2. Chapter Debt

• a contractual obligation:

  • to deliver cash or another financial asset to another entity

  • a contract that will or may be settled in the entity’s own equity instruments.

• primary sources of short-term financing (small companies)

• loan typically initiated with a promissory note, amount of the loan, the date payment is due, and the interest rate.

• agreement requires that the firm pay interest on the loan and pay back the principal in one lump sum

• The interest rate may be fixed or variable (Libor)

• As it is a rate paid by banks with the highest credit quality, most firms will borrow at a rate that exceeds LIBOR

• Characterisitics:

  • A bank agrees to lend a firm any amount up to a stated maximum.

  • flexible agreement allows the firm to draw upon the line of credit

  • finance seasonal needs.

  • legally binding written agreement that obligates the bank to provide funds to a firm regardless of the present financial condition of the firm (unless the firm is bankrupt)

• Payment:

  • The firm pays a commitment fee on the unused portion of the line of credit in

  • interest on the amount that the firm borrowed.

• commercial loan provided by a group of lenders

• structured, arranged, and administered by one or several commercial or investment banks known as arrangers.

• less expensive, more efficient to administrate

• A loan is originally launched to market at a target spread.

• Banks will make commitments that in many cases are tiered (abgestuft) by the spread.

• The arranger will total up the commitments and then make a call on where to price the facility.

• M&A-related transaction;

• recapitalization;

• refinancing debt;

• and general corporate purposes.

• underwritten deal (arrangers guarantee the entire commitment),

• a “best-efforts” syndication (arranger group commits to underwrite less than the entire amount of the loan),

• a “club deal” (smaller loan of up to $150 million that is pre-marketed to a group of relationship lenders).

• The syndicated loan market has become the dominant provider for loans because these are less expensive and more efficient to administer than traditional bilateral, or individual, credit lines.

• Default risk (borrower’s being unable to pay interest or principal on time)

• It is based on the issuer’s financial condition, industry segment, and conditions in that industry

• expressed by a public rating.

• Investors assess this risk based on the collateral (if any) backing the loan

• the amount of other debt and equity subordinated to the loan.

• Lenders will also look to covenants to provide a way of re-negotiating the terms of a loan if the issuer fails to meet financial targets

• Loss-given-default risk measures the severity (Wahrscheinlichkeit) of loss the lender is likely to incur in the event of default.

• Where an instrument ranks in priority of payment is referred to as seniority.

• Based on this ranking, an issuer will direct payments with the senior-most creditors paid first and the most junior equity holders last

• secured instruments typically move to the front of the line

• subordinate bondholders

• junior bondholders

• preferred shareholders

• common shareholders.

• RCL. allows borrowers to draw down, repay, and reborrow.

• Borrowers are charged an annual commitment fee on unused amounts (the facility fee).

• Revolving credits often run for 364 days and are generally limited to the investment-grade market

• after one year of extending credit under a revolving facility, banks must then increase their capital reserves to take into account the unused amounts.

• Therefore, banks can offer issuers 364-day facilities at a lower fee than a multi-year revolving credit.

• A term loan is simply an installment loan.

• The borrower may draw on the loan during a short commitment period

• during which lenders usual share a ticking fee, akin to a commitment fee on a revolver

• repays it based on either a scheduled series of repayments or a one-time lump-sum payment at maturity (bullet payment).

• An amortizing term loan (A-term loan or TLa)

  • term loan with a progressive repayment schedule

  • runs six years or less.

  • These loans are normally syndicated to banks along with revolving credits.

• An institutional term loan (B-term, C-term, or D-term loan) is a term loan facility carved out for nonbank accounts.

• LOCs are guarantees provided by the bank group to pay off debt or obligations if the borrower cannot.

• A letter of credit facility specifically refers to a line of credit taken by a business entity primarily for the purpose of financing international trade

• A/ E Lines … are credits that may be drawn down for a given period to purchase specified assets or equipment or to make acquisitions.

• The issuer pays a fee during the commitment period (a ticking fee).

• The lines are then repaid over a specified period (the term-out period).

• Repaid amounts may not be reborrowed.

• B.L. are loans that are intended to provide short-term financing to provide a “bridge”

• asset sale, bond offering, stock offering, divestiture, etc.

• Generally, bridge loans are provided by arrangers as part of an overall financing package.

• Typically, the issuer will agree to increasing interest rates if the loan is not repaid as expected

• An equity bridge loan is a bridge loan provided by arrangers that is expected to be repaid by a secondary equity commitment to a leveraged buyout.

• The lead arranger or bookrunner title is a league table designation used to indicate the “top dog” in a syndication

• In most syndications, there is one lead arranger

• is the bank that handles all interest and principal payments and monitors the loan

• is the bank that handles, in purest form, the syndication of the loan.

• is the bank that handles the documents and chooses the law firm

• is largely a meaningless title used mostly as an award for large commitments.

• Upfront fee (paid by the issuer at close)

• Commitment fee (paid to lenders on undrawn amount RCL/”ticking Fee”

• Facility fee (paid on the a facility’s entire committed amount)

• Usage fee ( is a fee paid when the utilization of a revolving credit is above, or more often, below a certain minimum)

• Prepayment Fee (e is a feature generally associated with institutional term loans. Typical prepayment fees will be set on a sliding scale; for instance, 2% in year one and 1% in year two)

• Administrative agent fee (is the annual fee typically paid to administer the loan)

• Loan agreements have a series of restrictions that dictate, how borrowers can operate and carry themselves financially.

• For instance, one covenant may prohibit it from taking on new debt.

• Most agreements also have financial compliance covenants, for example, that a borrower must maintain a prescribed level of performance, which, if not maintained, gives banks the right to terminate the agreement or push the borrower into default.

• The size of the covenant package increases in proportion to a borrower’s financial risk

• Affirmative covenants:

  • state what action the borrower must take to be in compliance with the loan, i.e. pay the bank interest and fees, provide audited financial statements, maintain insurance, pay taxes, and so forth.

• Negative covenants:

  • limit the borrower’s activities in some way. Negative covenants, can limit the type and amount of acquisitions and investments, new debt issuance, liens, asset sales, and guarantees.

• Financial covenants:

  • enforce minimum financial performance measures against the borrower. If an issuer fails to achieve these levels, lenders have the right to accelerate the loan. In most cases, though, lenders will instead grant a waiver in return for some combination of a fee and/or spread increase; a repayment or additional collateral or seniority.

• coverage covenant:

  • requires the borrower to maintain a minimum level of cash flow or earnings

• leverage covenant:

  • sets a maximum level of debt, relative to either equity or cash flow

• current-ratio covenant:

  • requires that the borrower maintain a minimum ratio of current assets to current liabilities

• tangible-net-worth (TNW) covenant:

  • requires that the borrower have a minimum level of TNW

• maximum-capital-expenditures covenant

  • requires that the borrower limit capital expenditures

• pledges of collateral (receivables or inventory)

• pledges of the Stock of a company

• subsidary guarantees

• negative pledge (not pledge any assets to new lenders

• Springing liens/ collateral release

• change of issuer control

• equity cures ( fix a violation of a covenant by adding additional money)

• technical defaults:

  • occur, because the issuer violates a provision of the loan agreement, the lenders can accelerate the loan and force the issuer into bankruptcy. In most cases, however, the issuer and lenders can agree on an amendment that waives the violation in exchange for a fee, spread increase, and/or tighter terms.

• payment default:

  • is a more serious matter. This type of default occurs when a company misses either an interest or principal payment. There is often a pre-set period of time, say 30 days, during which an issuer can cure a default. After that, the lenders can accelerate, or call, the loan.

—> If the lenders accelerate, the company will generally declare bankruptcy and restructure its debt. If the company is not worth saving, then the issuer and lenders may agree to a liquidation, in which the assets of the business are sold and the proceeds dispensed to the creditors.