INTRODUCTION TO DEBT FINANCE

Key issues for banks

Issue	Why is it an issue?	Solutions
Relationship	A bank needs to keep its customers happy if it wants to sell them products in the future. The desirability of maintaining a relationship with the borrower may affect the action that the bank will take if the borrower breaches a provision of the loan agreement, or the loan transfer mechanism it selects.	Loan transfer provisions (LMA) – Consent of borrower is not required if assignment/transfer is to an Existing Lender or if an Event of Default is continuing. Sub-participation or risk-participation will not require notification of the borrower.
Risk	Banks need to ensure that they are protected against credit risk. Risk is correlated with return. A bank may be willing to make a high-risk loan, but will expect higher interest to compensate it for taking this risk.	Due diligence on the borrower Well-drafted loan agreement – ensuring the borrower remains roughly the same entity with the same assets throughout the loan period (Representations and Warranties - Negative Pledges, No Financial Indebtedness) Security/guarantees Loan transfers (that achieve a transfer of risk)
Recourse	An important element of assessing the risk of a loan is working out where the money will come from to repay it – the bank needs to ensure it has recourse to sufficient assets. However, borrowers may deliberately seek to limit the assets to which the bank has recourse [e.g. SPV]. Lending to corporate groups may also raise issues of subordination – it is thus important to understand the location of the assets within a group structure when a bank is lending to a holdco.	Security/guarantees (recourse to assets on insolvency or parent company’s assets) – especially security on subsidiary’s assets where holdco is not a trading co Subordination agreements/intercreditor agreements Refinancing existing loans with higher ranked security Fuller security packages for SPVs [including right to receive income]
Profit: cost-plus loans	The bank’s cost of borrowing money is the interest rate at which it can obtain funds on LIBOR. However, LIBOR will fluctuate during the life of a loan. Therefore, many loans are priced on a cost-plus basis.	Margin (LIBOR + fixed rate) Mandatory Costs (other costs in making the loan available) Tax gross-up

Types of loans

Which form of debt is suitable for a borrower will largely depend on the purpose for which the money is required and the size of the capital sum required.

Characteristic	OVERDRAFT	TERM LOAN	RCF
Purpose of loan	Assist cash flow – usually a reserve of money to meet shortfalls in working capital (short-term funding requirements)	Borrower needs a specific sum of money for a medium to long period (fixed sum over fixed period)	Ideal for seasonal businesses – borrower can draw down when the money is needed and pay it back when it is not (saving interest)
Flexibility	Flexible – borrower can withdraw capital only when it is required	Not flexible – must be fully drawn down in one lump sum or in several tranches (within the Availability Period)	Flexible – borrower can withdraw capital when required (but bank will charge a commitment fee as a percentage of the undrawn amount of the facility from time to time)
Discretion to lend?	Uncommitted – bank has ultimate discretion	Committed – bank must lend if CPs fulfilled and no default continuing (Drawstop)	Committed – bank must lend if CPs fulfilled and no default continuing (Drawstop)
Documentation & negotiation of terms	‘Facility’ letter (very little formal documentation) Bank’s usual terms and conditions	Loan agreement and debenture/security documents/CPs (lots of formal documentation) Heavily negotiated	Similar documentation to term loan Repeating Representations deemed to be repeated every time funds are drawn down Clean down provision to prevent the RCF from becoming long-term core debt
When is it repayable?	Repayable on demand – bank needs no reason to demand.	Repayable by the end of the term, unless Event of Default Amortisation/balloon repayment/bullet repayment	Repayable as borrower chooses over the loan period (unless Event of Default) Within the Availability Period, individual loans are borrowed for an Interest Period and repaid at the end of that Interest Period [but borrower can ‘roll-over’ borrowing into the next Interest Period].

Anatomy of a loan agreement (bank’s perspective)

Fees are paid

Loan monies can only be used for specific purpose outlined in agreement

Operating clauses about use and repayment of loan monies:

Fees

Interest Payments

Repayment and Prepayment

Maturity

Early termination by bank

Interest on its loan is paid

Borrower’s financial health is monitored

Information and monitoring clauses:

Conditions Precedent

Representations and Warranties

Covenants/Undertakings

Events of Default

Loan capital is repaid

Security is taken over the borrower’s assets for the loan monies

Clauses governing the relationship between parties and enforcement of the agreement (‘boilerplate’):

Loan transfers

Service of notices

Governing law

Legal opinions

Legal opinions cover two things:
- Confirms that Borrower/Obligors are validly incorporated and have corporate capacity to enter into the Finance Documents and perform its obligations under those Documents; and
- Confirms that the Finance Documents are legally valid, binding and enforceable – reducing risk of non-payment
Will only apply to matters of law and not of fact – the opinion is not a guarantee that the borrower will be able to service the loan or repay the loan
- Qualifications (relating to matters of law) and assumptions (relating to matters of fact) by the lawyers providing them – to limit liability
Legal opinion will be addressed to the bank/agent of a syndicated loan
Legal opinions required if:

Secured lending – banking will require an opinion to confirm enforceability of the security and to outline any risks associated with the security
Overseas jurisdictions – bank will require a legal opinion from local lawyers

Be aware of any foreign companies in an exam scenario; each jurisdiction will require its own legal opinion!

*In the exam, think:
- What legal opinions do we need?
- Who are they covering? [esp if multiple companies in group]
- What documents do they cover [‘Finance Documents’]?

Syndicated loans

Why syndicate?

Large loans – not feasible for one lender to make available the entire sum.

Where time is of the essence, the borrower will enter into a loan agreement with the arranger or a small group of syndicate banks (to get its funds on time). The lending bank will then syndicate the loan by transferring portions of the loan to other banks. [see Loan Transfers]

Internal risk policy – banks will have considerable credit risk if it lent large sums to any one borrower
Large exposure regulations – may be prohibited by large exposure regulations from taking so much risk with a single borrower.
Fees and prestige from high profile syndicated loans – especially if bank wants to start a ‘relationship’ with the borrower
Faster and less regulated than raising finance on the capital markets [although bonds often used to refinance a loan]

Parties to a syndicated loan

1. Arranger

Arranger is appointed by the borrower to arrange the raising of the required amount of debt, and is expected to provide a substantial portion of the total facility
- The terms of this appointment will be confirmed and documented in a ‘mandate letter’ from the borrower after the agreement of a term sheet
Will charge an arrangement fee for its role as arranger (will be kept confidential in fee letter – will not want other banks to undercut)
Scope of duties:
- Advising the borrower as to the most appropriate loan structure
- Prepares an information memorandum [from information from the borrower] to market the loan to potential syndicate lenders
- Drafting the loan documentation and negotiating with the borrower on behalf of the syndicate members
- ‘Best efforts’ syndication vs ‘underwritten’ syndication
Role as ‘arranger’ will terminate once the loan agreement is signed, but will commonly take on the role of ‘agent’ of the syndicate
Note: ‘Market flex’ clauses gives arranger some ability to increase the pricing and/or fees of the loan if to do so would enhance the prospects of a successful syndication

2. Agent

The agent is the agent of the lenders and not the borrower (appointed under the terms of the loan agreement)
Scope of duties:
- Paying agency [receiving loan advances from syndicate lenders and paying them to the borrower]
- Checking conditions precedent
- Postman [receives and forwards documents and notices to the intended recipients]
- Banking duties [determining the applicable interest rate]
- Administering loan transfers [executing transfer certificates or assignment agreements]
- Action on default [duty to inform the syndicate of the occurrence of a default of which it is aware]
- Interpretation of the agreement [will engage lawyers to assist it – provision in loan agreement that allows it to rely on this]
- Monitoring the borrower [not active – receives information and transmits it to the syndicate as appropriate]

3. Security trustee

Security trustee will be appointed to hold the security for the benefit of the syndicate lenders
- Benefit of the security can also be transferred without the need for a separate formal arrangement – ‘Lenders’ defined as lenders from time to time
Local legal...

#10487 - Introduction To Debt Finance - Debt Finance

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