When a company takes out a loan from a lender like a bank, the loan agreement contains many provisions that govern the terms of the borrowing. One common clause is known as a “non-call period”.
What is a Non-Call Period?
A non-call period is a set period of time during the term of a loan agreement where the borrower cannot voluntarily prepay or refinance the loan. This effectively “locks in” the loan for that initial period.
For example, a loan agreement may have a 3-year term with a 12-month non-call period. This means the borrower must pay interest and make payments as scheduled for at least the first 12 months of the loan. Only after a year could they look to refinance or repay that loan early, without having to pay prepayment penalties.
Why Do Lenders Require This?
There are a few key reasons why lenders typically put non-call provisions into their loan contracts:
1. Interest Rate Risk Management
For lenders who fund loans using short-term deposits from their depositors, there is risk around changes in interest rates. If rates increase after making a long-term loan commitment at a lower fixed rate, the lender can lose money over time. By preventing prepayment for a period of time, lenders can lock in originally forecasted returns.
2. Recover Closing Costs
It takes considerable time and expense for lenders to source loans and conduct due diligence. From legal fees to underwriting costs, lenders have front-loaded costs to close each deal. A non-call period allows them to recoup these closing expenses through a guaranteed period of interest payments.
3. Manage Reinvestment Risk
If lenders suddenly have borrowers prepay loans shortly after closing, it can create challenges around re-lending those funds to earn a return. Non-call periods provide more stability and predictability in loan balances and income.
In essence, non-call provisions de-risk the transaction for lenders by preventing surprises early in the loan term. While borrowers lose some flexibility, they gain secured financing.
What is a Market Non-Call Period?
Common non-call terms vary by loan type and lender requirements. Some typical market standards are:
- Working Capital Loans: 6 – 12 months
- Commercial Mortgages: 1 – 5 years
- Investment Property Loans: 3 – 7 years
- Fixed Rate Home Loans: 3 – 5 years
So a “market” non-call period equates to what is commonly acceptable for that product type to balance both borrower and lender interests.
Warehouse facilities commonly have a 12 month non-call period.
Negotiating the Non-Call Period Clause
When negotiating loan terms, the non-call period is an area that can often be discussed between the borrower and lender:
- The borrower nearly always wants more flexibility or a shorter non-call window.
- The lender wants the longest justifiable non-call window available.
A savvy borrower will clarify reasons why they want a shorter non-call period, or may request exceptions in case of certain events like a liquidity event for the business.
They may also ask the lender “what is standard you’ve agreed to for other borrowers”. This provides helpful benchmarking data.
Having a rationale grounded in the financial interests of both parties (rather than purely to optimize for yourself) builds credibility during negotiations.
Waiver Options
Some lenders may allow, but not guarantee, options to waive the non-call restrictions under certain conditions. This maintains ultimate control for them to permit prepayment, but only when it aligns with their interests too.
Potential waiver conditions could include:
- Refinancing loan with the same lender
- Paying lender’s break funding costs
- Lender asset/liability management issues
- Major change proposed in loan purpose or structure
However any waivers are at the full discretion of the lender. The non-call period must be strictly honored unless specific approval is granted.
Alternatives to Refinancing During Non Call Periods
What should a borrower do if they want to adjust loan terms or obligations during the locked non-call window? There are options like:
1. Requesting Temporary Interest-Only Payments
If cash flow is tight, changing principal + interest payments to interest-only for a period can ease liquidity pressures. Lenders want to support borrowers through temporary challenges to maintain performing loans.
2. Payment Deferrals
If struggling for a few months, asking for approval to defer payments until business recovers may be possible without needing to refinance the entire loan. Most lenders would prefer this short-term risk over forcing defaults unnecessarily.
3. Modifying Future Payment Obligations
Renegotiating amounts owed prior to the next repricing date could provide payment flexibility to free up borrower cash flow without impacting lender economics much until then.
The key is to present reasonable requests that let lenders preserve originally anticipated returns over the full lifetime of the credits. By working together, both parties can often find alternatives to prepaying during non-call periods.
Summary
While non-call clauses do restrict a borrower’s early repayment options, they exist to reduce uncertainties that come with lending over long periods. By understanding why they are included and negotiating thoughtfully, borrowers can often still achieve the flexibility they require through open communication with lenders.
So be sure to have a consultative conversation about non-call terms early in the lending process before documents get signed. With market insights and a collaborative approach, viable compromises are generally available.