In PrecisionLender, you have the ability to price conversion loans in your Opportunity. A conversion loan is a loan that rolls over, or converts, to a different loan structure after a certain term. Pricing both pieces of the loan at once allows you to account for the sequential closing and funding dates in the opportunity profitability calculations. This functionality, enabled at the product level, is most commonly used to price construction-to-permanent loans, where a short-term loan converts to permanent financing at a later point.
Although conversion loans are often used for construction loans, they can be used to create other structures like a line of credit converting to a term or installment loan. A product can also be converted into the same type of product to capture more complex loan structures. Administrators have the ability to set up conversion options on any commercial loan product. This article will outline pricing in the context of a construction-to-permanent loan; however, the same details will apply to other types of conversion loans as well.
In this article:
- Selecting your Conversion Products
- Pricing a Construction-to-Permanent Loan
- Conversion Loans and Financial Statements
- Conversion Loans and Cost of Funds (COF)
- Conversion Loans and Liquidity Adjustments
Selecting your Conversion Products
If a product has one or more conversion options, a conversion arrow will be displayed next to the product tab.
If the product has exactly one conversion option, PrecisionLender will display the conversion arrow, and clicking the arrow will immediately open the available conversion option in another tab.
If there are multiple conversion options for the initial short term loan, the conversion arrow will be displayed, and clicking the arrow will display a drop-down list showing all the available conversion options.
Pricing a Construction-to-Permanent Loan
The first loan product selected will represent the short-term, construction piece of the loan. During the construction period, the borrower is typically drawing down the loan to fund building costs. Once you have selected your product, you can enter the loan details on the pricing screen. The Line of Credit (LOC), Scheduled Draws, and Scheduled Draws and Repays payment types assume that the borrower will be making interest only payments (plus any scheduled repays if you have selected that payment type). For more details on adding an interest only period, please see our Interest Only Period & Custom Amortization Schedule article.
- If you are using Scheduled Draws or Scheduled Draws and Repays, the timing of these draws may affect the profitability of the construction loan. Please note that PrecisionLender doesn’t prevent you from overdrawing your commitment. For more information on draw schedules, please see our Using Scheduled Draws and Repays article.
Once you have entered the pricing details for your first loan, you’ll want to select your second loan product from the available conversion options. The second product in the conversion will represent the long-term financing of the loan and will begin when the initial short term loan is paid off. PrecisionLender rolls over the utilized commitment (minus any repays) from the short term loan to the permanent loan. If you need to add or reduce funds on the permanent loan, click the chevron next to the Commitment field and enter the funds in the ‘Adjusted Amount’ field.
Because the permanent part of a conversion loan begins when the initial short term loan is paid off, the rate quote for the permanent portion represents a spread above the index by default. Without changing this default, the initial rate will be indicative of rates as of the pricing date, and the loan will price at modification at the spread over the index at the time of conversion. If you need to lock in the rate for the permanent portion at origination, click the field next to the Initial Rate field and select the ‘Fixed Rate Is Locked In At Origination’ option.
Conversion Loans and Financial Statements
The combined Financial Statement for both loans will be weighted by duration. Please see our Loan Weight article for additional details on how profitability is calculated with multiple loans. The funding costs for conversion loans will be reflected in the Financial Statements as:
- Gross Funding:
The Gross Funding line item for the short term loan will represent the initial draw or amount disbursed at closing. The amount of the permanent portion will be reflected in the individual loan column, but not the total loan column.
- Loan Net Funding:
The Loan Net Funding line item for the short term loan will represent the total balance advanced at origination minus any payoff from previous loans in this Relationship(if present). Any additional funds provided when the loan converts will be reflected in the permanent loan column but not the total loan column.
Conversion Loans and Cost of Funds
There are several factors to take into consideration in determining cost of funds upon conversion to the permanent loan.
- When the permanent financing is priced at a floating rate, the COF will be based on the shortest duration point on the corresponding funding curve.
- When the permanent financing is priced at a fixed rate:
- If the fixed rate is locked in at origination (fixed on pricing date), the COF will be locked in at the pricing date based on a forward rate. In other words, if you have a two year construction phase converting into a 5 year fixed term loan, where you commit to the 5 year fixed rate at the pricing date of the construction loan, you are buying 5 year money two years into the future. We use a standard forward rate formula to derive a future rate based on the funding curve on the loan’s pricing date.
- If the fixed rate is not locked in at origination, the COF will be match funded based on the current pricing date’s Funding Package characteristics for the loan being priced (current funding curve plus liquidity and funding curve adjustments if applicable). For more information on match funding please see How Does the math Work.
- When the permanent financing is adjustable, the COF will follow the same logic as the fixed rate cases above:
- If the rate is locked in at origination, we will use the forward rate shift calculation applied to the funding curve associated with the pricing date to calculate the COF for permanent segment.
- If the rate is not locked in at origination, the fixed rate COF will be derived using the funding curve associated with the pricing date.
*COF will be displayed as ‘Raw Interest Income’ in the Financial Statements.
Conversion Loans and Liquidity Adjustments
If present, liquidity adjustments may be added to your COF. Liquidity adjustments will vary depending on whether you have a ‘Raw’ or ‘All-in’ funding curve. Please see our Understanding Liquidity Adjustments article for more information on how these categories apply to your funding curve. You can confirm whether liquidity adjustments are being applied to an opportunity by clicking “Assumptions” in the upper right of your screen.
- Clients using a “Raw Funding Curve” will have the liquidity premium applied based on the duration of the combined loan maturities. For example, if a short term loan is 12 months and the permanent loan is 84 months, the 96 month liquidity rate would be added to the COF rate of each loan.
All in Curves
- Clients using an “All-in funding curve” will only have a liquidity premium applied to floating rate loans, or adjustable loans with an adjustment frequency of 1. The liquidity premium will be based on the maturity of each loan individually. If a 12 month short term loan and 84 month permanent loan were both priced with floating rates, a 12 month liquidity premium rate would be added to the short term loan’s COF rate and an 84 month liquidity rate would be added to the permanent loan’s COF rate. If the permanent loan is adjustable, with a fixed period of 12 months and an adjustment frequency of 1 month, the Liquidity premium will be based on the maturity of the loan and be applied after the fixed period. Please note that for shorter duration loans, there may not be a premium for that duration on the liquidity curve.