# [HW 2.3a] Construction Loans & Commitment Fees

You are trying to finance a construction project.  The builder has quoted a cost of \$135 million.  The project will take the builder 18 months to complete.  The builder will expect payment according the following spending curve:

 Month Spending Curve 0 20.0% 1 2.0% 2 2.0% 3 2.0% 4 9.0% 5 2.5% 6 5.0% 7 2.5% 8 2.5% 9 2.5% 10 2.5% 11 5.0% 12 10.0% 13 5.0% 14 2.5% 15 10.0% 16 2.5% 17 2.5% 18 10.0% Total 100.0%

Citibank has agreed to fund the project.  They will make a construction loan facility available.  The facility will be for 80% of the project cost.  The interest rate on the funds will be 8.75%, however, interest will not be paid during the construction period.  Instead, interest will accrue and be capitalized on the project company’s balance sheet.   At the end of the construction period, there will be other financing which will repay the outstanding amount of the construction loan.

Also, the bank will charge a 1.00% commitment fee on any undrawn amounts.  Assuming that the loan is drawn pro-rata (ie. all drawdowns will coincide with payments by the equity), how much is the loan amount and what is the total amount of interest during construction?

1. On the commitment fee, does the phrase “undrawn amounts” mean that you pay 1% on the starting balance- the amount withdrawn? Or do you pay 1% on the amount that you have withdrawn for that month?

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1. On the commitment fee, the phrase “undrawn amounts” means that you pay the 1% fee on the balance that is available to withdraw at the end of the month. In this case, you’ll draw \$27 million on day 1 and another 2.7 million on day 30, so the undrawn amount at the end of the first month is \$135 million minus \$29.7 million.

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2. Also, does the spending curve apply to the entire cost of the project, or just the loan?

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1. The builder has given a price of \$135 million to be paid according to the spending curve. So, to get going, they need to get their 20%, which is \$27 million. At the end of the first month, they’re going to require another 2%, or \$2.7 million, and so on. All this will get financed with the construction loan.

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1. Since the loan only covers 80% of the project cost, do we assume that the first \$27M is paid out of pocket?

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2. The other 20% will be funded by equity. The equity could go in first, last, or pari-passu (pro-rata). I didn’t specify which way it should go in, but it’s probably easiest to assume pari-passu…in other words that all draws are 80% debt funded and 20% equity funded.

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