This is often the case, too, for unsecured investment-grade loans. The flat fee is paid regardless of the lenders final allocation. Where an instrument ranks in priority of payment is referred to as seniority. Loan agreements have a series of restrictions that dictate, to varying degrees, how borrowers can operate and carry themselves financially. Relative value is a way of uncovering undervalued, or overvalued, assets. In a syndicated loan, a lender generally receives an upfront fee based on the lender's If the issuer defaults and the value of the loan goes to 70 cents on the dollar the participant will lose $3M. More recently, the evolution of covenant-lite loans (see above) has blurred the line. Until 1998, this would have been all there is to it. As their name implies, the claims on collateral of second-lien loans are junior to those of first-lien loans. Original Issue Discount (OID) = $1 million In the end, the issuer is left with two tranches: (1) the legacy paper at the initial spread and maturity and (2) the new longer-dated facility at a wider spread. Like second-lien loans, covenant-lite loans are a particular kind of syndicated loan facility. Arrangers tap nontraditional accountshedge funds, distressed investors, and high-yield accountsas well as traditional CLO and prime fund accounts to finance second-lien loans. For both investment-grade and leveraged issuers, an event of default in a credit agreement will be triggered by a merger, an acquisition of the issuer, some substantial purchase of the issuers equity by a third party, or a change in the majority of the board of directors. If not, it would have breached the covenant and be in technical default on the loan. It is based on the issuers financial condition, industry segment, and conditions in that industry, as well as economic variables and intangibles, such as company management. Leveraged loan repricings are just that: An issuer approaches institutional investors, via an arranger, to lower the interest rate on an existing credit, as opposed to refinancing an existing deal, which requires a more formal syndications process, and documentation (that being said a small portion of repricings are completed for a resyndication process). An issuer listsor, in the case of a P2P LBO, relistson an exchange. Thats the most extreme measure. Technical defaults occur when the issuer violates a provision of the loan agreement. In exchange the bondholders might receive stepped-up treatment, going from subordinated to senior, say, or from unsecured to second-lien. These deals support working capital, general operations and other business-as-usual purposes. The market is roughly divided into two segments: Default risk, of course, varies widely within each of these broad segments. 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. Financial covenants enforce minimum financial performance measures against the borrower, such: The company must maintain a higher level of current assets than of current liabilities. Just what qualifies as a leveraged loan is a discussion of long standing. By 2007 the market had accepted second-lien loans to finance a wide array of transactions, including acquisitions and recapitalizations. If it does not the judge may choose to not pay adequate protection or to divide it pro rata among the first- and second-lien creditors. Most often, bifurcated collateral refers to cases where the issuer divides collateral pledge between asset-based loans and funded term loans. An evergreen is an option for the borrowerwith consent of the syndicate groupto extend the facility each year, for an additional year. 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. Before formally offering a loan to these retail accounts, arrangers will often read the market by informally polling select investors to gauge appetite for the credit. In this case, the spread adjusts based on one or more financial criteria. An amend-to-extend transaction allows an issuer to push out part of its loan maturities through an amendment, rather than a full-out refinancing. Finally, the reputation of the private equity backer (sponsor) also plays a role, as does market liquidity (the amount of institutional investor cash available). For instance: 2% in year one and 1% in year two. Non-core acquisitions, in which a corporate issuer sells a division to a private equity firm. Borrowings cannot be prepaid without penalty. Typically, the loans are prenegotiated, and are part of the companys reorganization plan. Pricing a loan requires arrangers to evaluate the risk inherent in a loan and to gauge investor appetite for that risk. All of these, together, tell a story about the deal. However, because they are obviously less liquid than receivables, lenders are less generous in their formula. What is a leveraged loan? Repaid amounts may not be reborrowed. Of course, repricing a loan is attractive to an issuer only when new-issue loans spreads are lower than what an issuer is paying on existing debt. These firms take only public IMs and public materials and, therefore, retain the option to trade in the public securities markets even when an issuer for which they own a loan is involved. In some cases, they support acquisitions. An original issue discount (OID) is a type of debt instrument. An original issue discount (OID) is a debt instrument with a sale price thats lower than its face value at the time of the original issue. The arranger is generally a first among equals, and each lender gets a full cut, or nearly a full cut, of the fees. The level that a dealer agrees to essentially underwrite a BWIC or an auction. Investment-grade loans are, in most cases, senior unsecured instruments with loosely drawn covenants that apply only at incurrence. Inventories are also often pledged to secure borrowings. Why would institutional investors agree to what amounts to a money-losing enterprise? As this phrase implies, the price or spread at which a deal clears the primary market. Again, the claims on collateral of second-lien loans are junior to those of first-lien loans. Stock repurchase. At Standard & Poors LCD we have developed a more complex definition. They also include the ratio of senior secured loan to junior debt in the capital structure. Loans, by their nature, are flexible documents that can be revised and amended from time to time. The upfront fee is generally a portion of the total fee that the buyer must pay. 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. The dealer will then collate the bids and award each facility to the highest bidder. There may also be a fee paid to the sponsor. Some participants use a spread cut-off: i.e., any loan with a spread of LIBOR+ 125 or LIBOR+150 or higher qualifies. Conversely, referring to something as cheap means that it is trading at a spread that is high compared with its peer group. A prepayment fee is a feature generally associated with institutional term loans. All rights reserved. A commitment fee is a fee paid to lenders on undrawn amounts under a revolving credit or a term loan prior to draw-down. For leveraged loans, banks typically provide unfunded revolving credits, letters of credit (LOCs) and less and less, these days amortizing term loans, under a syndicated loan agreement. As of mid-2011 these included issuers with a European or even a Midwestern US angle. Leveraged loans are typically senior, secured instruments and rank highest in the capital structure. In these casesthis happened on a few occasions to lenders to retail companies in the early 1990sloan holders become unsecured lenders of the company and are put back on the same level with other senior unsecured creditors. For the most part, issuers undertake leveraged loans for four reasons: M&A is the lifeblood of leveraged finance. The balance sheet presentation of transaction costs for US GAAP is generally aligned to IFRS. An upfront fee may also be referred to by the parties as a closing fee, participation fee, or simply as OID. Typically, there is an advisory fee measured as a percentage of the transaction size, a financing fee associated with each tranche of debt calculated as a percentage of principal, and miscellaneous expenses of a fixed nature, such as legal and accounting fees. Conversely, if you bought the same loan at 99, the spread-to-expected life would be LIBOR+279. Morningstar Institutional Equity Research, How strong market conditions are at the time, To back a recapitalzation of a companys balance sheet, To fund general corporate purposes or project finance. Redemptions, however, are made via monthly or quarterly tenders, rather than each day, as with the open-end funds described above. Standard & Poors defines a default for the purposes of calculating default rates as a loan that is either (1) rated D by Standard & Poors, (2) to an issuer that has filed for bankruptcy, or (3) in payment default on interest or principal. Naturally, issuers with European operations can better tap banks in their home markets (banks still provide the lions share of loans in Europe) and, for Midwestern issuers, the heartland remains one of the few US regions with a deep bench of local banks. In others the company is bought outright, Sponsor-to-sponsor (S2S) deals, where one private equity firm sells a portfolio property to another. The loan market can be roughly divided into two segments: large corporate and middle market. If the loan were undersubscribedif investor interest in the loan was less than the amount arrangers were looking to syndicatethe arrangers could very well be left above their desired hold level. Over time, however, market-flex became a tool either to increase or decrease pricing of a loan, based on investor demand. In July 2018, new-issue loan spreads bottomed out, then rose noticeably, above a point where many companies were paying on existing loans. Still dont understand? These vehicles, for a variety of reasons, suffer tax consequence from buying loans in the primary. 
Among banks, investment factors may include whether the bank is party to the sponsors equity fund. The nature of the transaction will determine how highly it is leveraged. Calculating loss given default is tricky business. Leveraged (borrowers rated BB+ or lower). Standard & Poors defines a default for the purposes of calculating default rates as a loan that is either (1) rated D by Standard & Poors, (2) to an issuer that has filed for bankruptcy, or (3) in payment default on interest or principal. or one-on-one meetings with potential investors.). Indeed, banks often invest in loans for more than just spread income. This limits borrowings to a certain percentage of specified collateral, most often receivables and inventory (see Asset-based loan section below for a full discussion of this topic). The dealer will then put out a BWIC, asking potential buyers to submit for individual names or the entire portfolio. The spread is typically expressed in basis points. A club deal is a smaller loan (usually $25M to $100M, but as high as $150M) that is pre-marketed to a group of relationship lenders. If there are many dollars chasing little product then, naturally, issuers will be able to command lower spreads. Public-to-private (P2P)also called go-private dealsin which the private equity firm purchases a publicly traded company via a tender offer. The syndication agent is the bank that handles, in purest form, the syndication of the loan. These investors often seek asset-based loans that carry wide spreads. This was a way to encourage investors to trade with the arranger rather than with another dealer. The seller is paid a spread in exchange for agreeing to buy at par, or a pre-negotiated price, a loan if that loan defaults. WebAn upfront fee is distinguished from a commitment fee and the interest rate paid on the loan. So, why do arrangers underwrite loans? Incurrence covenants generally require that if an issuer takes an action (paying a dividend, making an acquisition, issuing more debt), it would need to still be in compliance. A supermajority is typically 67-80% of lenders. Underwritten loans usually require more lucrative fees because the agent is on the hook if potential lenders balk. Roll-up DIPs. Suppose a corporation were to issue bonds with a face value of $100. 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. It applies to primary commitments made by offshore accounts (principally CLOs and hedge funds). The arranger will prepare an information memo (IM) describing the terms of the transactions. For instance, a leverage test may say that an issuer cannot take on new debt if, on a pro forma basis, total debt to EBITDA would be 4x or morebut the test only kicks in once the issuer incurs more than, say, $100M of new debt. The most common type of asset-based loans are receivables and/or inventory lines. Often, repayments from excess cash flow and equity issuance are waived if the issuer meets a preset financial hurdle, most often structured as a debt/EBITDA test. Descriptions of the major risk factors follow. 
Underwriters. Two main reasons: Offering an underwritten loan can be a competitive tool to win mandates. 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. Beginning in 2000 the SEC directed bank loan mutual fund managers to use available price data (bid/ask levels reported by dealer desks and compiled by mark-to-market services), rather than fair value (estimates based on whether the loan is likely to repay lenders in whole or part), to determine the value of broadly syndicated loan portfolios. To contend with this issue the account could either designate one person who is on the private side of the wall to sign off on amendments or empower its trustee, or the loan arranger to do so. At the most basic level, covenant-lite loans are loans that have bond-like financial incurrence covenants, rather than traditional maintenance covenants that are normally part and parcel of a loan agreement. These tranches include first- and second-lien loans, as well as pre-funded letters of credit. An RC acts much like a corporate credit card, except that borrowers are charged an annual fee on unused amounts (a facility fee). These deals often require time-intensive collateral monitoring. A revolving credit line allows borrowers to draw down, repay, and reborrow. With liquidity in short supply, new innovations in DIP lending cropped up aimed at bringing nontraditional lenders into the market. Win whats next. Default risk will, in most cases, be most visibly expressed by a public rating from Standard & Poors Ratings Services or another ratings agency. The first is an amendment in which at least 50.1% of the bank group approves the issuers ability to roll some or all existing loans into longer-dated paper. The thresholds range widely. In the old days, a bright red line separated public and private information in the loan market. In a single security agreement second-lien lenders are in the same creditor class as first-lien lenders from the standpoint of a bankruptcy, according to lawyers who specialize in these loans. Loan defaults in the US continue to hold below historical norms. A coverage covenant requires the borrower to maintain a minimum level of cash flow or earnings, relative to specified expenses, most often interest, debt service (interest and repayments), and fixed charges (debt service, capital expenditures, and/or rent). As well, any price appreciation bolsters the returns. As the IM is being prepared the syndicate desk will solicit informal feedback from potential investors regarding potential appetite for the deal, and at what price they are willing to invest. The index provides a straightforward way for participants to take long or short positions on a broad basket of loans, as well as hedge exposure to the market. In simple terms, under a TRS program a participant buys from a counterparty, usually a dealer, the income stream created by a reference asset (in this case a syndicated loan). Lead manager and manager titles were doled out in exchange for large commitments. Under this definition, a loan rated BB+ that has a spread of LIBOR+75 would qualify, but a non-rated loan with the same spread would not. Leveraged loans can also be referred to as senior secured credits. Once relatively rare, covenant-lite has become the norm in both the US and European leveraged loan markets, thanks to sustained investor demand in the asset class. These vehicles allow managers greater flexibility than more tightly structured arbitrage deals. Co-underwriters will receive a lower fee, and then investors in the general syndicate will likely have fees tied to their commitment. The most commona fee for standby or financial LOCsguarantees that lenders will support various corporate activities. In many loan agreements the issuer loses its right to consent in the event of default. US loan investors found themselves sitting on a record pile of cash as the first half of 2018 came to close, as assets under management at US loan funds totaled a record $176B, according to LCD and Lipper. An inccurence covenant is tested only if an issuer takes an action, such as issuing debt or making an acquisition. Credit statistics are used by investors to help calibrate both default and loss-given-default risk. Second-lien loans also typically have less restrictive covenant packages, in which maintenance covenant levels are set wide of the first-lien loans. This is because they require an issuer to meet certain financial tests every quarter, whether or not it takes an action. Thats well above the 31% seen at the peak of the last credit cycle, in 2007, according to LCD. 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. A swingline is a small, overnight borrowing line, typically provided by the agent. OID is a sweetener to potential investors which increases the chances of a successful fundraise for the client. Webhonest; candid; straightforward: He's very up-front about discussing his past. When a loan or bond is fully subscribed at a given price it is said to be circled. The principal credit risk factors that banks and institutional investors contend with in buying loans. As part of such a deleveraging the company might revamp its loans or bonds at more favorable terms. The difference between these two amounts is the OID. In an assignment, the assignee becomes a direct signatory to the loan and receives interest and principal payments directly from the administrative agent. 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. Pro rata debt consists of the revolving credit and amortizing term loan (TLa), which are packaged together and, usually, syndicated to banks. Weba. Updated January 24, 2023 What is an Original Issue Discount (OID)? Banks that either underwrite or hold such loans could face penalties as a result. Running the books. Arrangers will distribute most IMsalong with other information related to the loan, pre- and post-closingto investors through digital platforms. Chief among them: How will these credits fare when the long-running default cycle finally turns, and loan defaults begin to mount? 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. Under the option, borrowers may take what is outstanding under the facility and pay it off according to a predetermined repayment schedule. The group receives the LOC fee on their respective shares while the fronting bank receives an issuing (or fronting, or facing) fee for issuing and administering the LOC. Others use a present value calculation using an estimated discount rate, typically 15-25%, demanded by distressed investors. Vendors of loan data, news, and prices also face many challenges in managing the flow of public and private information. The innovation here: amend-to-extend allows an issuer to term-out loans without actually refinancing into a new credit (which, obviously would require marking the entire loan to market, entailing higher spreads, a new OID, and stricter covenants). Of course, with flex-language now common, underwriting a deal does not carry the same risk it once did, when the pricing was set in stone prior to syndication. Voting to close for lack of prior research. Leveraged loans, in contrast, are usually senior secured instruments that, except for covenant-lite loans, have maintenance covenants that are measured at the end of each quarter, regardless of the issuer is in compliance with pre-set financial tests. Exchange-traded closed-end funds (ETF): These funds, which have skyrocketed in popularity over the past few years, trade on a stock exchange. Therefore, affixing a spread-to-maturity or a spread-to-worst on loans is little more than a theoretical calculation. 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 special-purpose vehicle is financed with several tranches of debt (typically a AAA rated tranche, a AA tranche, a BBB tranche, and a mezzanine tranche) that have rights to the collateral and payment stream, in descending order. The administrative agent is the bank that handles all interest and principal payments and monitors the loan. Rather, banks are driven by the overall profitability of the issuer relationship, including noncredit revenue sources. It is no surprise, then, that loan investors historically fare much better than other creditors on a loss-given-default basis. Either way, the deal strengthens the companys balance sheet. WebUpfront fees are the one-off fees paid by borrowers to mandated lead arrangers on the total commitment amount for arranging and originating the financing, structuring the syndicate, This stands for offers wanted in competition and is effectively a BWIC in reverse. This can refer to the relative return or spread between (1) various instruments of the same issuer, comparing for instance the loan spread with that of a bond; (2) loans or bonds of issuers that are similarly rated and/or in the same sector, comparing for instance the loan spread of one BB rated healthcare company with that of another; and (3) spreads between markets, comparing for instance the spread on offer in the loan market with that of high-yield or corporate bonds. These are called primary assignments and are effectively primary purchases. On the buyside there are firms that operate on either side of the public-private divide. These loans are secured by specific assets and usually are governed by a borrowing formula (or a borrowing base). Manufacturing firms need to make enough money, in aggregate, to cover initial research costs, but the marginal cost they charge only needs to 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 three primary types of loan covenants are affirmative, negative, and financial. Another example is the mortgage market where the primary capital providers have evolved from banks and savings and loan institutions to conduits structured by Fannie Mae, Freddie Mac, and the other mortgage securitization shops. 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. Consequently, traders, salespeople, and analysts do not receive private information even if somewhere else in the institution the private data are available. Hence, repricing activity completely vanished. The second innovation that weakened the public/private divide was trade journalism focusing on the loan market. Of course, the list of disintermediated markets is long and growing. For default rate by principal amount: the amount of loans that default over a 12-month period divided by the total amount outstanding at the beginning of the period. Moreover, some agreements test leverage on the basis of net debt (total less cash and equivalents) or senior debt. But now that institutional investors and banks put a premium on the ability to package loans and sell them, liquidity has become important. Once the loan is closed, the final terms are then documented in detailed credit and security agreements. This technique is used frequently in the bond market but rarely for first-lien loans. So, in the case above, had the 5x leverage maximum been a maintenance rather than incurrence test, the issuer would need to pass it each quarter, and would be in violation if either its earnings eroded or its debt level increased. This is the same technique that investment banks have used from time immemorial to separate their private investment banking activities from their public trading and sales activities. This second category can be divided into liquidity and market technicals (i.e., supply/demand). Since then, they have figured far less prominently into the loan landscape as investors across the capital markets shy away from leveraged, mark-to-market product. Another may prohibit it from taking on new debt. Investors, in times of inflows to market, are loath to sit on cash if theres actual return to be had. The co-agent or managing agent is largely a meaningless title used mostly as an award for large commitments. 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