Bullet Repayment

A bullet repayment is a loan or bond structure in which the borrower repays the entire principal in a single payment at maturity, with only interest (or nothing at all) paid before then. The final payment is the "bullet". Most bonds work this way, and so do many corporate loans, bridge loans and interest-only property loans.

The structure is the opposite of a fully amortising loan, where each instalment repays part of the principal according to an amortization schedule. It is close to, but not the same as, a balloon payment: a balloon loan repays some principal during its life and leaves a large remainder at the end, while a pure bullet repays none until maturity. The choice between them shapes the borrower's annual cash needs and its refinancing risk.

Think of borrowing a friend's car for a year. One way is to pay a small rental fee every month and return the car at the end. Another is to buy it in instalments, so by the end you have paid it off bit by bit. A bullet loan is like the rental: you pay a regular fee for using the money, then hand back the full amount on the last day.

That keeps the monthly cost low, which suits a borrower who expects a large sum later, such as the sale of a building or a new loan. The catch is that the full amount falls due on one day. If the expected money does not arrive, the borrower faces a large bill all at once.

During the life of the loan the borrower pays interest at each period. For a fixed-rate bullet loan the periodic interest is:

• $I$ is the interest paid each period.
• $P$ is the principal, which stays unchanged until maturity.
• $r$ is the annual interest rate, written as a decimal.
• $m$ is the number of payments a year.

A company borrows 10 million for five years at 6 percent with semi-annual interest. Each payment is 10,000,000 × 0.06 ÷ 2 = 300,000. It makes nine payments of 300,000 and then a final payment of 10,300,000, covering the principal and the last interest. Total interest is 3 million. A fully amortising loan of the same size and rate would cost less interest in total, about 1.7 million, because the balance falls over time, but its payments would be roughly four times larger each period.

A zero-coupon bond is the extreme case: it pays no interest along the way and repays a face value at maturity that includes the accrued return.

• Bond markets. Corporate, government bonds and Eurobonds almost always repay principal in one sum at maturity, with interest paid at the coupon rate.
• Corporate loans. Investment-grade companies often borrow on bullet terms through a term loan or a revolving credit facility. Leveraged term loans sold to investors typically have only token annual amortisation, around 1 percent, so they are close to bullet.
• Bridge and property finance. Short loans that will be repaid from a sale, a bond issue or permanent finance are usually bullet loans, as are many interest-only commercial property loans.
• Trade and working capital. Short-term advances repaid from a single expected receipt, such as an export payment, work the same way.

For borrowers the appeal is cash flow. Low payments during the loan leave more money for investment and improve measures such as the debt service coverage ratio, though not the interest coverage ratio, which ignores principal. Investors in bonds like the predictable cash flows and the clear maturity date.

The main risk is refinancing. A borrower that plans to repay a bullet with a new loan depends on credit markets being open when it matures. In a credit crunch, or when rates have risen sharply, refinancing may be impossible or far more expensive, and a solvent company can still default. Analysts speak of a "maturity wall" when many bullets fall due in the same period. Lenders face greater exposure because the balance never falls, so their liquidity risk and credit exposure stay at the full amount for the whole term.

Borrowers manage the risk by spreading maturities, refinancing early, keeping committed backup lines, and in some bonds using a sinking fund that sets money aside before the bullet date. Accounting does not change the economics: the loan stays a non-current liability until its final year, when the whole balance moves into current liabilities. Treasury teams track upcoming bullets closely in their cash forecasting.

• TreasuryDirect (US Department of the Treasury)