Demystifying loans for co‑operatives

Prudent borrowing can be part of managing the financial governance of a co‑op that:

• owns assets of significantly greater value than the loan, which it can offer as security for the loan
• has a well thought out business plan that demonstrates how it can repay the loan
• has a good credit history.

If a co-operative is considering borrowing, now is a good time. Interest rates are still very low and there are a growing number of financial institutions that are genuinely interested in lending to well-run organisations (whatever their size), particularly if they have a social purpose. Such lenders include the Charity Bank, Unity Trust Bank, Ecology Building Society, Triodos Bank, the Co‑operative Bank, Co‑operative and Community Finance and Social and Sustainable Capital.

In 2019, we advised borrowers on well over £2 billion of loans and our experience shows that organisations are put off going to banks as the loans industry is full of jargon. When lenders use jargon it can make us feel like we’re already on the back foot as we don’t want to appear like we don’t understand. Below are some common (and not so common) terms that are used in the loan industry, which will hopefully clarify the loan market for those considering entering into a loan agreement with a lender.

Term loan: A loan that is repaid in regular payments over a set period of time.

Revolving credit facilities (RCF or revolver): An arrangement that allows for the loan amount to be withdrawn, repaid, and redrawn again in any manner and any number of times.

Public bond: Bond financing is a type of long-term borrowing that larger borrowers with a credit rating frequently use to raise large amounts of money (usually over £100 million). They obtain this money by selling bonds to investors. In exchange, they promise to repay this money, with interest, according to specified schedules.

Private placement: A sale of notes (like an IOU) directly to a private investor, rather than as part of a public offering. This is usually to a pension or insurance company.

Floating charge: Typically, a loan might be secured by fixed assets such as property or equipment, but with a floating charge, the underlying assets are usually current assets or short-term assets that can change in quantity and value (for example cash in a bank account). 

Debenture: A security document that has fixed and floating charges over all the assets of an incorporated borrower.

Crystallisation: The process of a floating charge converting into a fixed charge when certain events occur (such as an event of default in a loan agreement).

Bullet repayment: A lump sum payment made for the entirety of an outstanding loan amount, usually at maturity. Loans with bullet repayments are also referred to as balloon loans.

Club deal: If a financing requirement goes beyond the volume which a bank is prepared to supply on its own, the "club deal" may be the solution: Several banks issue a loan together from day one.

Syndicated loan: This occurs if a bank initially lends a borrower a large amount of money and then after entering into the agreement, it sells some of the loan arrangements to other financial institutions.

Hedging: An interest rate swap/hedge turns the interest on a variable rate loan into a fixed cost. It does so through an exchange of interest payments between the borrower and the lender. The parties do not exchange a principal amount. Hedging can be very complex and if a co-op is considering entering into one they should take expert advice. Depending on which way interest rates move once an interest rate swap has been entered into, such a swap can be very expensive to terminate.

Break costs: The economic cost to a lender whenever a loan is repaid or cancelled on a date other than the last day of an interest period. This relates to costs as a result of meeting its matched funding obligations. A bank may well have borrowed the loan amount itself on the wholesale banking market and so if it has to repay its loan early because it has been repaid early, the bank will incur break costs itself, which it will pass on to the borrower.

Haircut: A discount or loss. A lender is said to take a haircut on a distressed loan that has been sold at a loss.

Soft mini perm: This could be relevant for the funding of a specific project. This is a clause within a loan agreement. To encourage the borrower to either refinance or repay early, if a loan is not refinanced by a certain date, the margin on the loans will increase and most, if not all, of the project's available cash flow must be used to pay down the principal amount of the loans. We would advise co-ops to resist such clauses if at all possible.

Hard mini perm: As above, but if the loan is not refinanced before a certain date it results in an event of default. As with a soft mini-perm, these should also be avoided if possible.