An overview of the relationships and cash flows in commercial credit transactions, from simple asset purchases to trade financing to commercial construction loans and mortgages.

1. Financing Capital Assets
Relationships between parties
Risks and mitigations
Sample credit transactions
Financial markets & debt instruments
Dan Goldzband, CMA
Financial Management
BUSA 40439
UCSD Extension

2. Part 1:
Relationships between parties
Note: All primary parties are shaded
throughout this presentation.

3. Capital asset sale:
cash flows between parties
Lender/source of Seller Buyer
funds: (manufacturer (sale)
• Short-term or dealer)
(whse line) to Sale proceeds
finance inventory Payments from
from finance buyer to finance
• Long-term company
financing of sale company
(not buyer) to
contracts seller
Cash flows
indicated by
Captive finance solid arrows
company or
independent Capital asset
leasing/finance transfer indicated
company by dashed
arrow

4. Relationships between parties:
commercial real estate loan
Capital Lender (bank, Borrowing Principle
sources finance entity (general
(depositors) company, etc) partner, etc.)
Collateral
Agreements/contracts
indicated by Contractors
solid arrows and service
Tenants
providers
Security interest
indicated by
dashed arrows

5. Part 2:
Risks and mitigations

6. Borrower risk and mitigation
Lender (bank, Borrowing
finance entity
company, etc)
Risk Mitigation
Credit evaluation Credit reports
Tax return copy from IRS
Late payment Late fee
Payment default Foreclosure
Technical default Default interest rate

7. Collateral risk and mitigation
(pre-loan/underwriting phase)
Lender (bank,
finance
company, etc)
Collateral
Risk Mitigation
Title Title insurance
Physical condition Inspection, reserve loan funds for repairs
Environmental contamination Phase 1 review
Adequacy of value Appraisal
Violation of building code Certificate of occupancy
Violation of zoning, land use Zoning confirmation
Absence of utilities service Utilities’ confirmations of service

8. Collateral risk and mitigation
(post-funding)
Lender (bank,
finance
company, etc)
Collateral
Risk Mitigation
Insurance coverage Notification of coverage lapse by carrier
Force-placed insurance
Loss due to property tax default Annual check of property tax status
Failure to pay insurance, taxes Additional advances from loan
Loss from fire, accident, etc. Insurance proceeds payable to lender
Secondary financing Balance due upon any further encumbrance

9. Tenant risk and mitigation
Lender (bank,
finance
company, etc)
Collateral
Tenants
Risk Mitigation
Vacancy upon foreclosure Subordination, non-disburbance and attornment
agreements
Adequate tenant improvement funds Reserve loan funds for this purpose
New tenant’s effect on value Lender’s review of proposed new leases

10. Contractor & service provider risk
and mitigation
Lender (bank,
finance
company, etc)
Collateral
Contractors
and service
providers
Risk Mitigation
Mechanics’ liens Lien releases from contractors, separate bond to
offset any lien
Service provider liability Proof of liability insurance
Incomplete / inadequate work Holdback of portion of each progress payment
by contractor/service provider until satisfactory completion
Insurance carrier financially weak Minimum carrier standards (AB Best ratings, etc.)

11. Separate loan guaranty:
mitigation of previous risks
Lender (bank, Principle
finance (general
company, etc) Loan guaranty partner, etc.)
Guarantee invoked in event of failure or
inadequacy of:
Borrower’s ability to pay
Collateral value (after foreclosure)
Other means to repay loan.
Risk Mitigation
Inadequacy of previous remedies Loan guaranty by principle or independent party
Note: effectiveness depends upon state law. CA law holds guarantees by related parties
to be invalid.

12. Interest rate risk
Capital Lender (bank, Borrowing
sources finance entity
(depositors) company, etc)
Interest on Loan payments
deposits or at X%
other capital
sources at Y%
Risk Mitigation
Disintermediation (X% < Y%) Loan sale to fixed-income investor
Short-to-medium loan term to minimize exposure

13. Part 3:
Sample credit transactions
Transaction 1: Production and trade
financing, followed by repayment
and take-out financing

14. Short-term financing: L/C trade credit
Seller’s bank Letter of Buyer’s bank
credit
Short-term L/C
production agreement
loan
Equipment
Seller/mfgr Buyer
• Buyer & Seller conclude a sale contract, but have no credit relationship between them.
• Buyer and Seller each have a banking relationship with credit facility.
• The two banks are correspondent banks, with a credit relationship between them
• Buyer’s Bank issues letter of credit to Seller’s Bank.
• Seller’s Bank makes production loan to Seller on basis of L/C (source of repayment).
• Seller ships goods, consigned to Buyer’s Bank per L/C instructions.
• Seller present’s shipping docs to Seller’s Bank, receives Banker’s Acceptance & 90-day draft.
• Seller discounts draft to Seller’s Bank for proceeds.
• Seller’s Bank presents draft to Buyer’s Bank for ultimate payment.

15. Paying off short-term financing,
replacing with medium-term loan
Funds per L/C
Seller’s bank (disbursed Buyer’s bank
90 days later)
Buyer’s Bank
L/C funds Equipment loan receives security
repay replaces L/C , interest in
production finances equipment (lien
loan. equipment. on collateral).
Seller/mfgr Buyer
• Seller has been paid via discounted draft.
• Seller’s Bank is repaid for production loan via L/C funds. Equipment
• Buyer obtains equipment after signing equipment loan,
which replaces L/C agreement.
• Buyer’s Bank is repaid for funds disbursed under L/C by
equipment loan principle payments.

16. Part 3:
Sample credit transactions
Transaction 2: Commercial
construction loan, followed by
repayment and take-out financing

17. Commercial construction loan:
Construction phase
Loan guaranty (separate from loan)
Principle
Borrowing entity (general
(property partner, etc.)
Lender owner/developer)
(commercial Service providers:
bank)
Architect,
Collateral engineers, etc.
(land and
Risk mitigations: improvements) General
contractor
• Lender receives security interest in collateral (dotted line).
• All service providers (contractor, architect, etc.) contract with
developer but assign their contracts to lender (dotted lines). Subcontractors
• Separate loan guaranty from principle or independent party.
• Lender disburses funds (progress payments) directly to
contractor and subcontractor, in exchange for lien releases,
less any holdbacks.

18. Commercial construction loan:
leasing / stabilization phase
Borrowing entity
Lender (property
(commercial owner/developer)
bank)
Lease
SNDA
Risk mitigations: Tenants
Loan guaranty continues (but is not shown).
Lender reviews proposed leases and prospective tenant credit (to determine effect on
collateral value).
SNDA: Subordination, non-disturbance and attornment agreement (between tenant and
lender). Provides for subordination of lease to lender’s security in collateral, and, in
event of foreclosure, guarantees non-disturbance of tenant and preservation of lease
by lender and attornment by tenant to lender (as new landlord).

19. Commercial construction loan:
takeout / permanent financing
Borrowing entity
Permanent lender (life (property
insurance company, owner/developer)
pension fund), pays off
construction loan with Lease
“permanent mortgage” (unchanged)
SNDA (with
new lender) Tenants
Risk mitigations:
Separate guarantee may or may not be required (varies by lender).
Lender reviews proposed leases and prospective tenant credit (to determine effect on
collateral value), in addition to all other underwriting of borrower and guarantor.
SNDA: Subordination, non-disturbance and attornment agreement (between tenant and
lender). Provides for subordination of lease to lender’s security in collateral, and, in
event of foreclosure, guarantees non-disturbance of tenant and preservation of lease
by lender and attornment by tenant to lender (as new landlord).

20. Part 4:
Financial markets and debt instruments

21. Financial Markets & Debt Instruments
Overview: Financial market structure and
organization. Financial markets divided into two
sectors:
• Equity markets (trade & set prices for equity securities)
• Debt markets (trade & set prices for debt securities)
Submarket Securities traded
Money markets Original duration <= 1 year
Capital markets Original duration > 1 year

22. Money markets
• Used to trade short-term securities (<= 1 year)
• Purpose of short-term financing: to meet transactional,
production, seasonal or operating cycle needs. Types of
financing include:
Short-term loans
A/R financing
INV flooring lines
Letters of credit
Revolving credit lines
• Examples of securities created and traded:
Commercial paper
Short-term negotiable CD’s
Bankers’ acceptances

23. Money markets
• Sources of financing:
Commercial banks
Factors, commercial credit companies, asset-
based lenders
Money market funds

24. Debt markets
Organization: two ways to organize/divide:
• By issuer: government & corporate
• By term: medium-term (1-5 years) and long-
term (>5 years) debt instruments

25. Debt markets--issuers
• Government debt :
1) Federal (US treasury securities & others backed
by “full faith & credit of US goverment”)
2) State, municipality and other govt agency debt
(incl. special districts and US debt not fully
guaranteed)
• Corporate debt:
1) Debentures (unsecured corporate bonds)
2) Secured corporate debt instruments (often
issued by special purpose entities)

26. Medium-term financing
• Purpose: to meet project or medium-term asset financing needs.
• Types of financing:
Auto and truck loans
Equipment purchases and leases
Other medium-term consumer loans
Construction loans
Interim / mezzanine financing
• Sources of financing:
Commercial banks
Captive finance companies
Commercial finance companies
• Securities created: generally 3-5 year asset-backed securities

27. Long-term (permanent) financing
• Purpose: to provide long-term (“permanent”) financing of
major capital assets (including corporate acquisitions) and meet
general financing needs of large public corporations and
governments.
• Types of financing:
Home mortgages and equity lines
Commercial real estate mortgages (incl. “take-out” loans)
Major (non-real estate) fixed asset loans (large equipment,
aircraft, etc.)
Infrastructure construction financing

28. Long-term financing
• Sources of financing:
Commercial banks (as brokers and arrangers)
Mortgage companies
Investment banks
Life insurance companies
Pension funds
• Securities created: Long-term , fixed-rate instruments:
Unsecured bonds
Bonds secured by specific assets or pools of assets