What is Mandatory Debt Amortization?
Mandatory Debt Amortization is the contractually required repayment of the original principal by a borrower throughout the lending term.
Typically required by senior lenders, mandatory amortization reduces the outstanding debt balance and lowers the risk of loss of initial capital.
Debt Amortization Schedule: Mandatory Principal Repayment
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 Debt Lenders: Senior debt lenders are far more likely to request some amount of mandatory amortization throughout the lending period as additional downside protection. Compared to high-yield investors, senior lenders tend to be more conservative by prioritizing capital preservation rather than chasing higher returns.
- High-Yield Debt Investors: If the debt principal is paid down, the interest expense β the fees associated with debt financing and a source of returns for lenders β also becomes lower. Therefore, high-yield debt investors, which are returns-oriented, are unlikely to require mandatory debt amortization.
Modeling Debt Amortization in Financial Models
The amount of amortization due is tied to the original debt principal β 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).