Quarter by quarter, the excess cash a sweep applies to the loan, the paydown the trigger requires, and why the cure time explodes as the decline deepens.
A cash sweep cures a debt yield trigger only as fast as the property's excess cash can pay the loan down to the level the trigger allows. On an illustrative $60.0M interest-only loan at 6.00 per cent, a 15 per cent fall in NOI takes the debt yield from 9.50 to 8.08 per cent against an 8.50 per cent trigger: the loan must fall by $3.00M, and sweeping about $0.24M a quarter into principal releases the trap after 13 quarters. At a 20 per cent fall the same mechanism takes 32 quarters, eight years.
Worked in full in How to Read a Real Estate Loan Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A sponsor holds an office building financed with a fixed-rate, interest-only loan. The agreement sets a cash management trigger at a debt yield of 8.50 per cent, tested quarterly. Below it, every dollar left after interest and the reserves is swept into principal, and the trap releases after two consecutive quarters at or above the trigger. A tenant default and a weak letting market take NOI down 15 per cent. All figures are illustrative, and NOI is taken as the annualised quarterly figure; a trailing twelve-month test lags further.
| Input | Value |
|---|---|
| Loan, interest-only | 60.0 |
| Fixed rate | 6.00% |
| NOI at origination (debt yield 9.50%) | 5.70 |
| Fall in NOI | 15% |
| Debt yield trigger | 8.50% |
| Capex and leasing reserves, paid before the sweep | 0.30 a year |
| Consecutive passing tests to release | 2 |
After the fall, NOI is $4.845M and the debt yield is 4.845 / 60.0 = 8.08 per cent. The trigger is a ratio, so it defines the largest loan the reduced NOI can support.
Allowed loan = NOI / trigger = 4.845 / 8.50% = 57.00
Paydown required = 60.0 − 57.00 = 3.00, 5% of the loan
Interest is $3.60M a year and reserves $0.30M, so the sweep captures $0.95M in the first year, $0.24M a quarter. Dividing the paydown by that gives 3.17 years, 12.7 quarters. The real answer is a little faster, because every dollar swept into principal reduces next quarter's interest, but the release needs a second passing test.
Quarterly sweep = (NOI − reserves) / 4 − balance × rate / 4
Balanceq = Balanceq−1 − sweepq; release when NOI / Balance ≥ 8.50% for 2 quarters
Excel, quarters to reach the allowed loan: =NPER(6%/4, (4.845-0.3)/4, -60, 57) returns 11.7
The debt yield first passes in quarter 12, at a balance of $56.92M. The second passing test comes in quarter 13, after $3.36M has been swept. The trap has held the sponsor's distributions for 39 months.
Some agreements apply the sweep to principal; others hold it in a cash collateral account. The difference is not cosmetic.
| Treatment | Quarters to release |
|---|---|
| Applied to principal | 13 |
| Held as collateral, netted from the loan for the test | 14 |
| Held as collateral, not netted | never, without NOI recovery |
If the cash is netted from the loan when the ratio is tested, the cure takes one extra quarter, because interest keeps running on the full $60.0M. If it is not netted, the ratio cannot improve from cash at all: the trap releases only when NOI climbs back to $5.10M, 5.3 per cent above the trough and 89.5 per cent of where it started. With 3 per cent growth that takes 1.7 years; with none, the trap is permanent.
| NOI fall | Debt yield | Paydown needed | Flat NOI | NOI +3% a year |
|---|---|---|---|---|
| 12.5% | 8.31% | 1.32 | 6 | 4 |
| 15.0% | 8.08% | 3.00 | 13 | 6 |
| 20.0% | 7.60% | 6.35 | 32 | 12 |
| 25.0% | 7.13% | 9.71 | 64 | 19 |
The cure time does not scale with the decline; it explodes. A deeper fall raises the paydown and shrinks the excess cash that pays it, at the same time. Going from 15 to 20 per cent more than doubles the paydown and more than doubles the time: 32 quarters is longer than the remaining term of most loans, so in practice the trap does not cure before maturity. At a 31.6 per cent fall there is no excess cash at all, and the sweep stops working.
Sponsors tend to read a cash sweep as a temporary inconvenience that pays the loan down and switches itself off. That is true only in a narrow band of declines, here roughly up to 15 per cent with flat income. Beyond it the sweep is a distribution stop until refinancing, and the real cure is either NOI recovery or equity. A $3.00M paydown today passes the next test, releases the trap at the second, and saves $0.18M a year of interest; leaving it to the sweep costs 39 months of distributions instead of six.
Read three things in the agreement before modelling the sweep: whether trapped cash is applied to principal or held, whether held cash is netted for the test, and how many consecutive passes release the trap. Together they decide whether the cure takes three years or never comes.
The deposit and prepayment cures, which buy the trigger back with the sponsor's own money, are priced in why prepaying to cure a covenant costs eleven times a deposit.
The book treats cash management as a set of drafting choices with a price, and the free workbook for this case includes the cure worksheet and a case on a trap that cannot pay for the leasing.
When a covenant such as debt yield falls below a trigger, the lender takes control of the property's cash and, after debt service and reserves, sweeps the rest either into principal or into a collateral account. On the example loan the sweep captures $0.95M a year at the trough, and in 13 quarters it has applied $3.36M to principal.
Only if the agreement says so. Where trapped cash is netted against the loan for the test, the cure takes 14 quarters here instead of 13, because interest still runs on the full balance. Where it is not netted, holding cash does nothing for the ratio, and the trap releases only when NOI recovers to $5.10M, 5.3 per cent above the trough.
Because the decline works on both sides at once: it raises the paydown the trigger requires and shrinks the excess cash available to make it. At a 15 per cent fall the loan needs $3.00M and the sweep releases in 13 quarters; at 20 per cent it needs $6.35M and takes 32; at 25 per cent, $9.71M and 64 quarters, far beyond any loan term.
This article is one calculation from How to Read a Real Estate Loan Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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