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Mandatory Debt Amortization

Learn the Steps to Modeling Mandatory Debt Amortization

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Mandatory Debt Amortization

Key Learning Objectives
  • What is mandatory debt amortization?
  • What are the steps to modeling mandatory debt amortization?
  • How do you determine the order of repayment?
  • How does mandatory debt amortization impact interest expense?

Mandatory Debt Amortization Definition

Risk-averse lenders can attach provisions requiring scheduled repayments of principal as part of the lending agreement.

For the borrower, the amortization of debt represents a required legal obligation to pay down debt, as opposed to a discretionary decision.

Senior lenders are more likely to request some amount of mandatory amortization throughout the lending period as additional downside protection.

If the debt principal is paid down, the interest expense – the fees associated with debt financing and a source of returns for lenders – also becomes lower.

Compared to high-yield investors, senior lenders tend to be more conservative by prioritizing capital preservation rather than chasing higher returns.

Modeling Mandatory Debt Amortization

The amount of amortization due is tied to the original debt principal – i.e. the required amortization (%) is multiplied by the original principal amount on the initial lending date.

In Excel, the purpose behind the “MIN” function is to ensure the debt balance never falls below zero, as a negative figure would imply the borrower paid off more than it initially borrowed.

Each lender will have a different risk tolerance, so the required amortization percentage varies based on which type of lender is providing the funding (e.g. corporate bank, institutional investor).

Additionally, the credit profile of the borrower can also contribute towards the required amortization, as lenders are more likely to require a higher percentage of amortization for higher-risk borrowers (and vice versa).

Mandatory Amortization Excel Template

Now that we’ve defined what mandatory amortization is within a debt schedule, we can complete an example modeling exercise in Excel. To access the template, fill out the form below:

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Mandatory Debt Amortization Example Calculation

First, we’ll begin by listing out the assumptions for our model. In our simple example, there is just one tranche of debt: Term Loan A (TLA).

The term loan A has a tenor – i.e. the length of the borrowing arrangement – of 5 years.

Term Loan A – Model Assumptions
  • Beginning Balance (Year 1) = $200 million
  • Mandatory Amortization = 20.0%
  • Interest Rate = LIBOR + 200 bps

Using the first two assumptions, we can calculate the annual mandatory amortization amount by multiplying the 20.0% of mandatory amortization by the original principal amount, which comes out to $40 million per year.

The formula for calculating the mandatory amortization can be found below – note the inclusion of the “MIN” function to prevent the ending balance from falling below zero.

Mandatory Amortization Excel Formula

From Year 1 to Year 5, the borrower will pay $40m in equal installments of mandatory amortization.

Given the 5-year term of the debt, the ending TLA balance in Year 5 should be zero, as our model confirms.

Regardless of the fact that the ending balance is decreasing over time, the mandatory amortization is always calculated off the original principal amount (i.e. the $200m).

The interest expense, however, declines from $11m in Year 1 to $1m in Year 5 as a result of the gradual paydown in the principal.

While not applicable to our example, if there were any outstanding principal remaining at the end of the lending term, the balance is required to be paid entirely in one lump sum payment (i.e. a “bullet” repayment).

Ultimately, mandatory amortization for lenders is about finding the right balance between risk and return.

Mandatory Amortization Output

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