Timeshare is an evolving vacation ownership concept. It is flexible, innovative and dynamic. It adapts to changing market conditions, consumer preferences and technology. It can operate in a right to use, deed and trust environment. It can be based on days, weeks or longer periods. It can be reduced simply to points—like the digital revolution in other sectors—giving owners greater personal choice to vacation when and where they please.

While the vacation business has readily embraced change, the financial world has been challenged to keep pace. Banks and other lenders operate in a regulated environment that places a premium on safety and soundness—after all, they want to be assured that they will be fully repaid. They tend to be risk adverse and focus on “what happens if things go wrong?”

Lenders have been trained to understand traditional time-based vacation products, such as week intervals tied to specific resorts, because they can physically verify the inventory and develop a system of releases as payments are made. If a project fails, they know exactly what inventory remains and how that might affect the resort.

Points, on the other hand, make lenders nervous. Points-based regimes generally operate in a multi-resort context. Typically, they are the currency of vacation clubs that allow their members to cash in their points to stay at any one of their participating resorts for varying lengths of time chosen by the members. This is one step removed from the traditional vacation product. For lenders, points are not a form of collateral they are used to. While points are a general intangible under commercial law and may be secured by security agreements, they are like quicksilver and are not tied to any specific collateral. Rather, they are a bundle of rights and obligations. As points become increasingly common as a vacation product, lenders will need a new set of tools to protect their interests.

Lending generally falls into two categories. There are acquisition, development and construction (A, D & C) loans
designed to provide financing for the development of a resort. There are also receivables loans which finance the acquisition of vacation products by consumers.

Banks are commonly the source of financing for A, D & C loans, although some specialty lenders do as well. An A, D & C loan is secured by a mortgage on the resort property and by a security interest in all other assets of the borrower, such as accounts, inventory and personal property. When the development is complete, the borrower is able to establish timeshare inventory and commence sales. Sales activity allows the borrower to convert inventory into cash through a receivables loan.

The cash generated from the receivables loan is then used in part to pay down the A, D & C loan in exchange for releases on the sold inventory. The receivables lender obtains a security interest in the financed timeshare interests and is paid over time by the consumers. Here, both the A, D & C lender and the receivables lender know the nature and character of their security interests and what remedies are available in the event of a failure of the resort.

Points don’t easily fit within this framework. Points are a fungible product not tied to any specific time period or resort. Each participating resort contributes to the vacation club a total number of points representing the inventory of units and time periods available for use by club members. Usually, this is accomplished by establishing specific values for types of units and various time periods of year.

The vacation club may rate the participating resorts and their point values may vary to reflect their relative attractiveness of resorts and time periods within the regime. The result is a total aggregate amount of points that represents the maximum use rights that can be asserted by the club members at any given time. It is not uncommon, and in fact is desirable, for vacation clubs to appoint an independent trustee to hold all points inventory for the benefit of the club members and to verify that the points actually exist to meet the potential demands of the members.

If there is one A, D & C and receivables lender for a vacation club and its participating resorts, the protection of the rights of the lender is relatively simple. The security interest of the lender can follow the points into the club and the release of the points from the security interest of the A, D & C loan can be reduced to a per point payment. This process can be monitored by the trustee. Likewise, the receivables loan is secured by the points purchased by a member. If the borrower fails, the lender will know what points remain in the inventory and can sell those points to recoup its losses. Practically speaking, the points character of the vacation club will have to be continued by the lender because it is difficult, if not impossible, to unravel a club back to the participating resort level due to the nature of use rights represented by points. That is a risk that the lender will have to assume. However, it is not much different from the risk lenders already assume with traditional vacation products.

If there is more than one A, D & C lender and/or receivables lender, the picture is more complicated. Imagine, for example, a vacation club consisting of six resorts. Three of the resorts are fully developed and have no A, D & C loans outstanding. The remaining three are in the development stage and have three separate A, D & C lenders. The receivables lender for the vacation club is also a separate specialty lender. Let’s say that the total aggregate inventory of the vacation club is projected to be100 million points and that the developed resorts each have contributed 10 million points and the three other resorts subject to the A, D & C loans intend to contribute 15 million, 25 million and 30 million points, respectively. How do their security interests get sorted out? As sales proceed, who gets paid release fees and when?

There are basically two ways to solve the problem. The first method is an intercreditor agreement between the lenders that establishes a percentage interest that each of the A, D & C lenders will have in the points inventory and determines the release payment due to each lender from sales of points. The agreement confirms that the receivable lender will have an unencumbered security interest in sold points. The agreement provides for governance of the vacation club in the event of the failure of the borrower.

The second method is to adopt a “just in time” approach to the contribution of inventory to the vacation club. The participating resorts contribute inventory to the vacation club as needed to match sales of points and pay release fees to the individual A, D & C lenders as provided in their loan documents. In this manner, the points inventory of the club remains free and clear of the security interests of the A, D & C lenders and is subject only to the security interest of the receivables lender.

The lesson here is that financing for points vacation products is more complex than is the case with traditional products. It takes more time to educate lenders and to negotiate the loan documents. If more than one lender is involved, especially banks, they will tend to be cautious and opt for a “just in time” approach because it presents the least risk to them. Inventory control of points is of paramount concern to any lender having a security interest in points. The trustee is critically important in assuring the lender that its security interest is unencumbered and that the vacation club has sufficient points to meet member demand.

It will take time for lenders to fully adapt to points-based lending. However, as more resorts move in this direction, lenders will respond to the opportunity and continue to finance the growth of vacation ownership.

*W. John Funk is admitted in New Hampshire, Vermont and Massachusetts.