INTRODUCTION TO DEBT FINANCE Key issues for banks Issue Relationship

Risk

Why is it an issue?
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. Banks need to ensure that they are protected against credit risk. Risk is correlated with return. A bank may be willing to make a highrisk loan, but will expect higher interest to compensate it for taking this risk.

Solutions 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. Subparticipation or risk
participation will not require notification of the borrower.

Due diligence on the borrower Welldrafted 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

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].

Profit: costplus loans

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. 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.

Loan transfers (that achieve a transfer of risk) 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]

Margin (LIBOR + fixed rate) Mandatory Costs (other costs in making the loan available) Tax grossup

Buy the full version of these notes or essay plans and more in our Debt Finance Notes.