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Secured Loans with Bonds, Notes, and Mortgages Part 2

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As a contractor, the scope of your operations is dictated by the owner’s ability to secure funding for a construction project. Without secured loans, it would be impossible to complete projects and you certainly wouldn’t be paid. Therefore, it’s important that you possess a fundamental understanding of how these agreements are handled.

In part one, the construction law experts at Cotney Construction Law introduced secured loans with bonds, note, and mortgages. In part two, we will continue to explore this topic, focusing primarily on evaluating bond values and the features of bond agreements. If you feel apprehensive about your future compensation on a project because you feel like your owner is failing to secure proper funding, consult a Boca Raton construction lawyer.

Factors for Determining Bond Values

The value of a bond is determined by assessing the project budget and the risk associated with bond issuance. For example, the lender will modify the value of the bond to adjust for the potential of the borrower defaulting on required interest and principal payments. For publicly traded bonds, special rating companies divide bonds into different risk categories to minimize the chance of a borrower defaulting.

If a bond is likely to default, it will have a lower value. In addition, lenders can adjust the value of a bond to account for new standards in the tax code that can affect the after-tax return from a bond. Lenders also consider how future inflation and deflation, as well as exchanges rates, will alter the value of a bond’s market value over time.

Features of Borrowing Agreements

Borrowing agreements commonly use variable interest rates to ensure that interest payments vary in accordance with the current market interest rate. This is generally disadvantageous for the borrower since cash flows are harder to predict. However, owners can procure variable rate loans at lower interest rates because these types of loans offer the lender a much higher degree of protection from significant increases in the market interest rate which results in a substantial reduction in repayment value. Lenders can set floors and ceilings for the applicable interest rate on these loans to help stabilize the borrowing agreement.

Required Reserve Funds

Borrowing agreements usually include various required reserve funds. For an 18 month project costing $5 million, the owner would seek out coupon bonds to help generate sufficient revenues for paying interest charges throughout the construction project as well as construction costs, issuance expenses, and to preserve a debt service reserve fund. This reserve fund is a tool for assuring that bondholders are compensated in the event of project delays.

If you would like to speak with a Boca Raton construction attorney, please contact us today.

Disclaimer: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.