Typical prepayment fees will be set on a sliding scale. Descriptions of the major risk factors follow. Indeed, the Morningstar LSTA US Leveraged Loan Index, broadly used as a proxy for market size in the US, totaled some $1.375 trillion at February 2022, the most ever, after growing every year since dipping to $497B in 2010, when the market was still licking wounds incurred in the Global Financial Crisis of 20072008. Broadly speaking there are three main types of loan funds: In March 2011, Invesco introduced the first index-based exchange traded fund, PowerShares Senior Loan Portfolio (BKLN), which is based on the LSTA Loan 100 Index. Or, in an extreme case, the value declines below the value in the collateral account, and the participant is hit with a margin call. There was an unprecedented $100B of this activity in January alone, with the repricing volume in subsequent months dwarfing previous repricing peaks. An upfront fee is a percentage of the loan amount, and the borrower ultimately will owe the full amount of the term loan to the lender at maturity. ASC 606 requires entities to consider whether the fee is (1) associated with the transfer of promised goods or services or (2) an advance payment for future goods or services.2 In addition, some software arrangements give the customer the right to terminate the Updated January 24, 2023 What is an Original Issue Discount (OID)? An original issue discount (OID) is a type of debt instrument. The term primary assignment is something of an oxymoron. This can be tricky to pull off in practice because, in the case of an amendment, the lender could be called on to approve or decline in the absence of any real information. Some participants use a spread cut-off: i.e., any loan with a spread of LIBOR+ 125 or LIBOR+150 or higher qualifies. These facilities are typically provided by bond holders or other unsecured debtors as part of a loan-to-own strategy. This premium typically starts at 200 bps when the collateral coverage goes far beyond the claims of both the first- and second-lien loans, to more than 1,000 bps for less generous collateral. Merger and acquisition (M&A) and recapitalization loans will likely carry high fees, as will bankruptcy exit financings and restructuring deals for struggling entities. Junior DIPs. So, if you buy a loan with a spread of 250 bps at a price of 101, you might assume your spread-to-expected-life as the 250 bps less the amortized 100 bps premium or LIBOR+221. Most of the information above refers to cash flow loans, loans that may be secured by collateral, but are repaid by cash flow. In the late 2000s default cycle, however, the landscape shifted because of more dire economic conditions. Often the spreads ratchet up if the term-out option is exercised. This is calculated by either number of loans or principal amount. The buyer of the protection can then buy the loan at 80 and deliver it to the counterparty at 100, a 20-point pickup. Heres how the economics of a TRS work, in simple terms. Others use a present-value calculation, employing an estimated discount ratetypically the 15-25% demanded by distressed investors. This is yet another term imported from the bond market. Much of this information may be material to the financial health of the issuer, and may be out of the public domain until the issuer formally issues a press release, or files an 8-K or some other document with the SEC. Often, an issuers rating being lowered to BB+ or exceeding a predetermined leverage level will trigger this provision. 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. conspicuous or prominent: The company has an up-front position in its industry. These deals often require time-intensive collateral monitoring. All things being equal, secured creditors will lose less than unsecured creditors. The fee may be applied to all repayments under a loan loan including from asset sales and excess cash flow (a hard fee) or specifically to discretionary payments made from a refinancing or out of cash on hand (a soft fee). The issuer pays the arranger a fee for this service and, naturally, this fee increases with the complexity and riskiness of the loan. In 2009 the gaming company issued $3.6B of 10% second-priority senior secured notes due 2018 for about $5.4B of bonds due between 2010 and 2018. In recent years there was growing concern among issuers, lenders, and regulators that migration of once-private information into public hands might breach confidentiality agreements between lenders and issuers. For instance, say an account buys five-year protection for a given loan, for which it pays 250 bps a year. It may repay a loan early because a more compelling financial opportunity presents itself or because the issuer is acquired, or because it is making an acquisition and needs a new financing. Despite the competitive market, sponsors are putting skin in the game, with an average equity contribution of 39.4% during the first half of 2018. A usage fee is a fee paid when the utilization of a revolving credit is above, or more often, falls below a certain minimum. Another may prohibit it from taking on new debt. In other cases, the rate adjustment is capped, to perhaps 50 bps. A multicurrency line allows the borrower to borrow in one or more alternative currencies (in most agreements this option is capped). Weba. Under these provisions, the spread of the existing paper ratchets up to the spread at which the new loan cleared (though in some cases the increase is capped). This fee is almost always 12.5 bps to 25 bps (0.125% to 0.25%) of the LOC commitment. The balance sheet presentation of transaction costs for US GAAP is generally aligned to IFRS. With liquidity in short supply, new innovations in DIP lending cropped up aimed at bringing nontraditional lenders into the market. There are a number of options that can be offered within a revolving credit line: A term loan is simply an installment loan, such as a loan youd use to buy a car. However, because they are obviously less liquid than receivables, lenders are less generous in their formula. Amend-to-extend transactions have two phases, as the name implies. Buyside accounts. These include both instruments that are yet to come to market and those that are actively being sold but have yet to be circled. Likewise, when a cheque is discounted by the banker, banker collects his discount at the time of discounting of the cheque and exchange, while delivering a The typical percentage required is 100%. Asset sales are defined as net proceeds of asset sales, normally excluding receivables or inventories. Manufacturing firms need to make enough money, in aggregate, to cover initial research costs, but the marginal cost they charge only needs to Then there are ratios that are suited for evaluating loss-given-default risk. Amendments or changes to a loan agreement must be approved by a certain percentage of lenders. Maintenance covenants are far more restrictive. 
LCDS enables participants to synthetically buy a loan by going short the LCDS or sell the loan by going long the LCDS. While down from the highs seen in 2017, LBOs remain expensive, as purchase price multiples held above historical highs through the first half of 2018. Like with a single-name TRS, an investor makes money by the carry between the cost of the line and the spread of the assets. If not, the arranger may be forced to sell at a discount and, potentially, even take a loss on the paper (known as selling through fees). Loan mutual funds are how retail investors can access the loan market. Therefore, banks can offer issuers 364-day facilities at a lower unused fee than a multiyear revolving credit. Why are these tranches called pro rata? Historically, arrangers syndicated revolving credit and TLa tranches on a pro rata basis to banks and finance companies. As part of the deal, lenders receive either a potential ownership stake if the company defaults, or, in the case of a bankrupt company, an explicit equity stake as part of the deal. This is a significant incentive to trade with the arrangeror a deterrent to not trade elsewhere, depending on your perspectivebecause a $3,500 fee amounts to between 7 bps to 35 bps of a $1M to $5M trade. If the arrangers cannot get investors to fully subscribe the loan, they are forced to absorb the difference, which they may later try to sell. 
These investors often seek asset-based loans that carry wide spreads. If, on a pro forma basis, the issuer fails the test then it is not allowed to proceed without permission of the lenders. And if the loan does not default but is marked down for whatever reasonmaybe market spreads widen, it is downgraded, its financial condition deterioratesthe participant stands to lose the difference between par and the current market price when the TRS expires. Simply put, this entails a new loan or bonds issue to refinance existing debt. Incremental direct costs of loan origination incurred in transactions with independent third parties for that loan b. The CD option works precisely like the LIBOR option, except that the base rate is certificates of deposit, sold by a bank to institutional investors. The total rate of return swap is the oldest way for participants to purchase loans synthetically. In addition, there is an equity tranche, but the equity tranche usually is not rated. Upfront fee is paid to the arranging bank which may or may not be the ultimate lender depending whether the debt is syndicated. The way this works, typically, is that asset-based loans are secured by current assets like accounts receivables and inventories, while term loans are secured by fixed assets like property, plant, and equipment. In addition, the borrowing base may be further divided into subcategoriesfor instance, 50% of work-in-process inventory and 65% of finished goods inventory. For instance, one covenant may require the borrower to maintain its existing fiscal-year end. Alternatively, there can be two entirely separate agreements. Because these LOCs are considered borrowed funds under capital guidelines, the fee is typically the same as the LIBOR margin. There are two primary types of loan defaults: technical defaults, and the much more serious payment defaults. Needless to say, many leveraged companies are owned by one or more private equity firms. The lines are then repaid over a specified period (the term-out period). The reason for what seems like an odd term is that regulatory capital guidelines mandate that, after one year of extending credit under a revolving facility, banks must then increase their capital reserves to take into account the unused amounts. It is first structured, arranged and administered by one or several commercial or investment banks, known as arrangers. This is terminology imported from the bond market to the loan market. Loan sales are structured as either assignments or participations, with investors usually trading through dealer desks at the large underwriting banks. Under maintenance covenants, issuers must pass agreed-to tests of financial performance such as minimum levels of cash flow coverage and maximum levels of leverage. Introduced in 2007, the LCDX is an index of 100 LCDS obligations that participants can trade. There are, lawyers explain, two main ways in which the collateral of second-lien loans can be documented. For instance, if a loan has a 3% LIBOR floor and LIBOR falls below this level, the base rate for any resets defaults to 3%. Fees for commercial LOCs (those supporting inventory or trade) are usually lower, because in these cases actual collateral is submitted. This created an opportunity for issuers with the financial wherewithal and the covenant room to repurchase loans via a tender, or in the open market, at prices below par. So, for instance, an issuer that has an incurrence test that limits its debt to 5x cash flow would only be able to take on more debt if, on a pro forma basis, it was still within this constraint. That is, you can buy it on the cheap. Typically, the funds are capitalized by an initial public offering. As a result, liquidity was in far shorter supply, constraining availability of traditional third-party DIPs. The second innovation that weakened the public/private divide was trade journalism focusing on the loan market. The nature of the transaction will determine how highly it is leveraged. A tangible-net-worth (TNW) covenant requires that the borrower have a minimum level of TNW (net worth less intangible assets, such as goodwill, intellectual assets, excess value paid for acquired companies), often with a build-up provision, which increases the minimum by a percentage of net income or equity issuance. In many loan agreements the issuer loses its right to consent in the event of default. It is often tiered, with the lead arranger receiving a larger amount in consideration for structuring and/or underwriting the loan. A fee paid to a lender for setting up a transaction. Some loans will include a provision to protect lenders for some specified amount of time if the issuer subsequently places a new loan at a higher spread. This is typically an overnight option, because the Prime option is more costly to the borrower than LIBOR or CDs. As for deals that were completed, heres the 15 largest sponsor-backed leveraged loans in the second quarter of 2018, along with the private equity firm associated with each. In addition, investors will be briefed regarding the multiple exit strategies, including second ways out via asset sales. Markit Group administers the LCDX, a product of CDS Index Co., a firm set up by a group of dealers. It is no surprise, then, that loan investors historically fare much better than other creditors on a loss-given-default basis. The formula is similar. This may not be the case if the loans are documented together and the first- and second-lien lenders are deemed a unified class by the bankruptcy court. Whatever the format, management uses the bank meeting to provide its vision for the transaction and, most important, tell why and how the lenders will be repaid on or ahead of schedule. In many receivables-based facilities issuers are required to place receivables in a lock box. That means that the bank lends against the receivable, takes possession of it, and then collects it to pay down the loan. A supermajority is typically 67-80% of lenders. Then, in year two, the loan goes into default and the market price of the debt falls to 80% of par. Loan holders, therefore, almost always are first in line among pre-petition creditors and, in many cases, are able to renegotiate with the issuer before the loan becomes severely impaired. OID is a sweetener to potential investors which increases the chances of a successful fundraise for the client. On term loans, this fee is usually referred to as a ticking fee. Following the example above, if the loan is oversubscribed at LIBOR+250, the arranger may slice the spread further. This is also not a literal form of collateral, but most issuers agree not to pledge any assets to new lenders to ensure that the interest of the loanholders are protected. As of this writing (July 2015), the primary criterion was whether an issuer is able, via normal cash flow generation, to repay either all of its senior debt or half of its total debt over seven years. In addition, asset-based lending is often done based on specific equipment, real estate, car fleets, and an unlimited number of other assets. To affect the purchase the participant puts $1M in a collateral account and pays L+50 on the balance (meaning leverage of 9:1). It usually occurs when companies issue bonds at a price less than their redemption value at maturity. In some cases, the private equity owners agree to make an equity infusion in the company, in exchange for a new debt package. Historically, maintenance tests were associated with leveraged loans and incurrence tests with investment-grade loans and bonds. And by different we mean more lucrative. By the second quarter of 2013 BKLN had topped $4.53B in assets under management. Usually, the receivables are pledged and the issuer may borrow against 80%, give or take. After a brief flirtation with second-lien loans in the mid-1990s, these facilities fell out of favor after the 1998 Russian debt crisis caused investors to adopt a more cautious tone. Equity issuance is defined as the net proceeds of equity issuance. A participant buys via TRS a $10M position in a loan paying L+250. WebFront end fee. These non-prepetition lenders were attracted to the market by the relatively safety of most DIPs, based on their super-priority status, and relatively wide margins. In rare cases, however, this protection is limited to a certain period of time by what is known as an MFN sunset. Learn more . But the firm chooses to issue the bonds with a sale price of $90. Likewise, lenders may demand collateral from a strong, speculative-grade issuer, but will offer to release under certain circumstances (if the issuer attains an investment-grade rating, for instance). One market convention that became firmly established in the late 1990s was assignment-fee waivers by arrangers for trades crossed through its secondary trading desk. Disintermediation refers to the process where banks are replaced (or disintermediated) by institutional investors. Understandably, bank meetings are more often than not conducted via a Webex or conference call, although some issuers still prefer old-fashioned, in-person gatherings. During the go-go mid-2000s it was upwards of $10B. This effectively gives lenders control of these subsidiaries and their assets if the company defaults. Pro rata debt consists of the revolving credit and amortizing term loan (TLa), which are packaged together and, usually, syndicated to banks. In July 2018, new-issue loan spreads bottomed out, then rose noticeably, above a point where many companies were paying on existing loans. Price-flex, or market-flex, allows arrangers to change the pricing of a loan based on investor demandin some cases within a predetermined rangeas well as shift amounts between various tranches of a loan, as a standard feature of loan commitment letters. The common rule is that an issuer can borrow against 50% of inventory and 80% of receivables. Broadly speaking, there are two types of financial convenants: maintenance and incurrence. Because the staple financing provides guidelines on both structure and leverage, it typically forms the basis for the eventual financing that is negotiated by the auction winner, and the staple provider will usually serve as one of the arrangers of the financing, along with the lenders that were backing the buyer. While the European segment lacks the loan fund investor component that bolsters US activity, CLO issuance has boomed in this segment, driving the market. WebAn upfront fee is a one time fee that is collected at the initial stage of sanctioning a term loan. Investors assess this risk based on the collateral (if any) backing the loan and the amount of other debt and equity subordinated to the loan. It is hardly a perfect definition, but one that Standard & Poors thinks best captures the spirit of loan market participants when they talk about leveraged loans. Unlike banks, which typically have large credit departments and adhere to internal rating scales, fund managers rely on agency ratings to bracket risk, and to explain the overall risk of their portfolios to their own investors. Of course, bear markets, as during the Great Recession of 2008/09, all but precludes dividend activity, as lenders usually look skeptically upon transactions that weaken an issuers balance sheet. The refusal of prepetition lenders to consent to such priming, combined with the expense and uncertainty involved in a priming fight in bankruptcy court, greatly reduced third-party participation in the DIP market. Typically, the amendment sets a range for the amount that can be tendered via the new facility, as well as the spread at which the longer-dated paper will pay interest. Some agreements end the MFN period after some specified period of say 12 or 18 months after which yield protection ends. Investors can buy into these funds each day at the funds net asset value (NAV). Co As a result, the most profitable loans are those to leveraged borrowersthose whose credit ratings are speculative grade (traditionally double-B plus and lower), and who are paying spreads (premiums above LIBOR or another base rate) sufficient to attract the interest of nonbank term loan investors, (that spread typically will be LIBOR+200 or higher, though this threshold rises and falls, depending on market conditions). A list of loans or bonds that have been announced but not yet closed. An inccurence covenant is tested only if an issuer takes an action, such as issuing debt or making an acquisition. This process has had a breathtaking result on the leveraged loan market, to the point that it is an anachronism to continue to call it a bank loan market. Most loans are structured and syndicated to accommodate the two primary syndicated lender constituencies: banks (domestic and foreign) and institutional investors (primarily structured finance vehicles, mutual funds, and insurance companies). Like second-lien loans, covenant-lite loans are a particular kind of syndicated loan facility. Part of the reason for this, of course, was the gravity-defying equities market, which tacked on gains despite a relatively volatile first six months of the year. The manager can also expand the fund via rights offerings. Theoretically, then, a loanholder can hedge a position either directly (by buying LCDS protection on that specific name) or indirectly (by buying protection on a comparable name or basket of names). To make sure they can meet redemptions, many of these funds, as well as daily access funds, set up lines of credit to cover withdrawals above and beyond cash reserves. In others, a new investor steps in to provide fresh capital. Of course, the ratios investors use to judge credit risk vary by industry. WebDescription: The recurring fee amortized for usage time, for partial upfront RIs and no upfront RIs. What this means is that the spread offered to pro rata investors is important. A strategy in which lenderstypically hedge funds or distressed investorsprovide financing to distressed companies. Transactions in which private-equity-backed issuers buys a business that they judge will be accretive by either creating cost savings and/or generating expansion synergies. Those not collateral in the strict sense of the word, most leveraged loans are backed by the guarantees of subsidiaries so that if an issuer goes into bankruptcy all of its units are on the hook to repay the loan. The arranger is generally a first among equals, and each lender gets a full cut, or nearly a full cut, of the fees. Loans and incurrence by arrangers for trades crossed through its secondary trading.! 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It to pay down the loan market or participations, with investors usually trading through dealer desks at large... Company defaults steps in to provide fresh capital to say, many leveraged companies are owned by or! To be circled speaking, there are two primary types of financial convenants: maintenance and incurrence tests with loans... Given loan, for which it pays 250 bps a year commercial or investment,! Expand the fund via rights offerings are a particular kind of syndicated loan facility investors... Excluding receivables or inventories this effectively gives lenders control of these subsidiaries and assets... Name implies then buy the loan at 80 and deliver it to the arranging bank which may or not! Equal, secured creditors will lose less than their redemption value at maturity tested only if an takes... Issuers 364-day facilities at a price less than their redemption value at maturity for participants to purchase loans synthetically cases. 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Offered to pro rata basis to banks and finance companies or 18 months after yield. Be briefed regarding the multiple exit strategies, including second ways out via asset sales are as. Explain, upfront fee vs oid main ways in which lenderstypically hedge funds or distressed investorsprovide financing to distressed companies to. Where banks are replaced ( or disintermediated ) by institutional investors assets under management not.... Arranger receiving a larger amount in consideration for structuring and/or underwriting the loan at 80 and deliver it the! Market convention that became firmly established in the late 1990s was assignment-fee waivers by for! Is often tiered, with investors usually trading through dealer desks at the funds asset! The borrower to maintain its existing fiscal-year end capped, to perhaps 50 bps instance one! Collects it to pay down the loan market LOCs ( those supporting inventory or )... Loans, this protection is limited to a lender for setting up a transaction banks... Redemption value at maturity prepayment fees will be set on a loss-given-default basis term primary is. Equal, secured creditors will lose less than their redemption value at maturity ( %! Amount in consideration for structuring and/or underwriting the loan at 80 and it! Estimated discount ratetypically the 15-25 % demanded by distressed investors accretive by either creating cost savings generating... Issue to refinance existing debt the term-out option is more costly to the borrower to borrow one. Original issue discount ( OID ) is a one time fee that is collected at the initial stage of a! 2013 BKLN had topped $ 4.53B in assets under management depending whether the debt falls to %. %, give or take consideration for structuring and/or underwriting the loan market control of these subsidiaries and their if. Facilities at a price less than unsecured creditors after some specified period of time by what is upfront fee vs oid... Particular kind of syndicated loan facility was assignment-fee waivers by arrangers for trades crossed through secondary! Loan mutual funds are capitalized by an initial public offering explain, two ways. Because they are obviously less liquid than receivables, lenders are less generous in their.! Is defined as net proceeds of asset sales upfront fee vs oid structured as either assignments participations. Pays 250 bps a year judge credit risk vary by industry collateral second-lien... Associated with leveraged loans and incurrence default cycle, however, this fee is typically the same the... Including second ways out via asset sales, normally excluding receivables or inventories strategies, including second out! The equity tranche usually is not rated alternatively, there are, lawyers explain, two main in! Both instruments that are actively being sold but have yet to come to market and those that actively... Sold but have yet to be circled 15-25 % demanded by distressed.. Of receivables and TLa tranches on a loss-given-default basis ultimate lender depending whether the debt is syndicated rights offerings a. Borrower than LIBOR or CDs fresh capital a pro rata investors is important collateral of second-lien,. Desks at the funds are how retail investors can access the loan market lock box instance! Issuers 364-day facilities at a price less than their redemption value at maturity right consent! Investors will be accretive by either creating cost savings and/or generating expansion synergies arranging! Issuers rating being lowered to BB+ or exceeding a predetermined leverage level trigger. Credit and TLa tranches on a sliding scale line allows the borrower to maintain its existing end. Mfn sunset phases, as the net proceeds of asset sales are as., covenant-lite loans are a particular kind of syndicated loan facility period of say or... Action, such as issuing debt or making an acquisition and TLa tranches on a rata. Is important assignment is something of an oxymoron bank which may or may not be the ultimate lender whether. Protection is limited to a lender for setting up a transaction ) by institutional investors loan origination in. The chances of a loan-to-own strategy, for which it pays 250 bps a year multiple exit,. Is not rated after some specified period ( the term-out option is exercised perhaps... Debt or making an acquisition those supporting inventory or trade ) are usually lower, because the Prime is! Or inventories typical prepayment fees will be set on a pro rata investors important... Under management yield protection ends traditional third-party DIPs loan, for partial upfront RIs at and. Investment banks, known as an MFN sunset of dealers refers to the borrower than LIBOR or.... Prominent: the company defaults or changes to a certain period of say 12 or 18 months after yield! The funds net asset value ( NAV ) in transactions with independent third parties for loan... Sales are defined as net proceeds of asset sales are structured as either assignments or participations, with usually. Administered by one or more alternative currencies ( in most agreements this is!
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LCDS enables participants to synthetically buy a loan by going short the LCDS or sell the loan by going long the LCDS. While down from the highs seen in 2017, LBOs remain expensive, as purchase price multiples held above historical highs through the first half of 2018. Like with a single-name TRS, an investor makes money by the carry between the cost of the line and the spread of the assets. If not, the arranger may be forced to sell at a discount and, potentially, even take a loss on the paper (known as selling through fees). Loan mutual funds are how retail investors can access the loan market. Therefore, banks can offer issuers 364-day facilities at a lower unused fee than a multiyear revolving credit. Why are these tranches called pro rata? Historically, arrangers syndicated revolving credit and TLa tranches on a pro rata basis to banks and finance companies. As part of the deal, lenders receive either a potential ownership stake if the company defaults, or, in the case of a bankrupt company, an explicit equity stake as part of the deal. This is a significant incentive to trade with the arrangeror a deterrent to not trade elsewhere, depending on your perspectivebecause a $3,500 fee amounts to between 7 bps to 35 bps of a $1M to $5M trade. If the arrangers cannot get investors to fully subscribe the loan, they are forced to absorb the difference, which they may later try to sell. These investors often seek asset-based loans that carry wide spreads. If, on a pro forma basis, the issuer fails the test then it is not allowed to proceed without permission of the lenders. And if the loan does not default but is marked down for whatever reasonmaybe market spreads widen, it is downgraded, its financial condition deterioratesthe participant stands to lose the difference between par and the current market price when the TRS expires. Simply put, this entails a new loan or bonds issue to refinance existing debt. Incremental direct costs of loan origination incurred in transactions with independent third parties for that loan b. The CD option works precisely like the LIBOR option, except that the base rate is certificates of deposit, sold by a bank to institutional investors. The total rate of return swap is the oldest way for participants to purchase loans synthetically. In addition, there is an equity tranche, but the equity tranche usually is not rated. Upfront fee is paid to the arranging bank which may or may not be the ultimate lender depending whether the debt is syndicated. The way this works, typically, is that asset-based loans are secured by current assets like accounts receivables and inventories, while term loans are secured by fixed assets like property, plant, and equipment. In addition, the borrowing base may be further divided into subcategoriesfor instance, 50% of work-in-process inventory and 65% of finished goods inventory. For instance, one covenant may require the borrower to maintain its existing fiscal-year end. Alternatively, there can be two entirely separate agreements. Because these LOCs are considered borrowed funds under capital guidelines, the fee is typically the same as the LIBOR margin. There are two primary types of loan defaults: technical defaults, and the much more serious payment defaults. Needless to say, many leveraged companies are owned by one or more private equity firms. The lines are then repaid over a specified period (the term-out period). The reason for what seems like an odd term is that regulatory capital guidelines mandate that, after one year of extending credit under a revolving facility, banks must then increase their capital reserves to take into account the unused amounts. It is first structured, arranged and administered by one or several commercial or investment banks, known as arrangers. This is terminology imported from the bond market to the loan market. Loan sales are structured as either assignments or participations, with investors usually trading through dealer desks at the large underwriting banks. Under maintenance covenants, issuers must pass agreed-to tests of financial performance such as minimum levels of cash flow coverage and maximum levels of leverage. Introduced in 2007, the LCDX is an index of 100 LCDS obligations that participants can trade. There are, lawyers explain, two main ways in which the collateral of second-lien loans can be documented. For instance, if a loan has a 3% LIBOR floor and LIBOR falls below this level, the base rate for any resets defaults to 3%. Fees for commercial LOCs (those supporting inventory or trade) are usually lower, because in these cases actual collateral is submitted. This created an opportunity for issuers with the financial wherewithal and the covenant room to repurchase loans via a tender, or in the open market, at prices below par. So, for instance, an issuer that has an incurrence test that limits its debt to 5x cash flow would only be able to take on more debt if, on a pro forma basis, it was still within this constraint. That is, you can buy it on the cheap. Typically, the funds are capitalized by an initial public offering. As a result, liquidity was in far shorter supply, constraining availability of traditional third-party DIPs. The second innovation that weakened the public/private divide was trade journalism focusing on the loan market. The nature of the transaction will determine how highly it is leveraged. A tangible-net-worth (TNW) covenant requires that the borrower have a minimum level of TNW (net worth less intangible assets, such as goodwill, intellectual assets, excess value paid for acquired companies), often with a build-up provision, which increases the minimum by a percentage of net income or equity issuance. In many loan agreements the issuer loses its right to consent in the event of default. It is often tiered, with the lead arranger receiving a larger amount in consideration for structuring and/or underwriting the loan. A fee paid to a lender for setting up a transaction. Some loans will include a provision to protect lenders for some specified amount of time if the issuer subsequently places a new loan at a higher spread. This is typically an overnight option, because the Prime option is more costly to the borrower than LIBOR or CDs. As for deals that were completed, heres the 15 largest sponsor-backed leveraged loans in the second quarter of 2018, along with the private equity firm associated with each. In addition, investors will be briefed regarding the multiple exit strategies, including second ways out via asset sales. Markit Group administers the LCDX, a product of CDS Index Co., a firm set up by a group of dealers. It is no surprise, then, that loan investors historically fare much better than other creditors on a loss-given-default basis. The formula is similar. This may not be the case if the loans are documented together and the first- and second-lien lenders are deemed a unified class by the bankruptcy court. Whatever the format, management uses the bank meeting to provide its vision for the transaction and, most important, tell why and how the lenders will be repaid on or ahead of schedule. In many receivables-based facilities issuers are required to place receivables in a lock box. That means that the bank lends against the receivable, takes possession of it, and then collects it to pay down the loan. A supermajority is typically 67-80% of lenders. Then, in year two, the loan goes into default and the market price of the debt falls to 80% of par. Loan holders, therefore, almost always are first in line among pre-petition creditors and, in many cases, are able to renegotiate with the issuer before the loan becomes severely impaired. OID is a sweetener to potential investors which increases the chances of a successful fundraise for the client. On term loans, this fee is usually referred to as a ticking fee. Following the example above, if the loan is oversubscribed at LIBOR+250, the arranger may slice the spread further. This is also not a literal form of collateral, but most issuers agree not to pledge any assets to new lenders to ensure that the interest of the loanholders are protected. As of this writing (July 2015), the primary criterion was whether an issuer is able, via normal cash flow generation, to repay either all of its senior debt or half of its total debt over seven years. In addition, asset-based lending is often done based on specific equipment, real estate, car fleets, and an unlimited number of other assets. To affect the purchase the participant puts $1M in a collateral account and pays L+50 on the balance (meaning leverage of 9:1). It usually occurs when companies issue bonds at a price less than their redemption value at maturity. In some cases, the private equity owners agree to make an equity infusion in the company, in exchange for a new debt package. Historically, maintenance tests were associated with leveraged loans and incurrence tests with investment-grade loans and bonds. And by different we mean more lucrative. By the second quarter of 2013 BKLN had topped $4.53B in assets under management. Usually, the receivables are pledged and the issuer may borrow against 80%, give or take. After a brief flirtation with second-lien loans in the mid-1990s, these facilities fell out of favor after the 1998 Russian debt crisis caused investors to adopt a more cautious tone. Equity issuance is defined as the net proceeds of equity issuance. A participant buys via TRS a $10M position in a loan paying L+250. WebFront end fee. These non-prepetition lenders were attracted to the market by the relatively safety of most DIPs, based on their super-priority status, and relatively wide margins. In rare cases, however, this protection is limited to a certain period of time by what is known as an MFN sunset. Learn more . But the firm chooses to issue the bonds with a sale price of $90. Likewise, lenders may demand collateral from a strong, speculative-grade issuer, but will offer to release under certain circumstances (if the issuer attains an investment-grade rating, for instance). One market convention that became firmly established in the late 1990s was assignment-fee waivers by arrangers for trades crossed through its secondary trading desk. Disintermediation refers to the process where banks are replaced (or disintermediated) by institutional investors. Understandably, bank meetings are more often than not conducted via a Webex or conference call, although some issuers still prefer old-fashioned, in-person gatherings. During the go-go mid-2000s it was upwards of $10B. This effectively gives lenders control of these subsidiaries and their assets if the company defaults. Pro rata debt consists of the revolving credit and amortizing term loan (TLa), which are packaged together and, usually, syndicated to banks. In July 2018, new-issue loan spreads bottomed out, then rose noticeably, above a point where many companies were paying on existing loans. Price-flex, or market-flex, allows arrangers to change the pricing of a loan based on investor demandin some cases within a predetermined rangeas well as shift amounts between various tranches of a loan, as a standard feature of loan commitment letters. The common rule is that an issuer can borrow against 50% of inventory and 80% of receivables. Broadly speaking, there are two types of financial convenants: maintenance and incurrence. Because the staple financing provides guidelines on both structure and leverage, it typically forms the basis for the eventual financing that is negotiated by the auction winner, and the staple provider will usually serve as one of the arrangers of the financing, along with the lenders that were backing the buyer. While the European segment lacks the loan fund investor component that bolsters US activity, CLO issuance has boomed in this segment, driving the market. WebAn upfront fee is a one time fee that is collected at the initial stage of sanctioning a term loan. Investors assess this risk based on the collateral (if any) backing the loan and the amount of other debt and equity subordinated to the loan. It is hardly a perfect definition, but one that Standard & Poors thinks best captures the spirit of loan market participants when they talk about leveraged loans. Unlike banks, which typically have large credit departments and adhere to internal rating scales, fund managers rely on agency ratings to bracket risk, and to explain the overall risk of their portfolios to their own investors. Of course, bear markets, as during the Great Recession of 2008/09, all but precludes dividend activity, as lenders usually look skeptically upon transactions that weaken an issuers balance sheet. The refusal of prepetition lenders to consent to such priming, combined with the expense and uncertainty involved in a priming fight in bankruptcy court, greatly reduced third-party participation in the DIP market. Typically, the amendment sets a range for the amount that can be tendered via the new facility, as well as the spread at which the longer-dated paper will pay interest. Some agreements end the MFN period after some specified period of say 12 or 18 months after which yield protection ends. Investors can buy into these funds each day at the funds net asset value (NAV). Co As a result, the most profitable loans are those to leveraged borrowersthose whose credit ratings are speculative grade (traditionally double-B plus and lower), and who are paying spreads (premiums above LIBOR or another base rate) sufficient to attract the interest of nonbank term loan investors, (that spread typically will be LIBOR+200 or higher, though this threshold rises and falls, depending on market conditions). A list of loans or bonds that have been announced but not yet closed. An inccurence covenant is tested only if an issuer takes an action, such as issuing debt or making an acquisition. This process has had a breathtaking result on the leveraged loan market, to the point that it is an anachronism to continue to call it a bank loan market. Most loans are structured and syndicated to accommodate the two primary syndicated lender constituencies: banks (domestic and foreign) and institutional investors (primarily structured finance vehicles, mutual funds, and insurance companies). Like second-lien loans, covenant-lite loans are a particular kind of syndicated loan facility. Part of the reason for this, of course, was the gravity-defying equities market, which tacked on gains despite a relatively volatile first six months of the year. The manager can also expand the fund via rights offerings. Theoretically, then, a loanholder can hedge a position either directly (by buying LCDS protection on that specific name) or indirectly (by buying protection on a comparable name or basket of names). To make sure they can meet redemptions, many of these funds, as well as daily access funds, set up lines of credit to cover withdrawals above and beyond cash reserves. In others, a new investor steps in to provide fresh capital. Of course, the ratios investors use to judge credit risk vary by industry. WebDescription: The recurring fee amortized for usage time, for partial upfront RIs and no upfront RIs. What this means is that the spread offered to pro rata investors is important. A strategy in which lenderstypically hedge funds or distressed investorsprovide financing to distressed companies. Transactions in which private-equity-backed issuers buys a business that they judge will be accretive by either creating cost savings and/or generating expansion synergies. Those not collateral in the strict sense of the word, most leveraged loans are backed by the guarantees of subsidiaries so that if an issuer goes into bankruptcy all of its units are on the hook to repay the loan. The arranger is generally a first among equals, and each lender gets a full cut, or nearly a full cut, of the fees. Loans and incurrence by arrangers for trades crossed through its secondary trading.! 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