overwhelmed with the terms and acronyms used in the banking industry. For first-time applicants, it can sometimes feel like learning a new language!
This industry jargon can make the commercial loan process seem more confusing than it needs to be. To make things clearer, we’ve put together a list of common terms below, complete with definitions and explanations of where they come from.
Equity
Typically, banks do not provide 100% financing. Rather, they expect the customer to provide equity, commonly in the form of cash, so the customer shares in the risk associated with the financing need.
Debt Service Coverage Ratio (DSCR)
DSCR measures a business’ ability to generate enough income to cover its debt obligations. The formula is DSCR = Net Operating Income (NOI) / Total Debt Service. A business with a 12-month NOI of $425,000 and an annual debt service of $275,000 will have a DSCR of (425,000/275,000 = 1.54) or for every dollar of debt, the business has $1.54 to repay that debt.
Loan to Value (LTV)
LTV compares the amount of a loan to the fair market value of the assets it’s secured against. If a commercial mortgage loan is used to purchase a property, that property will be subject to an appraisal to determine its value. If the property is appraised at $945,000 and the mortgage is $750,000 the LTV would be (750,000/945,000 = 79%). Banks commonly lend up to 75% or 80% of the value of a commercial property loan. Other types of collateral may have higher LTV limits.
Loan to Cost (LTC)
LTC represents the proportion of a project’s total cost that is financed by a commercial loan. Let’s say a business wants to buy land and construct a new building with a total project cost of $1,250,000. The business has $300,000 in cash to contribute to the project and would like to borrow $950,000 with a commercial loan. The LTC would be calculated (950,000/1,250,000 = 76%). The higher the LTC means the bank is taking a greater portion of the risk versus the borrower’s risk.
Pro Forma
Pro forma means projections. In the case of a start-up business or a business that is changing their business model, banks will ask for pro forma financial statements. A pro forma provides projected future cash flows of a business based on assumptions developed by the borrower.
Capitalization Rate (Cap Rate)
In real estate, Cap Rate is a percentage that estimates the potential rate of return on an investment property. The Cap Rate is determined by dividing the Net Operating Income (NOI) by the market value of a property. Say an eight-unit apartment building has a NOI of $65,000 and is valued at $1,000,000. The Cap Rate of the property will be (65,000/1,000,000 = 6.50%). A higher cap rate generally indicates a higher potential return, but also potentially higher risk.
Subordinated Debt
Also called junior debt, Subordinated Debt is a type of debt that ranks below other, senior debt when it comes to repayment. For example, an existing business decides to sell to a new owner, who has cash to offer along with seller financing and bank financing to complete the transaction. As a condition of approval, the bank will require the seller’s debt to be subordinated to the bank’s debt until the bank loan is paid in full.
Uniform Commercial Credit filing (UCC-1 filing)
UCC-1 filing, also known as Uniform Commercial Credit filing, is a public notice that a lender has a security interest in a borrower’s assets used as collateral for a loan.
It’s helpful to know the industry jargon before you sign for a loan. If you ever need help understanding commercial loan lingo, feel free to reach out to your SBSI lender.
