How to renew a bullet loan
Renewing a credit facility can be a sensitive topic for clients enjoying a Private Banking relationship. In this article, we discuss potential pitfalls surrounding the renewal of a credit facility.
A bullet loan is a loan where a payment of the entire principal of the loan, and sometimes the principal and interest, is paid at the end of the loan term. Bullet loans are an integral part of Private Banks’ wealth management toolkits.
Private Bank lending includes mainly mortgage and Lombard loans, when banks lend money to individuals who offer assets – typically shares and bonds, but sometimes other financial products – as collateral.
For private banks, lending has a number of advantages. The first is that interest payments provide an additional income stream. A second advantage, is that clients who have a loan, and in particular a mortgage loan, are less likely to leave than those who merely have deposits.
For High Net Worth clients, bullet loans offer benefits such as:
– Tax optimisation : the value of net taxable assets under French wealth tax scheme can be reduced by carrying a secured loan
– Cash flow management : for obvious reasons, servicing an interest-only loan is less burdensome than servicing an amortizing loan
– Cheap access to capital : in a low interest environment, raising capital against real estate assets is a great way to fund a wide variety of projects, including, in the case of entrepreneurs, investing in one’s own business
Bullet loans are normally arranged over terms of 3 to 5 years and rarely exceed 7 years.
Reaching the end of the contractual term is an important tollgate in a private banking relationship. Clients enjoying a “healthy” relationship are normally offered an option to renew their credit facility for 3/5 or 7 years at competitive terms.
However, it is not uncommon for lenders to impose new hurdles which can come in the form of:
a/ additional collateral requirements … in practice, banks require additional assets to be deposited before a credit line can be renewed
b/ an increase in the spread applied to the borrowing facility
c/ in extreme cases, a non-renewal of the credit facility