Definition of Commercial Loan Curtailment

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A commercial loan curtailment is the partial prepayment of the loan principal amount. If a corporate borrower pays the full principal amount -- that is, settles the obligation -- financial analysts call the transaction a "full curtailment." Business debt curtailment transactions generally happen in a specific economic or corporate context.

How It Works

Before curtailing a loan, a company's leadership analyzes conditions on credit markets, talks with department heads to learn what's going on in the competitive ground and studies the organization's cash position as well as its sales numbers and overall economic soundness. Senior leaders also engage in talks with lenders to make sure a potential curtailment doesn't end up costing the company more than the expected savings.

If external economic factors and corporate internal conditions give top management the green light for a curtailment transaction, company principals reach out to specialists such as investment bankers to determine whether it's strategically more beneficial to prepay using company money or borrowing at lower rates. This makes sense, because companies typically curtail loans to reduce borrowing costs, lighten up their balance sheets or improve their creditworthiness.

Strategic Considerations

There's a lot of strategic thinking that goes in loan curtailment, especially before a company sends lenders a prepayment check. Top leadership relies on the expertise of department supervisors and business-unit chiefs to determine the best course of action, analyze the company's cash flows and heed what rivals are doing about debt curtailment.

The idea is to make sure supervisors don't rely on misguided policies -- especially when it comes to debt analysis and financial management -- and set tactics that ultimately do great operating damage to the company. For example, if the organization uses its own money to prepay a loan and the business needs cash six months later, it would be detrimental if it ends up borrowing at a rate that is higher than the initial debt's rate.

Costs

Commercial loan curtailment transactions involve costs. Personnel who work in the corporate treasury or are responsible for debt management play a key role in debt curtailment analysis. They usually work in tandem with external advisers to determine the best time to engage in loan prepayment initiatives. Besides staff and consulting expenses, a company may have to pay prepayment penalty fees to a lender if the loan covenant indicates so. Tools the business uses to track debt levels and determine curtailment opportunities also cost money.

Tools and Technology

Commercial loan prepayment initiatives call for state-of-the-art technology to track liability levels, engage in scenario analysis, evaluate curtailment opportunities and monitor conditions of credit markets. The tools of the trade include calendar and scheduling software, accounts receivable and payable management applications, financial analysis software and credit adjudication and lending management system software, also known as CALMS.

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