MONTHLY NEWSLETTER: APRIL 2006 ISSUE
HOW MUCH DOES THAT COST?
BY BRENT VAN ALFEN, PROVIDENCE FINANCIAL COMPANY, INC.
A lady in panic called 911 to report that her house was on fire. She was screaming into the phone for the fire department to hurry. In a calming voice,
the dispatcher asked her “Okay madam, we’ll hurry; but how do we get there?” After a slight pause, she said, “Well duh, in your big red truck!”
One intriguing aspect of communications is that one party can have something entirely different in mind than the other party in the same discussion.
Especially in areas of finance and costs, it is a good idea to think things through to the end result For example, you add some extras to your new
facility at the suggestion of the contractor that cost “only” $50,000. In the context of your $5 million project, that seems like very little. Now
let’s think about the end result of that innocuous addition. At 7% interest, the additional payment will be $332.65 per month. That still is not
terrible; but now add that up over the next 30 years, and it becomes a $119,754.45 additional cost. Of course there may still be a good reason to
add those extras, but you should at least think through the additional cost to its end result. In this example, that is almost 2.4 times the original
cost of the project.
I know of an underwriter that charges 3.5% to 4% in underwriter fees while I almost never have more than 2% underwriter fees charged to my clients.
Let’s take the 2% difference and see what the end result of that savings is on a $5million project.
2% X $5M = $100,000 savings at inception
$100,000 increases the payment by $665.30/month
Total of additional payments saved over thirty years = $239,508.
In this case, thinking through to the end result and some shopping and bargaining would save a charter school almost $240,000 over the life of their loan.
What is the effect of saving 1% on your interest rate? Assume a $5 million project over thirty years:
Payment at 8% = $36,688
Total of payments over 30 years = $13,207,762
Payment at 7% = $33,265
Total of payments over 30 years = $11,975,445
Saving 1% on your interest rate = dollar savings of $1,232,317
There are other potentially significant cost items that may be hidden in the body of financing documents.
On one project I was able to save a school 2.25% on the underwriting fee and ½% in the interest rate from what they had been quoted directly by an underwriter. In their
case, that will save them $1,072,318 over thirty years.
I have been able to do this, in part, by bringing competition to the market. I have introduced four underwriters to the charter school facilities financing market in the
last two years. What used to be a cozy business for a few underwriters is now a much better market for many charter schools. I think competition is good for the market and,
as an advocate for my charter clients, I try to get the best pricing I can for my schools without sacrificing service and professionalism.
There are other potentially significant cost items that may be hidden in the body of financing documents. These do not have costs spelled out like the other costs that
I refer to above, but they must be considered carefully and understood before someone gets out their pen and hands it to you. For example, several schools have reported
that they were told there was no prepayment penalty if they refinanced. After a few years, when they wanted to refinance, they were told there was a very large charge
called a “defeasance” cost. This is bond-speak for an extra charge if you want to pay off your loan during the “lock out” period. I guess technically, in someone’s
mind, that is not a pre-payment penalty; but it sure feels like one to me. Another possible land mine in the documents is called a “mandatory call”. Some underwriters
want to put this feature in the documents so investors can free up their money.
What it means to the borrower is that they will be forced to refinance at that time,
usually from seven to fifteen years. To be fair, one must understand that underwriters walk a tight rope between the needs of the borrower and the demands of investors.
The underwriter has to sell those bonds, and I don’t underestimate that challenge. Sometimes they are placed in situations where features that are not always to the
borrowers liking must be there if they are going to be able to sell the bonds. The charter school business is still new, so investors are demanding considerations
today that will most likely disappear in a few years. I think the financing environment will continue to improve as the charter movement continues to grow.