Leverage loan program

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We generated a verification code for you. Consents, fees, or minimums are almost never required. The participant has the right to vote only on material changes in the loan document rate, term, and collateral. Non-material changes do not require approval of participants. A participation can be a riskier way of purchasing a loan because, if the lender becomes insolvent or defaults, the participant does not have a direct claim on the loan.

In this case the participant then becomes a creditor of the lender, and often must wait for claims to be sorted out to collect on its participation. Traditionally, accounts bought and sold loans in the cash market through assignments and participations. Aside from that, there was little synthetic activity outside over-the-counter total rate of return swaps.

By , however, the market for synthetically trading loans was budding. Loan credit default swaps LCDS are standard derivatives that have secured loans as reference instruments.

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. 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.

Moreover, unlike the cash markets, which are long-only markets for obvious reasons, the LCDS market provides a way for investors to short a loan. If the loan subsequently defaults, the buyer of protection should be able to purchase the loan in the secondary market at a discount and then deliver it at par to the counterparty from which it bought the LCDS contract. For instance, say an account buys five-year protection for a given loan, for which it pays bps a year.

The buyer of the protection can then buy the loan at 80 and deliver it to the counterparty at , a point pickup. Or instead of physical delivery, some buyers of protection may prefer a cash settlement in which the difference between the current market price and the delivery price is determined by polling dealers or using a third-party pricing service. 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.

The LCDX is reset every six months, with participants able to trade each vintage of the index that is still active. The index will be set at an initial spread, based on the reference instruments, and trade on a price basis. The total rate of return swap is the oldest way for participants to purchase loans synthetically.

In essence, a TRS allows an institution to by a loan on margin. 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. Then the participant receives the spread of the loan less the financial cost. If the reference loan defaults the participant is obligated to buy the facility at par or cash settle the position based on a mark-to-market price or an auction price.

Thus, the participant would receive:. Of course, this is not a risk-free proposition. And if the loan does not default, but is marked down for whatever reason — maybe market spreads widen, it is downgraded, its financial condition deteriorates — the participant stands to lose the difference between par and the current market price when the TRS expires.

Or, in an extreme case, the value declines below the value in the collateral account, and the participant is hit with a margin call. In addition to the type of single-name TRS, another way to invest in loans is via a TRS program in which a dealer provides financing for a portfolio of loans, rather than a single reference asset. The products are similar in that an investor would establish a collateral account equal to some percent of the overall TRS program and borrow the balance from a dealer.

The program typically requires managers to adhere to diversification guidelines as well as weighted average maturity maximums as well as weighted average rating minimums. 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. As well, any price appreciation bolsters the returns. As well, if collateral value declines below a predetermined level, the investor could face a margin call, or in the worst-case scenario, the TRS could be unwound.

TRS programs were widely used prior to the credit contraction. 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. Prominent fees associated with syndicated loans:. An upfront fee is a fee paid by the issuer at close. Co-underwriters will receive a lower fee, and then investors in the general syndicate will likely have fees tied to their commitment.

Sometimes upfront fees will be structured as a percentage of final allocation plus a flat fee. This happens most often for larger fee tiers, to encourage potential lenders to step up for larger commitments. Fees are usually paid to banks, mutual funds, and other non-offshore investors at close. A facility fee is often charged instead of a commitment fee on revolving credits to investment-grade borrowers, because these facilities typically have competitive bid options that allow a borrower to solicit the best bid from its syndicate group for a given borrowing.

The lenders that do not lend under the CBO are still paid for their commitment. Typical prepayment fees will be set on a sliding scale. An administrative agent fee is the annual fee paid to administer the loan including to distribute interest payments to the syndication group, to update lender lists, and to manage borrowings. For secured loans particularly those backed by receivables and inventory the agent often collects a collateral monitoring fee, to ensure that the promised collateral is in place.

The most common — a fee for standby or financial LOCs — guarantees that lenders will support various corporate activities. Fees for commercial LOCs those supporting inventory or trade are usually lower, because in these cases actual collateral is submitted.

The LOC is usually issued by a fronting bank usually the agent and syndicated to the lender group on a pro rata basis. 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.

This fee is almost always The original-issue discount OID , or the discount from par at which the loan is offered for sale to investors, is used in the new issue market as a spread enhancement. If a loan is issued at 99 cents on the dollar to pay par, the OID is said to be bps, or 1 point.

After all, in both cases the lender effectively pays less than par for a loan. From the perspective of the lender, actually, there is no practical difference. From an accounting perspective, an OID and a fee may be recognized, and potentially taxed, differently.

Amendments or changes to a loan agreement must be approved by a certain percentage of lenders. Most loan agreements have three levels of approval: required-lender level, full vote, and supermajority:. A full vote of all lenders, including participants, is required to approve material changes such as RATS rights rate, amortization, term, and security; or collateral , but as described below, there are occasions when changes in amortization and collateral may be approved by a lower percentage of lenders a supermajority.

It sometimes is required for certain material changes, such as changes in term loan repayments and release of collateral. Loan agreements have a series of restrictions that dictate, to varying degrees, how borrowers can operate and carry themselves financially.

For instance, one covenant may require the borrower to maintain its existing fiscal-year end. Another may prohibit it from taking on new debt. Most agreements have financial compliance covenants, stipulating perhaps 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. Agreements to investment-grade companies are usually thin and simple.

Agreements to leveraged borrowers are more restrictive. Affirmative covenants state what action the borrower must take to be in compliance with the loan. These covenants are usually boilerplate, and require a borrower to pay the bank interest and fees, for instance, or to provide audited financial statements, maintain insurance, pay taxes, and so forth.

Many negative covenants are structured with baskets that allow issuers flexibility to take certain actions — for example, to pay dividends or make acquisitions — as long as the amounts involved remain within a set range. In many cases, the agreement will provide initial capacity, known as a Starter Basket, as well as additional capacity based on a percent of free cash flow or net income, known as a Building Basket.

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.

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.

If an issuer fails to achieve these levels, lenders have the right to accelerate the loan. An inccurence covenant is tested only if an issuer takes an action, such as issuing debt or making an acquisition.

If, on a pro forma basis, the issuer fails the test then it is not allowed to proceed without permission of the lenders. Historically, maintenance tests were associated with leveraged loans and incurrence tests with investment-grade loans and bonds. More recently, the evolution of covenant-lite loans see above has blurred the line. In general, there are five types of financial covenants—coverage, leverage, current ratio, tangible net worth, and maximum capital expenditures:.

Leveraged loans usually require a borrower to prepay with proceeds of excess cash flow, asset sales, debt issuance, or equity issuance. In the leveraged market, collateral usually includes all the tangible and intangible assets of the borrower and, in some cases, specific assets that back a loan. Virtually all leveraged loans and some of the more shaky investment-grade credits are backed by pledges of collateral. In the asset-based market, for instance, that typically takes the form of inventories and receivables, with the maximum amount of the loan that the issuer may draw down capped by a formula based off of these assets.

There are loans backed by certain equipment, real estate, and other property as well. In the leveraged market there are some loans that are backed by capital stock of operating units. In this structure the assets of the issuer tend to be at the operating-company level and are unencumbered by liens, but the holding company pledges the stock of the operating companies to the lenders.

This effectively gives lenders control of these subsidiaries and their assets if the company defaults. The risk to lenders in this situation, simply put, is that a bankruptcy court collapses the holding company with the operating companies and effectively renders the stock worthless. In these cases — this happened on a few occasions to lenders to retail companies in the early s — loan holders become unsecured lenders of the company and are put back on the same level with other senior unsecured creditors.

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.

These provision allow issuers to fix a covenant violation — exceeding the maximum leverage test for instance — by making an equity contribution. These provisions are generally found in private equity backed deals. The equity cure is a right, not an obligation. Asset-based lending is a distinct segment of the loan market.

Inventories are also often pledged to secure borrowings. However, because they are obviously less liquid than receivables, lenders are less generous in their formula. In addition, asset-based lending is often done based on specific equipment, real estate, car fleets, and an unlimited number of other assets. Most often, bifurcated collateral refers to cases where the issuer divides collateral pledge between asset-based loans and funded term loans.

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.

Current assets are considered to be a superior form of collateral because they are more easily converted to cash. Unlike most bonds, which have long no-call periods and high-call premiums, most loans are prepayable at any time, typically without prepayment fees. Therefore, affixing a spread-to-maturity or a spread-to-worst on loans is little more than a theoretical calculation. 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.

Traders and investors will often speak of loan spreads, therefore, as a spread to a theoretical call. Loans, on average, now assume a three or four year average life. There are two primary types of loan defaults: technical defaults, and the much more serious payment defaults. Technical defaults occur when the issuer violates a provision of the loan agreement.

When this occurs, the lenders can accelerate the loan and force the issuer into bankruptcy. Payment defaults are a more serious matter. As the name implies, this type of default occurs when a company misses either an interest or principal payment. After that, the lenders can choose to either provide a forbearance agreement that gives the issuer some breathing room or take appropriate action, up to and including accelerating, or calling, the loan.

If the lenders accelerate, the company will generally declare bankruptcy and restructure debt via Chapter If the company is not worth saving, however, because its primary business has cratered, then the issuer and lenders may agree to a Chapter 7 liquidation, under which the assets of the business are sold and the proceeds dispensed to the creditors.

Debtor-in-possession DIP loans are made to bankrupt entities. These loans constitute super-priority claims in the bankruptcy distribution scheme, and thus sit ahead of all prepretition claims. Traditionally, prepetition lenders provided DIP loans as a way to keep a company viable during the bankruptcy process and therefore protect their claims.

In the early s a broad market for third-party DIP loans emerged. 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. This was the case again the early s default cycle.

In the late s default cycle, however, the landscape shifted because of more dire economic conditions. As a result, liquidity was in far shorter supply, constraining availability of traditional third-party DIPs. 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.

With liquidity in short supply, new innovations in DIP lending cropped up aimed at bringing nontraditional lenders into the market. These include:. Junior and roll-up DIPs are suited to challenging markets during which liquidity is scarce.

Sub-par loan buybacks are another technique that grew out of the bear market, that began in Performing paper fell to a price not seen before in the loan market — with many names trading south of 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.

Sub-par buybacks have deep roots in the bond market. In fact, most loan documents do not provide for a buyback. Instead, issuers typically need obtain lender approval via a This is a negotiated tender in which classholders will swap existing paper for a new series of bonds that typically have a lower principal amount and, often, a lower yield. In exchange the bondholders might receive stepped-up treatment, going from subordinated to senior, say, or from unsecured to second-lien.

This technique is used frequently in the bond market but rarely for first-lien loans. Loan defaults in the U. For default rate by number of loans: the number of loans that default over a given month period divided by the number of loans outstanding at the beginning of that period.

For default rate by principal amount: the amount of loans that default over a month period divided by the total amount outstanding at the beginning of the period.

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. Amend-to-extend transactions came into widespread use in as borrowers struggled to push out maturities in the face of difficult lending conditions that made refinancing prohibitively expensive. The first is an amendment in which at least 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.

The new debt is pari passu with the existing loan. But because it matures later and, thus, is structurally subordinated, it carries a higher rate and, in some cases, more attractive terms. Because issuers with big debt loads are expected to tackle debt maturities over time, amid varying market conditions, in some cases accounts insist on most-favored-nation protection. Under such protection the spread of the loan would increase if the issuer in question prints a loan at a wider margin. The second phase is the conversion, in which lenders can exchange existing loans for new loans.

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. 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.

Banks that either underwrite or hold such loans could face penalties as a result. As of this writing July , the primary criteria 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 to restrictions on arranging banks, CLO managers were to, beginning in , face risk-retention requirements under Section of Dodd-Frank. Under these rules, investment managers are required to retain no less than five percent of the credit risk of assets they securitized, except for pools of qualified mortgages. Axe sheets These are lists from dealers with indicative secondary bids and offers for loans.

Axes are simply price indications. Break prices Simply, the price at which loans or bonds are initially traded into the secondary market after they close and allocate. It is called the break price because that is where the facility breaks into the secondary market. Typically, an account will offer up a portfolio of facilities via a dealer. The dealer will then put out a BWIC, asking potential buyers to submit for individual names or the entire portfolio.

The dealer will then collate the bids and award each facility to the highest bidder. Circled When a loan or bond is fully subscribed at a given price it is said to be circled. After that, the loan or bond moves to allocation and funding. The dealer, to win the business, may give an account a cover bid, effectively putting a floor on the auction price.

Default rate This is calculated by either number of loans or principal amount. The formula is similar. Distressed loans In the loan market, loans traded at less than 80 cents on the dollar are usually considered distressed. In the bond market, the common definition is a spread of 1, bps or more. For loans, however, calculating spreads is an elusive art see above and therefore a more pedestrian price measure is used. Disintermediation Disintermediation refers to the process where banks are replaced or disintermediated by institutional investors.

This is the process that the loan market has been undergoing for the past 20 years. 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.

Of course, the list of disintermediated markets is long and growing. In addition to leveraged loans and mortgages, this list also includes auto loans and credit card receivables.

Forward calendar A list of loans or bonds that have been announced but not yet closed. These include both instruments that are yet to come to market and those that are actively being sold but have yet to be circled.

Leveraged loan Just what is a leveraged loan is a discussion of long standing. Some participants use a spread cut-off: i.

Others use rating criteria: i. But what of loans that are not rated? Loan-to-own A strategy in which lenders—typically hedge funds or distressed investors—provide financing to distressed 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.

Loss-given-default This is simply a measure of how much creditors lose when an issuer defaults. The loss will vary depending on creditor class and the enterprise value of the business when it defaults. All things being equal, secured creditors will lose less than unsecured creditors. Likewise, senior creditors will lose less than subordinated creditors. Market-clearing level As this phrase implies, the price or spread at which a deal clears the primary market.

Running the books. Middle market The loan market can be roughly divided into two segments: large corporate and middle market. There are as many ways to define middle market as there are bankers.

Most favored nation clauses 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. 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.

MFN sunset Some agreements end the MFN period after some specified period of say 12 or 18 months after which yield protection ends. Instead of seeking bids, a dealer is asked to buy a portfolio of paper and solicits potential sellers for the best offer. Recovery Recovery is the opposite of loss-given-default—it is the amount a creditor recovers, rather than loses, in a given default.

Relative value is a way of uncovering undervalued, or overvalued, assets. If you refer to a loan as rich, it means it is trading at a spread that is low compared with other similarly rated loans in the same sector. Conversely, referring to something as cheap means that it is trading at a spread that is high compared with its peer group.

That is, you can buy it on the cheap. So, if a private equity firm is working with an investment bank to acquire a property, that bank, or a group of banks, may provide a staple financing to ensure that the firm has the wherewithal to complete the deal. 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.

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What industry or sector does your company fit into? We will use this information to route your request to the right team within our company. What is your job within the company type you selected? If the interest margin is above a certain level, it is considered a leveraged loan. A leveraged loan is structured, arranged, and administered by at least one commercial or investment bank. These institutions are called arrangers and subsequently may sell the loan, in a process known as syndication , to other banks or investors to lower the risk to lending institutions.

Typically, banks are allowed to change the terms when syndicating the loan, which is called price flex.

The interest margin can be raised if demand for the loan is insufficient at the original interest level in what is referred to as upward flex. Conversely, the spread over LIBOR can be lowered, which is called reverse flex, if demand for the loan is high. An LBO occurs when a company or private equity company purchases a public entity and takes it private. Typically, debt is used to finance a portion of the purchase price.

A recapitalization of the balance sheet occurs when a company uses the capital markets to change the composition of its capital structure. A typical transaction issues debt to buy back stock or pay a dividend , which are cash rewards paid to shareholders. Leveraged loans allow companies or individuals that already have high debt or poor credit history to borrow cash, though at higher interest rates than usual.

Alternatively, a loan that is nonrated or BBB- or higher is often classified as a leveraged loan if the spread is LIBOR plus basis points or higher and is secured by a first or second lien.

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