The Capital
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The Capital

No BS Guide to Business Credit

Guide to Both Businesses and Lenders/Investors

Typical Syndicated Loan Structures

Syndicated loans fall into four basic categories:

  1. Revolvers
  2. Term
  3. Letter of Credit (LOC)
  4. Acquisition or Equipment

(1) Revolvers

Revolving credit loans (revolvers) are relatively flexible short-term (generally 364 days) facilities with several common variations. Their key distinguishing feature is that they allow you to draw down and repay the line as needed. However, you are charged a facility fee on the line’s unused portion. Given their flexibility, they are generally used for working capital and other short-term funding needs. Revolving lines granted to sub-investment grade borrowers are usually collateralized by receivables or inventory.

Small business commercial and industrial loan (C&I loan) is revolving line-of-credit typically used to finance payroll, working capital, equipment purchases, and other non-real estate oriented stuff. While most C&I are unsecured (mostly), some are secured. Most of C&I revolving facilities have floating rates, with terms of up to 2 years.

Common revolver options:

Swingline — small overnight loan, typically provided to you by the lead bank.

Multicurrency — allows you to draw the line in more than one currency.

Competitive Bid Option (CBO) — permits syndicate group lenders to bid on a particular drawdown. Typically available only to large investment-grade borrowers.

Term-out — allows you to convert the outstanding balance to a term loan on a given date. The loan’s spread is often raised if the option is exercised. This option is usually granted to you if you are an investment-grade borrower.

Evergreen — gives you an annual option — subject to lender consent — to renew the facility for another year.

Commercial credit card: Function as a personal credit card. These commercial cards are revolving facilities that you use to make purchases typically over a payment network (for example, Brex card over MasterCard network) and pay them off over time as you wish.

(2) Term loans

A term is a common type of syndicated loan. You would be allowed to draw the loan during a short commitment period. Principal repayment can either be via a regularly scheduled series of payments (amortization) or a single payment at maturity (bullet). Prepayments are usually permitted, though, at the discretion of lenders.

SBA government-guaranteed loans: The most popular SBA loan programs are 7(a) loans. 7(a) loans are effectively term Commercial and Industrial (C&I) loans the SBA guarantees up to 85% and SBA 504 Loans. The 7(a) loans are usually used to finance significant fixed assets such as equipment or real estate (50% guarantee).

To help foster small business development and increase banks’ willingness to lend to small businesses, the Small Business Administration (SBA) has several loan guarantee programs. The SBA guarantees against default for certain portions of business loans made by banks (and non-banks) that conform to its guidelines. This allows lenders to make loans with more extended repayment periods and looser underwriting criteria than standard commercial business loans.

Given that the SBA will partially guarantee loans up to ~$5M in size, banks are incentivized to originate small business loans under the SBA guaranteed programs. As opposed to fully assuming the credit risk, although this is not always the case.

More traditional syndicated loans

Relationship Loan — Loan provided to you by a bank based on a long term relationship. Use of proceeds is usually general corporate purposes. Relationship loan is typically the most common type of syndicated loan in Asia, for example.

Bridge Loan — Temporary transaction finance used until permanent funding is arranged. Typically maturity is less than one year.

Acquisition Loan — Long-term asset funding. It can be issued as part of a package that includes bonds and/or equity. Typically used to repay bridge loans. Acquisition loans are typical in the U.S. and Europe but traditionally were relatively less common in Asia.

LBO Financing — Loan portion of a debt-dominated acquisition finance package. Common in the U.S. and Europe, Seen occasionally in Australia, but still very rare in the rest of Asia-Pacific.

Refinancing, Recapitalization, and Rescue Financing — Transactions that have an immediate credit-enhancing impact. Classifications are in ascending order of urgency. Refinancing loans are common across the world.

Types of Term Loans

i) Amortizing term loan (A-Term Loans or TLA) — are typically distributed to banks. Tenor is usually less than six years. Principal repayment is via an amortization schedule, as the name implies. These types of loans are occasionally used in SaaS funding, with borrowers preferring less-stringent (covenant light) terms offered by non-bank lenders.

Covenant-lite Loans These are loans with incurrence — as opposed to maintenance — covenants, making them more bond-like. A borrower needs to pass maintenance covenant tests regularly (usually each quarter).

By contrast, incurrence covenants only require compliance at specific action points. When you, as a borrower, take on more debt or disposes of/sell assets…or potentially pay a dividend. Loan investors clearly favor maintenance covenants, as they permit early action on a deteriorating borrower, thus improving recovery prospects in the event of a default.

ii) Institutional term loan — (B-term, C-term or D-term or TLb, TLc, and TLd) — are mostly taken up by non-bank financial institutional investors. When these first emerged in the 1990s, they featured longer tenors than TLa facilities and back-loaded repayment schedules, with higher spreads to compensate. Since then, terms of the two tranches have begun to mirror each other.

(3) Letter of Credit (LC)

An LC is a bank guarantee of a borrower’s debts. Letter of Credit is recognized internationally. It is issued by a bank on behalf of you (the importer) with the exporter being the beneficiary, whereby no payment obligation arises until goods are satisfactorily shipped by the exporter to you.

A letter of credit process is traditionally manually intensive; thus, it has been ripe for digitization. A typical Letter of Credit transaction can involve over 150 different records and require signatures from up to 10 various parties, such as banks, shipping companies, and customs. Not to mention, most of letter of credit transactions have some sort of discrepancy, which delays the deal.

(4) Acquisition/equipment line (delayed-draw term loan)

A delayed-draw term loan is a loan that may be drawn to purchase a specific asset (often a piece of equipment) within a prescribed timeframe. The loan is repaid over a specific term, usually by installment. Once repaid, the line is canceled.

There are also…

2nd Lien Loans

As their name implies, these are loan tranches (typically TLb, TLc, and TLd). In theory, can be any of the above loan structures) whose collateral claim ranks below 1st lien loans. Their covenants are typically weaker than 1st lien loans.

Second lien loans first emerged in the 1990s. They were used initially as rescue financing. While subordinated, they still carried substantive protective provisions. Second lien loans (reflecting rescue intent) were distributed to investors who had common lending philosophies and were ready to work together if the borrower came under stress. These two features have largely fallen away as 2nd lien loans became a mainstream source of funding.

How 2nd lien holders are treated in the unfortunate case of bankruptcy is primarily driven by their documentation.

Most second liens are documented in one of two ways:

  1. As part of a single agreement also covering the 1st lien where the collateral is apportioned between tranches. This makes for a more straightforward workout in the event of a restructuring. The first format is preferred by 2nd lien holders. This arrangement makes it likely that both will be included in the same creditor class in the event of a bankruptcy, thus improving potential 2nd lien recovery rates.
  2. By a stand-alone Security Agreement. Under this format, 1st lien holders are likely to be treated as a separate creditor class and unable to take a seat on 1st lien creditor committees. First lien holders prefer this format, as gains by 2nd lien holders reduce 1st lien recoveries. Ratings of many 2nd lien loans relative to their 1st lien counterparts often hinge on which of the two documentation methods is used.

and…

Mezzanine Loans

Mezzanine loans are not secured against the assets of your company. Mezzanine loans were initially the vehicle of choice for borrowers/issuers looking to place a small amount of subordinated debt. Companies that needed to issue a significant amount of unsecured debt would typically tap the bond market via a high-yield issue.

In the mid-2000s, mezzanine was displacing high-yield bonds as a subordinated debt vehicle. Particularly so in the case of LBO financing, where the ‘Mezz’ piece has become a regular feature of the package.

Mezzanine loans typically carry the same type of covenants as 1st and 2nd lien loans. They rank behind 2nd lien loans — but above bonds — in the security structure. However, the hurdle rates are typically looser. The degree of incremental weakness as compared to more senior tranches is generally referred to as the ‘haircut.’ Standard & Poor’s reports that the typical Mezzanine covenant ‘haircut’ is 10%.

However, these instruments carry many equity-type risk and reward features:

Standstill periods — As a mezzanine issuer, you would typically have 60–90 days to cure a payment default, 90–120 days to cure a covenant default, and 120–150 days to cure other defaults.

Interest payments — Usually consist of cash and Pay-In-Kind (or PIK) components.

Warrants — A common feature of Mezzanine debt. Issues that do not offer equity upside (to lenders/investors), offer significantly higher interest components.

Prepayment penalties — This differentiates mezzanine debt from term loans, where prepayments are the norm and are usually penalty-free. It makes their structure more ‘bullet’-like, typical of bonds.

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Mark Justin

Mark Justin

Interest in FinTech, Deep Tech, Social Psychology, Neuroscience & Neuropsychology, Health and Longivity, and Global Polictics.