Guide to Loan Market Fundamentals

A Guide to the
Loan Market
September 2011

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A Guide To The
Loan Market
September 2011

Copyright © 2011 by Standard & Poor’s Financial Services LLC (S&P) a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.

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To Our Clients
tandard & Poor's Ratings Services is pleased to bring you the 2011-2012 edition of our

S Guide To The Loan Market, which provides a detailed primer on the syndicated loan
market along with articles that describe the bank loan and recovery rating process as
well as our analytical approach to evaluating loss and recovery in the event of default.
Standard & Poor’s Ratings is the leading provider of credit and recovery ratings for leveraged
loans. Indeed, we assign recovery ratings to all speculative-grade loans and bonds that we rate
in nearly 30 countries, along with our traditional corporate credit ratings. As of press time,
Standard & Poor's has recovery ratings on the debt of more than 1,200 companies. We also
produce detailed recovery rating reports on most of them, which are available to syndicators
and investors. (To request a copy of a report on a specific loan and recovery rating, please refer
to the contact information below.)
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mation, data and analytical services for loan market participants, including:
● Data and commentary: Standard & Poor's Leveraged Commentary & Data (LCD) unit is the

leading provider of real-time news, statistical reports, market commentary, and data for
leveraged loan and high-yield market participants.
● Loan price evaluations: Standard & Poor's Evaluation Service provides price evaluations for

leveraged loan investors.
● Recovery statistics: Standard & Poor's LossStats(tm) database is the industry standard for

recovery information for bank loans and other debt classes.
● Fundamental credit information: Standard & Poor’s Capital IQ is the premier provider of financial

data for leveraged finance issuers.
If you want to learn more about our loan market services, all the appropriate contact
information is listed in the back of this publication. We welcome questions, suggestions, and
feedback on our products and services, and on this Guide, which we update annually. We
publish Leveraged Matters, a free weekly update on the leveraged finance market, which
includes selected Standard & Poor's recovery reports and analyses and a comprehensive list
of Standard & Poor's bank loan and recovery ratings.
To be put on the subscription list, please e-mail your name and contact information to
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Steven Miller William Chew

Standard & Poor’s ● A Guide To The Loan Market September 2011 3

Contents
A Syndicated Loan Primer 7

Rating Leveraged Loans: An Overview 31

Criteria Guidelines For Recovery Ratings On Global Industrials
Issuers’ Speculative-Grade Debt 36

Key Contacts 53


A Syndicated Loan Primer

Steven C. Miller syndicated loan is one that is provided by a group of lenders
New York
(1) 212-438-2715
steven_miller@standardandpoors.com
A and is structured, arranged, and administered by one or
several commercial or investment banks known as arrangers.
Starting with the large leveraged buyout (LBO) loans of the mid-
1980s, the syndicated loan market has become the dominant way
for issuers to tap banks and other institutional capital providers
for loans. The reason is simple: Syndicated loans are less expen-
sive and more efficient to administer than traditional bilateral,
or individual, credit lines.

At the most basic level, arrangers serve the these borrowers will effectively syndicate a
time-honored investment-banking role of rais- loan themselves, using the arranger simply to
ing investor dollars for an issuer in need of craft documents and administer the process.
capital. The issuer pays the arranger a fee for For leveraged issuers, the story is a very dif-
this service, and, naturally, this fee increases ferent one for the arranger, and, by “different,”
with the complexity and riskiness of the loan. we mean more lucrative. A new leveraged
As a result, the most profitable loans are loan can carry an arranger fee of 1% to 5%
those to leveraged borrowers—issuers whose of the total loan commitment, generally
credit ratings are speculative grade and who speaking, depending on (1) the complexity of
are paying spreads (premiums above LIBOR the transaction, (2) how strong market condi-
or another base rate) sufficient to attract the tions are at the time, and (3) whether the
interest of nonbank term loan investors, typi- loan is underwritten. Merger and acquisition
cally LIBOR+200 or higher, though this (M&A) and recapitalization loans will likely
threshold moves up and down depending on carry high fees, as will exit financings and
market conditions. restructuring deals. Seasoned leveraged
Indeed, large, high-quality companies pay issuers, by contrast, pay lower fees for
little or no fee for a plain-vanilla loan, typi- refinancings and add-on transactions.
cally an unsecured revolving credit instru- Because investment-grade loans are infre-
ment that is used to provide support for quently used and, therefore, offer drastically
short-term commercial paper borrowings or lower yields, the ancillary business is as
for working capital. In many cases, moreover, important a factor as the credit product in



arranging such deals, especially because many arranger will total up the commitments and
acquisition-related financings for investment- then make a call on where to price the paper.
grade companies are large in relation to the Following the example above, if the paper is
pool of potential investors, which would oversubscribed at LIBOR+250, the arranger
consist solely of banks. may slice the spread further. Conversely, if it is
The “retail” market for a syndicated loan undersubscribed even at LIBOR+275, then the
consists of banks and, in the case of leveraged arranger will be forced to raise the spread to
transactions, finance companies and institu- bring more money to the table.
tional investors. Before formally launching a
loan to these retail accounts, arrangers will
often get a market read by informally polling
Types Of Syndications
select investors to gauge their appetite for the There are three types of syndications: an
credit. Based on these discussions, the arranger underwritten deal, a “best-efforts” syndica-
will launch the credit at a spread and fee it tion, and a “club deal.”
believes will clear the market. Until 1998, this
would have been it. Once the pricing was set, Underwritten deal
it was set, except in the most extreme cases. If An underwritten deal is one for which the
the loan were undersubscribed, the arrangers arrangers guarantee the entire commitment,
could very well be left above their desired hold and then syndicate the loan. If the arrangers
level. After the Russian debt crisis roiled the cannot fully subscribe the loan, they are
market in 1998, however, arrangers have forced to absorb the difference, which they
adopted market-flex language, which allows may later try to sell to investors. This is easy,
them to change the pricing of the loan based of course, if market conditions, or the credit’s
on investor demand—in some cases within a fundamentals, improve. If not, the arranger
predetermined range—as well as shift amounts may be forced to sell at a discount and,
between various tranches of a loan, as a stan- potentially, even take a loss on the paper. Or
dard feature of loan commitment letters. the arranger may just be left above its desired
Market-flex language, in a single stroke, hold level of the credit. So, why do arrangers
pushed the loan market, at least the leveraged underwrite loans? First, offering an under-
segment of it, across the Rubicon, to a full- written loan can be a competitive tool to win
fledged capital market. mandates. Second, underwritten loans usually
Initially, arrangers invoked flex language to require more lucrative fees because the agent
make loans more attractive to investors by is on the hook if potential lenders balk. Of
hiking the spread or lowering the price. This course, with flex-language now common,
was logical after the volatility introduced by underwriting a deal does not carry the same
the Russian debt debacle. Over time, how- risk it once did when the pricing was set in
ever, market-flex became a tool either to stone prior to syndication.
increase or decrease pricing of a loan, based
on investor reaction. Best-efforts syndication
Because of market flex, a loan syndication A “best-efforts” syndication is one for which
today functions as a “book-building” exercise, the arranger group commits to underwrite less
in bond-market parlance. A loan is originally than the entire amount of the loan, leaving the
launched to market at a target spread or, as credit to the vicissitudes of the market. If the
was increasingly common by the late 2000s, loan is undersubscribed, the credit may not
with a range of spreads referred to as price talk close—or may need major surgery to clear the
(i.e., a target spread of, say, LIBOR+250 to market. Traditionally, best-efforts syndications
LIBOR+275). Investors then will make com- were used for risky borrowers or for complex
mitments that in many cases are tiered by the transactions. Since the late 1990s, however,
spread. For example, an account may put in the rapid acceptance of market-flex language
for $25 million at LIBOR+275 or $15 million has made best-efforts loans the rule even for
at LIBOR+250. At the end of the process, the investment-grade transactions.

8 www.standardandpoors.com

Club deal post-closing—to investors through digital
A “club deal” is a smaller loan (usually $25 platforms. Leading vendors in this space are
million to $100 million, but as high as $150 Intralinks, Syntrak, and Debt Domain.
million) that is premarketed to a group of The IM typically contain the following
relationship lenders. The arranger is generally sections:
a first among equals, and each lender gets a The executive summary will include a
full cut, or nearly a full cut, of the fees. description of the issuer, an overview of the
transaction and rationale, sources and uses,
and key statistics on the financials.
The Syndication Process Investment considerations will be, basically,
The information memo, or “bank book” management’s sales “pitch” for the deal.
Before awarding a mandate, an issuer might The list of terms and conditions will be a
solicit bids from arrangers. The banks will preliminary term sheet describing the pricing,
outline their syndication strategy and qualifi- structure, collateral, covenants, and other
cations, as well as their view on the way the terms of the credit (covenants are usually
loan will price in market. Once the mandate negotiated in detail after the arranger receives
is awarded, the syndication process starts. investor feedback).
The arranger will prepare an information The industry overview will be a description
memo (IM) describing the terms of the trans- of the company’s industry and competitive
actions. The IM typically will include an position relative to its industry peers.
executive summary, investment considera- The financial model will be a detailed
tions, a list of terms and conditions, an indus- model of the issuer’s historical, pro forma,
try overview, and a financial model. Because and projected financials including manage-
loans are not securities, this will be a confi- ment’s high, low, and base case for the issuer.
dential offering made only to qualified banks Most new acquisition-related loans kick off
and accredited investors. at a bank meeting at which potential lenders
If the issuer is speculative grade and seek- hear management and the sponsor group (if
ing capital from nonbank investors, the there is one) describe what the terms of the
arranger will often prepare a “public” ver- loan are and what transaction it backs.
sion of the IM. This version will be stripped Understandably, bank meetings are more
of all confidential material such as manage- often than not conducted via a Webex or
ment financial projections so that it can be conference call, although some issuers still
viewed by accounts that operate on the pub- prefer old-fashioned, in-person gatherings.
lic side of the wall or that want to preserve At the meeting, call or Webex, manage-
their ability to buy bonds or stock or other ment will provide its vision for the transac-
public securities of the particular issuer (see tion and, most important, tell why and how
the Public Versus Private section below). the lenders will be repaid on or ahead of
Naturally, investors that view materially non- schedule. In addition, investors will be
public information of a company are disqual- briefed regarding the multiple exit strate-
ified from buying the company’s public gies, including second ways out via asset
securities for some period of time. sales. (If it is a small deal or a refinancing
As the IM (or “bank book,” in traditional instead of a formal meeting, there may be a
market lingo) is being prepared, the syndi- series of calls or one-on-one meetings with
cate desk will solicit informal feedback from potential investors.)
potential investors on what their appetite for Once the loan is closed, the final terms are
the deal will be and at what price they are then documented in detailed credit and secu-
willing to invest. Once this intelligence has rity agreements. Subsequently, liens are per-
been gathered, the agent will formally mar- fected and collateral is attached.
ket the deal to potential investors. Arrangers Loans, by their nature, are flexible docu-
will distribute most IM’s—along with other ments that can be revised and amended
information related to the loan, pre- and from time to time. These amendments require



different levels of approval (see Voting rated. CLOs are created as arbitrage vehicles
Rights section below). Amendments can that generate equity returns through leverage,
range from something as simple as a by issuing debt 10 to 11 times their equity
covenant waiver to something as complex as contribution. There are also market-value
a change in the collateral package or allow- CLOs that are less leveraged—typically 3 to 5
ing the issuer to stretch out its payments or times—and allow managers more flexibility
make an acquisition. than more tightly structured arbitrage deals.
CLOs are usually rated by two of the three
The loan investor market major ratings agencies and impose a series of
There are three primary-investor consisten- covenant tests on collateral managers, includ-
cies: banks, finance companies, and institu- ing minimum rating, industry diversification,
tional investors. and maximum default basket. By 2007, CLOs
Banks, in this case, can be either a com- had become the dominant form of institutional
mercial bank, a savings and loan institution, investment in the leveraged loan market, tak-
or a securities firm that usually provides ing a commanding 60% of primary activity by
investment-grade loans. These are typically institutional investors. But when the structured
large revolving credits that back commercial finance market cratered in late 2007, CLO
paper or are used for general corporate pur- issuance tumbled and by mid-2010, CLO’s
poses or, in some cases, acquisitions. For share had fallen to roughly 30%.
leveraged loans, banks typically provide Loan mutual funds are how retail investors
unfunded revolving credits, LOCs, and— can access the loan market. They are mutual
although they are becoming increasingly less funds that invest in leveraged loans. These
common—amortizing term loans, under a funds—originally known as prime funds
syndicated loan agreement. because they offered investors the chance to
Finance companies have consistently repre- earn the prime interest rate that banks charge
sented less than 10% of the leveraged loan on commercial loans—were first introduced
market, and tend to play in smaller deals— in the late 1980s. Today there are three main
$25 million to $200 million. These investors categories of funds:
● Daily-access funds: These are traditional
often seek asset-based loans that carry wide
spreads and that often feature time-intensive open-end mutual fund products into which
collateral monitoring. investors can buy or redeem shares each
Institutional investors in the loan market day at the fund’s net asset value.
● Continuously offered, closed-end funds:
are principally structured vehicles known as
collateralized loan obligations (CLO) and These were the first loan mutual fund
loan participation mutual funds (known as products. Investors can buy into these
“prime funds” because they were originally funds each day at the fund’s net asset
pitched to investors as a money-market-like valueNAV. Redemptions, however, are
fund that would approximate the prime rate). made via monthly or quarterly tenders
In addition, hedge funds, high-yield bond rather than each day like the open-end
funds, pension funds, insurance companies, funds described above. To make sure they
and other proprietary investors do participate can meet redemptions, many of these
opportunistically in loans. funds, as well as daily access funds, set up
CLOs are special-purpose vehicles set up to lines of credit to cover withdrawals above
hold and manage pools of leveraged loans. and beyond cash reserves.
● Exchange-traded, closed-end funds: These
The special-purpose vehicle is financed with
several tranches of debt (typically a ‘AAA’ are funds that trade on a stock exchange.
rated tranche, a ‘AA’ tranche, a ‘BBB’ tranche, Typically, the funds are capitalized by an
and a mezzanine tranche) that have rights to initial public offering. Thereafter, investors
the collateral and payment stream in descend- can buy and sell shares, but may not
ing order. In addition, there is an equity redeem them. The manager can also expand
tranche, but the equity tranche is usually not the fund via rights offerings. Usually, they


are only able to do so when the fund is not (or not yet) a party to the loan. The sec-
trading at a premium to NAV, however—a ond innovation that weakened the public-pri-
provision that is typical of closed-end funds vate divide was trade journalism that focuses
regardless of the asset class. on the loan market.
In March 2011, Invesco introduced the Despite these two factors, the public versus
first index-based exchange traded fund, private line was well understood and rarely
PowerShares Senior Loan Portfolio controversial for at least a decade. This
(BKLN), which is based on the S&P/LSTA changed in the early 2000s as a result of:
Loan 100 Index. ● The proliferation of loan ratings, which, by

The table below lists the 20 largest loan their nature, provide public exposure for
mutual fund managers by AUM as loan deals;
of July 31, 2011. ● The explosive growth of nonbank investors

groups, which included a growing number
of institutions that operated on the public
Public Versus Private side of the wall, including a growing num-
In the old days, the line between public and ber of mutual funds, hedge funds, and even
private information in the loan market was a CLO boutiques;
simple one. Loans were strictly on the private ● The growth of the credit default swaps

side of the wall and any information trans- market, in which insiders like banks often
mitted between the issuer and the lender sold or bought protection from institu-
group remained confidential. tions that were not privy to inside
In the late 1980s, that line began to blur as information; and
a result of two market innovations. The first ● A more aggressive effort by the press to

was more active secondary trading that report on the loan market.
sprung up to support (1) the entry of non- Some background is in order. The vast
bank investors in the market, such as insur- majority of loans are unambiguously private
ance companies and loan mutual funds and financing arrangements between issuers and
(2) to help banks sell rapidly expanding port- their lenders. Even for issuers with public
folios of distressed and highly leveraged loans equity or debt that file with the SEC, the
that they no longer wanted to hold. This credit agreement only becomes public when it
meant that parties that were insiders on loans is filed, often months after closing, as an
might now exchange confidential information exhibit to an annual report (10-K), a quar-
with traders and potential investors who were terly report (10-Q), a current report (8-K), or

Largest Loan Mutual Fund Managers
Assets under management (bil. $) DWS Investments 2.61
Eaton Vance Management 13.39 T. Rowe Price 2.00
Fidelity Investments 12.12 BlackRock Advisors LLC 1.84
Hartford Mutual Funds 7.25 ING Pilgrim Funds 1.84
Oppenheimer Funds 6.39 RS Investments 1.51
Invesco Advisers 4.44 Nuveen Investments 1.37
PIMCO Funds 4.16 MainStay Investments 1.34
Lord Abbett 4.16 Pioneer Investments 0.88
RidgeWorth Funds 4.13 Highland Funds 0.74
Franklin Templeton Investment Funds 2.71 Goldman Sachs 0.64
John Hancock Funds 2.61

Source: Lipper FMI.



some other document (proxy statement, secu- the public side of the wall. As well, under-
rities registration, etc.). writers will ask public accounts to attend a
Beyond the credit agreement, there is a raft public version of the bank meeting and dis-
of ongoing correspondence between issuers tribute to these accounts only scrubbed
and lenders that is made under confidentiality financial information.
agreements, including quarterly or monthly ● Buy-side accounts. On the buy-side there
financial disclosures, covenant compliance are firms that operate on either side of
information, amendment and waiver requests, the public-private divide. Accounts that
and financial projections, as well as plans for operate on the private side receive all
acquisitions or dispositions. Much of this confidential materials and agree to not
information may be material to the financial trade in public securities of the issuers in
health of the issuer and may be out of the question. These groups are often part of
public domain until the issuer formally puts wider investment complexes that do have
out a press release or files an 8-K or some public funds and portfolios but, via
other document with the SEC. Chinese walls, are sealed from these parts
In recent years, this information has leaked of the firms. There are also accounts that
into the public domain either via off-line con- are public. These firms take only public
versations or the press. It has also come to IMs and public materials and, therefore,
light through mark-to-market pricing serv- retain the option to trade in the public
ices, which from time to time report signifi- securities markets even when an issuer for
cant movement in a loan price without any which they own a loan is involved. This
corresponding news. This is usually an indi- can be tricky to pull off in practice
cation that the banks have received negative because in the case of an amendment the
or positive information that is not yet public. lender could be called on to approve or
In recent years, there was growing concern decline in the absence of any real infor-
among issuers, lenders, and regulators that mation. To contend with this issue, the
this migration of once-private information account could either designate one person
into public hands might breach confidential- who is on the private side of the wall to
ity agreements between lenders and issuers sign off on amendments or empower its
and, more importantly, could lead to illegal trustee or the loan arranger to do so. But
trading. How has the market contended with it’s a complex proposition.
these issues? ● Vendors. Vendors of loan data, news, and
● Traders. To insulate themselves from vio- prices also face many challenges in man-
lating regulations, some dealers and buy- aging the flow of public and private infor-
side firms have set up their trading desks mation. In generally, the vendors operate
on the public side of the wall. under the freedom of the press provision
Consequently, traders, salespeople, and of the U.S. Constitution’s First
analysts do not receive private informa- Amendment and report on information in
tion even if somewhere else in the institu- a way that anyone can simultaneously
tion the private data are available. This is receive it—for a price of course.
the same technique that investment banks Therefore, the information is essentially
have used from time immemorial to sepa- made public in a way that doesn’t deliber-
rate their private investment banking ately disadvantage any party, whether it’s
activities from their public trading and a news story discussing the progress of an
sales activities. amendment or an acquisition, or it’s a
● Underwriters. As mentioned above, in most price change reported by a mark-to-mar-
primary syndications, arrangers will pre- ket service. This, of course, doesn’t deal
pare a public version of information mem- with the underlying issue that someone
oranda that is scrubbed of private who is a party to confidential information
information like projections. These IMs is making it available via the press or
will be distributed to accounts that are on prices to a broader audience.


Another way in which participants deal overall risk of their portfolios to their own
with the public versus private issue is to ask investors. As of mid-2011, then, roughly
counterparties to sign “big-boy” letters. 80% of leveraged-loan volume carried a loan
These letters typically ask public-side institu- rating, up from 45% in 1998 and virtually
tions to acknowledge that there may be none before 1995.
information they are not privy to and they
are agreeing to make the trade in any case. Loss-given-default risk
They are, effectively, big boys and will accept Loss-given-default risk measures how severe a
the risks. loss the lender is likely to incur in the event
of default. Investors assess this risk based on
Credit Risk: An Overview the collateral (if any) backing the loan and
the amount of other debt and equity subordi-
Pricing a loan requires arrangers to evaluate
nated to the loan. Lenders will also look to
the risk inherent in a loan and to gauge
covenants to provide a way of coming back
investor appetite for that risk. The principal
to the table early—that is, before other credi-
credit risk factors that banks and institutional
tors—and renegotiating the terms of a loan if
investors contend with in buying loans are
the issuer fails to meet financial targets.
default risk and loss-given-default risk.
Investment-grade loans are, in most cases,
Among the primary ways that accounts judge
senior unsecured instruments with loosely
these risks are ratings, credit statistics, indus-
drawn covenants that apply only at incur-
try sector trends, management strength, and
rence, that is, only if an issuer makes an
sponsor. All of these, together, tell a story
acquisition or issues debt. As a result, loss
about the deal.
given default may be no different from risk
Brief descriptions of the major risk
incurred by other senior unsecured creditors.
factors follow.
Leveraged loans, by contrast, are usually sen-
ior secured instruments that, except for
Default risk
covenant-lite loans (see below), have mainte-
Default risk is simply the likelihood of a bor- nance covenants that are measured at the end
rower’s being unable to pay interest or princi- of each quarter whether or not the issuer is in
pal on time. It is based on the issuer’s compliance with pre-set financial tests. Loan
financial condition, industry segment, and holders, therefore, almost always are first in
conditions in that industry and economic line among pre-petition creditors and, in
variables and intangibles, such as company many cases, are able to renegotiate with the
management. Default risk will, in most cases, issuer before the loan becomes severely
be most visibly expressed by a public rating impaired. It is no surprise, then, that loan
from Standard & Poor’s Ratings Services or investors historically fare much better than
another ratings agency. These ratings range other creditors on a loss-given-default basis.
from ‘AAA’ for the most creditworthy loans
to ‘CCC’ for the least. The market is divided, Credit statistics
roughly, into two segments: investment grade
Credit statistics are used by investors to help
(loans to issuers rated ‘BBB-’ or higher) and
calibrate both default and loss-given-default
leveraged (borrowers rated ‘BB+’ or lower).
risk. These statistics include a broad array of
Default risk, of course, varies widely within
financial data, including credit ratios measur-
each of these broad segments. Since the mid-
ing leverage (debt to capitalization and debt
1990s, public loan ratings have become a de
to EBITDA) and coverage (EBITDA to inter-
facto requirement for issuers that wish to do
est, EBITDA to debt service, operating cash
business with a wide group of institutional
flow to fixed charges). Of course, the ratios
investors. Unlike banks, which typically have
investors use to judge credit risk vary by
large credit departments and adhere to inter-
industry. In addition to looking at trailing
nal rating scales, fund managers rely on
and pro forma ratios, investors look at man-
agency ratings to bracket risk and explain the



agement’s projections and the assumptions tional investors, weight is given to an individ-
behind these projections to see if the issuer’s ual deal sponsor’s track record in fixing its
game plan will allow it to service its debt. own impaired deals by stepping up with addi-
There are ratios that are most geared to tional equity or replacing a management team
assessing default risk. These include leverage that is failing.
and coverage. Then there are ratios that are
suited for evaluating loss-given-default risk.
These include collateral coverage, or the
Syndicating A Loan By Facility
value of the collateral underlying the loan rel- Most loans are structured and syndicated to
ative to the size of the loan. They also include accommodate the two primary syndicated
the ratio of senior secured loan to junior debt lender constituencies: banks (domestic and
in the capital structure. Logically, the likely foreign) and institutional investors (primarily
severity of loss-given-default for a loan structured finance vehicles, mutual funds, and
increases with the size of the loan as a per- insurance companies). As such, leveraged
centage of the overall debt structure so does. loans consist of:
After all, if an issuer defaults on $100 million ● Pro rata debt consists of the revolving

of debt, of which $10 million is in the form credit and amortizing term loan (TLa),
of senior secured loans, the loans are more which are packaged together and, usually,
likely to be fully covered in bankruptcy than syndicated to banks. In some loans, how-
if the loan totals $90 million. ever, institutional investors take pieces of
the TLa and, less often, the revolving
Industry sector credit, as a way to secure a larger institu-
tional term loan allocation. Why are these
Industry is a factor, because sectors, natu-
tranches called “pro rata?” Because
rally, go in and out of favor. For that reason,
arrangers historically syndicated revolving
having a loan in a desirable sector, like tele-
credit and TLas on a pro rata basis to
com in the late 1990s or healthcare in the
banks and finance companies.
early 2000s, can really help a syndication
● Institutional debt consists of term loans
along. Also, loans to issuers in defensive sec-
structured specifically for institutional
tors (like consumer products) can be more
investors, although there are also some
appealing in a time of economic uncertainty,
banks that buy institutional term loans.
whereas cyclical borrowers (like chemicals
These tranches include first- and second-
or autos) can be more appealing during an
lien loans, as well as prefunded letters of
economic upswing.
credit. Traditionally, institutional tranches
were referred to as TLbs because they were
Sponsorship
bullet payments and lined up behind TLas.
Sponsorship is a factor too. Needless to say, Finance companies also play in the lever-
many leveraged companies are owned by one aged loan market, and buy both pro rata
or more private equity firms. These entities, and institutional tranches. With institutional
such as Kohlberg Kravis & Roberts or investors playing an ever-larger role, how-
Carlyle Group, invest in companies that have ever, by the late 2000s, many executions
leveraged capital structures. To the extent were structured as simply revolving
that the sponsor group has a strong following credit/institutional term loans, with the
among loan investors, a loan will be easier to TLa falling by the wayside.
syndicate and, therefore, can be priced lower.
In contrast, if the sponsor group does not
have a loyal set of relationship lenders, the Pricing A Loan In
deal may need to be priced higher to clear the The Primary Market
market. Among banks, investment factors Pricing loans for the institutional market is a
may include whether or not the bank is party straightforward exercise based on simple
to the sponsor’s equity fund. Among institu- risk/return consideration and market techni-


cals. Pricing a loan for the bank market, other fee-generating business to banks that
however, is more complex. Indeed, banks are part of its loan syndicate.
often invest in loans for more than just
spread income. Rather, banks are driven by Pricing loans for institutional players
the overall profitability of the issuer relation- For institutional investors, the investment
ship, including noncredit revenue sources. decision process is far more straightforward,
because, as mentioned above, they are
Pricing loans for bank investors focused not on a basket of returns, but only
Since the early 1990s, almost all large com- on loan-specific revenue.
mercial banks have adopted portfolio-man- In pricing loans to institutional investors,
agement techniques that measure the returns it’s a matter of the spread of the loan rela-
of loans and other credit products relative tive to credit quality and market-based fac-
to risk. By doing so, banks have learned tors. This second category can be divided
that loans are rarely compelling investments into liquidity and market technicals (i.e.,
on a stand-alone basis. Therefore, banks are supply/demand).
reluctant to allocate capital to issuers unless Liquidity is the tricky part, but, as in all
the total relationship generates attractive markets, all else being equal, more liquid
returns—whether those returns are meas- instruments command thinner spreads than
ured by risk-adjusted return on capital, by less liquid ones. In the old days—before
return on economic capital, or by some institutional investors were the dominant
other metric. investors and banks were less focused on
If a bank is going to put a loan on its bal- portfolio management—the size of a loan
ance sheet, then it takes a hard look not didn’t much matter. Loans sat on the books
only at the loan’s yield, but also at other of banks and stayed there. But now that
sources of revenue from the relationship, institutional investors and banks put a pre-
including noncredit businesses—like cash- mium on the ability to package loans and sell
management services and pension-fund man- them, liquidity has become important. As a
agement—and economics from other capital result, smaller executions—generally those of
markets activities, like bonds, equities, or $200 million or less—tend to be priced at a
M&A advisory work. premium to the larger loans. Of course, once
This process has had a breathtaking result a loan gets large enough to demand
on the leveraged loan market—to the point extremely broad distribution, the issuer usu-
that it is an anachronism to continue to call it ally must pay a size premium. The thresholds
a “bank” loan market. Of course, there are range widely. During the go-go mid-2000s, it
certain issuers that can generate a bit more was upwards of $10 billion. During more
bank appetite; as of mid-2011, these include parsimonious late-2000s $1 billion was con-
issuers with a European or even a sidered a stretch.
Midwestern U.S. angle. Naturally, issuers Market technicals, or supply relative to
with European operations are able to better demand, is a matter of simple economics. If
tap banks in their home markets (banks still there are a lot of dollars chasing little prod-
provide the lion’s share of loans in Europe), uct, then, naturally, issuers will be able to
and, for Midwestern issuers, the heartland command lower spreads. If, however, the
remains one of the few U.S. regions with a opposite is true, then spreads will need to
deep bench of local banks. increase for loans to clear the market.
What this means is that the spread offered
to pro rata investors is important, but so,
too, in most cases, is the amount of other,
Mark-To-Market’s Effect
fee-driven business a bank can capture by Beginning in 2000, the SEC directed bank
taking a piece of a loan. For this reason, loan mutual fund managers to use available
issuers are careful to award pieces of bond- mark-to-market data (bid/ask levels
and equity-underwriting engagements and reported by secondary traders and compiled



by mark-to-market services like Markit banks can offer issuers 364-day facilities at
Loans) rather than fair value (estimated a lower unused fee than a multiyear revolv-
prices), to determine the value of broadly ing credit. There are a number of options
syndicated loans for portfolio-valuation that can be offered within a revolving
purposes. In broad terms, this policy has credit line:
made the market more transparent, 1. A swingline is a small, overnight borrow-
improved price discovery and, in doing so, ing line, typically provided by the agent.
made the market far more efficient and 2. A multicurrency line may allow the bor-
dynamic than it was in the past. In the pri- rower to borrow in several currencies.
mary market, for instance, leveraged loan 3. A competitive-bid option (CBO) allows
spreads are now determined not only by rat- borrowers to solicit the best bids from its
ing and leverage profile, but also by trading syndicate group. The agent will conduct
levels of an issuer’s previous loans and, what amounts to an auction to raise
often, bonds. Issuers and investors can also funds for the borrower, and the best
look at the trading levels of comparable bids are accepted. CBOs typically
loans for market-clearing levels. are available only to large, investment-
grade borrowers.
4. A term-out will allow the borrower to con-
Types Of Syndicated vert borrowings into a term loan at a given
Loan Facilities conversion date. This, again, is usually a
There are four main types of syndicated feature of investment-grade loans. Under
loan facilities: the option, borrowers may take what is
● A revolving credit (within which are outstanding under the facility and pay it
options for swingline loans, multicurrency- off according to a predetermined repay-
borrowing, competitive-bid options, term- ment schedule. Often the spreads ratchet
out, and evergreen extensions); up if the term-out option is exercised.
● A term loan; 5. An evergreen is an option for the bor-
● An LOC; and rower—with consent of the syndicate
● An acquisition or equipment line (a group—to extend the facility each year for
delayed-draw term loan). an additional year.
A revolving credit line allows borrowers A term loan is simply an installment loan,
to draw down, repay, and reborrow. The such as a loan one would use to buy a car.
facility acts much like a corporate credit The borrower may draw on the loan during a
card, except that borrowers are charged an short commitment period and repays it based
annual commitment fee on unused on either a scheduled series of repayments or
amounts, which drives up the overall cost a one-time lump-sum payment at maturity
of borrowing (the facility fee). Revolvers to (bullet payment). There are two principal
speculative-grade issuers are often tied to types of term loans:
borrowing-base lending formulas. This lim- ● An amortizing term loan (A-term loans, or

its borrowings to a certain percentage of TLa) is a term loan with a progressive
collateral, most often receivables and inven- repayment schedule that typically runs six
tory. Revolving credits often run for 364 years or less. These loans are normally syn-
days. These revolving credits—called, not dicated to banks along with revolving cred-
surprisingly, 364-day facilities—are gener- its as part of a larger syndication.
ally limited to the investment-grade market. ● An institutional term loan (B-term, C-term,

The reason for what seems like an odd term or D-term loans) is a term loan facility
is that regulatory capital guidelines man- carved out for nonbank, institutional
date that, after one year of extending credit investors. These loans came into broad
under a revolving facility, banks must then usage during the mid-1990s as the institu-
increase their capital reserves to take into tional loan investor base grew. This institu-
account the unused amounts. Therefore, tional category also includes second-lien


loans and covenant-lite loans, which are struggling with liquidity problems. By 2007,
described below. the market had accepted second-lien loans to
LOCs differ, but, simply put, they are guar- finance a wide array of transactions, including
antees provided by the bank group to pay off acquisitions and recapitalizations. Arrangers
debt or obligations if the borrower cannot. tap nontraditional accounts—hedge funds,
Acquisition/equipment lines (delayed-draw distress investors, and high-yield accounts—as
term loans) are credits that may be drawn well as traditional CLO and prime fund
down for a given period to purchase speci- accounts to finance second-lien loans.
fied assets or equipment or to make acquisi- As their name implies, the claims on col-
tions. The issuer pays a fee during the lateral of second-lien loans are junior to
commitment period (a ticking fee). The lines those of first-lien loans. Second-lien loans
are then repaid over a specified period (the also typically have less restrictive covenant
term-out period). Repaid amounts may not packages, in which maintenance covenant
be reborrowed. levels are set wide of the first-lien loans.
Bridge loans are loans that are intended to As a result, second-lien loans are priced at
provide short-term financing to provide a a premium to first-lien loans. This pre-
“bridge” to an asset sale, bond offering, mium typically starts at 200 bps when the
stock offering, divestiture, etc. Generally, collateral coverage goes far beyond the
bridge loans are provided by arrangers as claims of both the first- and second-lien
part of an overall financing package. loans to more than 1,000 bps for less
Typically, the issuer will agree to increasing generous collateral.
interest rates if the loan is not repaid as There are, lawyers explain, two main
expected. For example, a loan could start at a ways in which the collateral of second-lien
spread of L+250 and ratchet up 50 basis loans can be documented. Either the sec-
points (bp) every six months the loan remains ond-lien loan can be part of a single secu-
outstanding past one year. rity agreement with first-lien loans, or they
Equity bridge loan is a bridge loan pro- can be part of an altogether separate agree-
vided by arrangers that is expected to be ment. In the case of a single agreement, the
repaid by secondary equity commitment to a agreement would apportion the collateral,
leveraged buyout. This product is used when with value going first, obviously, to the
a private equity firm wants to close on a deal first-lien claims and next to the second-lien
that requires, say, $1 billion of equity of claims. Alternatively, there can be two
which it ultimately wants to hold half. The entirely separate agreements. Here’s a
arrangers bridge the additional $500 million, brief summary:
which would be then repaid when other ● In a single security agreement, the second-

sponsors come into the deal to take the $500 lien lenders are in the same creditor class as
million of additional equity. Needless to say, the first-lien lenders from the standpoint of
this is a hot-market product. a bankruptcy, according to lawyers who
specialize in these loans. As a result, for
adequate protection to be paid the collat-
Second-Lien Loans eral must cover both the claims of the first-
Although they are really just another type of and second-lien lenders. If it does not, the
syndicated loan facility, second-lien loans are judge may choose to not pay adequate pro-
sufficiently complex to warrant a separate sec- tection or to divide it pro rata among the
tion in this primer. After a brief flirtation with first- and second-lien creditors. In addition,
second-lien loans in the mid-1990s, these the second-lien lenders may have a vote as
facilities fell out of favor after the 1998 secured lenders equal to those of the first-
Russian debt crisis caused investors to adopt a lien lenders. One downside for second-lien
more cautious tone. But after default rates fell lenders is that these facilities are often
precipitously in 2003, arrangers rolled out smaller than the first-lien loans and, there-
second-lien facilities to help finance issuers fore, when a vote comes up, first-lien



lenders can outvote second-lien lenders to mum been a maintenance rather than incur-
promote their own interests. rence test, the issuer would need to pass it
● In the case of two separate security each quarter and would be in violation if
agreements, divided by a standstill agree- either its earnings eroded or its debt level
ment, the first- and second-lien lenders increased. For lenders, clearly, maintenance
are likely to be divided into two separate tests are preferable because it allows them to
creditor classes. As a result, second-lien take action earlier if an issuer experiences
lenders do not have a voice in the first- financial distress. What’s more, the lenders
lien creditor committees. As well, first- may be able to wrest some concessions from
lien lenders can receive adequate an issuer that is in violation of covenants (a
protection payments even if collateral fee, incremental spread, or additional collat-
covers their claims, but does not cover eral) in exchange for a waiver.
the claims of the second-lien lenders. Conversely, issuers prefer incurrence
This may not be the case if the loans are covenants precisely because they are less
documented together and the first- and stringent. Covenant-lite loans, therefore,
second-lien lenders are deemed a unified thrive when the supply/demand equation is
class by the bankruptcy court. tilted persuasively in favor of issuers.
For more information, we suggest
Latham & Watkins’ terrific overview and
analysis of second-lien loans, which was
Lender Titles
published on April 15, 2004 in the firm’s In the formative days of the syndicated loan
CreditAlert publication. market (the late 1980s), there was usually
one agent that syndicated each loan. “Lead
manager” and “manager” titles were doled
Covenant-Lite Loans out in exchange for large commitments. As
Like second-lien loans, covenant-lite loans are league tables gained influence as a marketing
a particular kind of syndicated loan facility. tool, “co-agent” titles were often used in
At the most basic level, covenant-lite loans are attracting large commitments or in cases
loans that have bond-like financial incurrence where these institutions truly had a role in
covenants rather than traditional maintenance underwriting and syndicating the loan.
covenants that are normally part and parcel During the 1990s, the use of league tables
of a loan agreement. What’s the difference? and, consequently, title inflation exploded.
Incurrence covenants generally require that Indeed, the co-agent title has become largely
if an issuer takes an action (paying a divi- ceremonial today, routinely awarded for what
dend, making an acquisition, issuing more amounts to no more than large retail commit-
debt), it would need to still be in compliance. ments. In most syndications, there is one lead
So, for instance, an issuer that has an incur- arranger. This institution is considered to be
rence test that limits its debt to 5x cash flow on the “left” (a reference to its position in an
would only be able to take on more debt if, old-time tombstone ad). There are also likely
on a pro forma basis, it was still within this to be other banks in the arranger group,
constraint. If not, then it would have which may also have a hand in underwriting
breeched the covenant and be in technical and syndicating a credit. These institutions
default on the loan. If, on the other hand, an are said to be on the “right.”
issuer found itself above this 5x threshold The different titles used by significant par-
simply because its earnings had deteriorated, ticipants in the syndications process are
it would not violate the covenant. administrative agent, syndication agent, docu-
Maintenance covenants are far more mentation agent, agent, co-agent or managing
restrictive. This is because they require an agent, and lead arranger or book runner:
issuer to meet certain financial tests every ● The administrative agent is the bank that

quarter whether or not it takes an action. So, handles all interest and principal payments
in the case above, had the 5x leverage maxi- and monitors the loan.


● The syndication agent is the bank that han- these lower assignment fees remained rare
dles, in purest form, the syndication of the into 2011, and the vast majority was set at
loan. Often, however, the syndication agent the traditional $3,500.
has a less specific role. One market convention that became firmly
● The documentation agent is the bank that established in the late 1990s was assignment-
handles the documents and chooses the fee waivers by arrangers for trades crossed
law firm. through its secondary trading desk. This was
● The agent title is used to indicate the lead a way to encourage investors to trade with
bank when there is no other conclusive the arranger rather than with another dealer.
title available, as is often the case for This is a significant incentive to trade with
smaller loans. arranger—or a deterrent to not trade away,
● The co-agent or managing agent is largely depending on your perspective—because a
a meaningless title used mostly as an award $3,500 fee amounts to between 7 bps to 35
for large commitments. bps of a $1 million to $5 million trade.
● The lead arranger or book runner title is a
league table designation used to indicate Primary assignments
the “top dog” in a syndication. This term is something of an oxymoron. It
applies to primary commitments made by
Secondary Sales offshore accounts (principally CLOs and
hedge funds). These vehicles, for a variety of
Secondary sales occur after the loan is closed
tax reasons, suffer tax consequence from
and allocated, when investors are free to
buying loans in the primary. The agent will
trade the paper. Loan sales are structured as
therefore hold the loan on its books for some
either assignments or participations, with
short period after the loan closes and then
investors usually trading through dealer desks
sell it to these investors via an assignment.
at the large underwriting banks. Dealer-to-
These are called primary assignments and are
dealer trading is almost always conducted
effectively primary purchases.
through a “street” broker.
Participations
Assignments
A participation is an agreement between an
In an assignment, the assignee becomes a
existing lender and a participant. As the
direct signatory to the loan and receives inter-
name implies, it means the buyer is taking
est and principal payments directly from the
a participating interest in the existing
administrative agent.
lender’s commitment.
Assignments typically require the consent
The lender remains the official holder of
of the borrower and agent, although consent
the loan, with the participant owning the
may be withheld only if a reasonable objec-
rights to the amount purchased. Consents,
tion is made. In many loan agreements, the
fees, or minimums are almost never required.
issuer loses its right to consent in the event
The participant has the right to vote only on
of default.
material changes in the loan document (rate,
The loan document usually sets a mini-
term, and collateral). Nonmaterial changes
mum assignment amount, usually $5 mil-
do not require approval of participants. A
lion, for pro rata commitments. In the late
participation can be a riskier way of pur-
1990s, however, administrative agents
chasing a loan, because, in the event of a
started to break out specific assignment min-
lender becoming insolvent or defaulting, the
imums for institutional tranches. In most
participant does not have a direct claim on
cases, institutional assignment minimums
the loan. In this case, the participant then
were reduced to $1 million in an effort to
becomes a creditor of the lender and often
boost liquidity. There were also some cases
must wait for claims to be sorted out to col-
where assignment fees were reduced or even
lect on its participation.
eliminated for institutional assignments, but



Loan Derivatives settlement could also be employed if there’s
Loan credit default swaps not enough paper to physically settle all
Traditionally, accounts bought and sold LCDS contracts on a particular loan.
loans in the cash market through assign-
ments and participations. Aside from that, LCDX
there was little synthetic activity outside Introduced in 2007, the LCDX is an index of
over-the-counter total rate of return swaps. 100 LCDS obligations that participants can
By 2008, however, the market for syntheti- trade. The index provides a straightforward
cally trading loans was budding. way for participants to take long or short
Loan credit default swaps (LCDS) are stan- positions on a broad basket of loans, as well
dard derivatives that have secured loans as as hedge their exposure to the market.
reference instruments. In June 2006, the Markit Group administers the LCDX, a
International Settlement and Dealers product of CDS Index Co., a firm set up by a
Association issued a standard trade confirma- group of dealers. Like LCDS, the LCDX
tion for LCDS contracts. Index is an over-the-counter product.
Like all credit default swaps (CDS), an The LCDX is reset every six months with
LCDS is basically an insurance contract. The participants able to trade each vintage of the
seller is paid a spread in exchange for agree- index that is still active. The index will be set
ing to buy at par, or a pre-negotiated price, a at an initial spread based on the reference
loan if that loan defaults. LCDS enables par- instruments and trade on a price basis.
ticipants to synthetically buy a loan by going According to the primer posted by Markit
short the LCDS or sell the loan by going long (http://www.markit.com/information/affilia-
the LCDS. Theoretically, then, a loanholder tions/lcdx/alertParagraphs/01/document/LCD
can hedge a position either directly (by buy- X%20Primer.pdf), “the two events that
ing LCDS protection on that specific name) would trigger a payout from the buyer (pro-
or indirectly (by buying protection on a com- tection seller) of the index are bankruptcy or
parable name or basket of names). failure to pay a scheduled payment on any
Moreover, unlike the cash markets, which debt (after a grace period), for any of the
are long-only markets for obvious reasons, constituents of the index.”
the LCDS market provides a way for All documentation for the index is posted
investors to short a loan. To do so, the at: http://www.markit.com/information/affili-
investor would buy protection on a loan that ations/lcdx/alertParagraphs/01/document/LC
it doesn’t hold. If the loan subsequently DX%20Primer.pdf.
defaults, the buyer of protection should be
able to purchase the loan in the secondary Total rate of return swaps (TRS)
market at a discount and then and deliver it This is the oldest way for participants to pur-
at par to the counterparty from which it chase loans synthetically. And, in reality, a
bought the LCDS contract. For instance, say TRS is little more than buying a loan on mar-
an account buys five-year protection for a gin. In simple terms, under a TRS program a
given loan, for which it pays 250 bps a year. participant buys the income stream created
Then in year 2 the loan goes into default and by a loan from a counterparty, usually a
the market price falls to 80% of par. The dealer. The participant puts down some per-
buyer of the protection can then buy the loan centage as collateral, say 10%, and borrows
at 80 and deliver to the counterpart at 100, a the rest from the dealer. Then the participant
20-point pickup. Or instead of physical deliv- receives the spread of the loan less the finan-
ery, some buyers of protection may prefer cial cost plus LIBOR on its collateral
cash settlement in which the difference account. If the reference loan defaults, the
between the current market price and the participant is obligated to buy it at par or
delivery price is determined by polling dealers cash settle the loss based on a mark-to-mar-
or using a third-party pricing service. Cash ket price or an auction price.


Here’s how the economics of a TRS work, because the prime option is more costly to
in simple terms. A participant buys via TRS a the borrower than LIBOR or CDs.
$10 million position in a loan paying L+250. ● The LIBOR (or Eurodollar) option is so
To affect the purchase, the participant puts called because, with this option, the inter-
$1 million in a collateral account and pays est on borrowings is set at a spread over
L+50 on the balance (meaning leverage of LIBOR for a period of one month to one
9:1). Thus, the participant would receive: year. The corresponding LIBOR rate is
L+250 on the amount in the collateral used to set pricing. Borrowings cannot be
account of $1 million, plus prepaid without penalty.
200 bps (L+250 minus the borrowing cost of ● The CD option works precisely like the
L+50) on the remaining amount of $9 million. LIBOR option, except that the base rate is
The resulting income is L+250 * $1 million certificates of deposit, sold by a bank to
plus 200 bps * $9 million. Based on the par- institutional investors.
ticipants’ collateral amount—or equity contri- ● Other fixed-rate options are less common
bution—of $1 million, the return is L+2020. but work like the LIBOR and CD options.
If LIBOR is 5%, the return is 25.5%. Of These include federal funds (the overnight
course, this is not a risk-free proposition. If rate charged by the Federal Reserve to
the issuer defaults and the value of the loan member banks) and cost of funds (the
goes to 70 cents on the dollar, the participant bank’s own funding rate).
will lose $3 million. And if the loan does not
default but is marked down for whatever rea- LIBOR floors
son—market spreads widen, it is down- As the name implies, LIBOR floors put a
graded, its financial condition floor under the base rate for loans. If a loan
deteriorates—the participant stands to lose has a 3% LIBOR floor and three-month
the difference between par and the current LIBOR falls below this level, the base rate
market price when the TRS expires. Or, in an for any resets default to 3%. For obvious
extreme case, the value declines below the reasons, LIBOR floors are generally seen
value in the collateral account and the partic- during periods when market conditions are
ipant is hit with a margin call. difficult and rates are falling as an incentive
for lenders.
Pricing Terms
Rates Fees

Loans usually offer borrowers different inter- The fees associated with syndicated loans are
est-rate options. Several of these options allow the upfront fee, the commitment fee, the
borrowers to lock in a given rate for one facility fee, the administrative agent fee, the
month to one year. Pricing on many loans is letter of credit (LOC) fee, and the cancella-
tied to performance grids, which adjust pric- tion or prepayment fee.
● An upfront fee is a fee paid by the issuer at
ing by one or more financial criteria. Pricing
is typically tied to ratings in investment-grade close. It is often tiered, with the lead
loans and to financial ratios in leveraged arranger receiving a larger amount in con-
loans. Communications loans are invariably sideration for structuring and/or under-
tied to the borrower’s debt-to-cash-flow ratio. writing the loan. Co-underwriters will
Syndication pricing options include prime, receive a lower fee, and then the general
LIBOR, CD, and other fixed-rate options: syndicate will likely have fees tied to their
● The prime is a floating-rate option.
commitment. Most often, fees are paid on
Borrowed funds are priced at a spread over a lender’s final allocation. For example, a
the reference bank’s prime lending rate. loan has two fee tiers: 100 bps (or 1%) for
The rate is reset daily, and borrowerings $25 million commitments and 50 bps for
may be repaid at any time without penalty. $15 million commitments. A lender com-
This is typically an overnight option, mitting to the $25 million tier will be paid
on its final allocation rather than on initial



commitment, which means that, in this and 1% in year two. The fee may be
example, the loan is oversubscribed and applied to all repayments under a loan or
lenders committing $25 million would be “soft” repayments, those made from a refi-
allocated $20 million and the lenders nancing or at the discretion of the issuer
would receive a fee of $200,000 (or 1% of (as opposed to hard repayments made from
$20 million). Sometimes upfront fees will excess cash flow or asset sales).
be structured as a percentage of final allo- ● An administrative agent fee is the annual

cation plus a flat fee. This happens most fee typically paid to administer the loan
often for larger fee tiers, to encourage (including to distribute interest payments
potential lenders to step up for larger com- to the syndication group, to update lender
mitments. The flat fee is paid regardless of lists, and to manage borrowings). For
the lender’s final allocation. Fees are usu- secured loans (particularly those backed
ally paid to banks, mutual funds, and by receivables and inventory), the agent
other non-offshore investors at close. often collects a collateral monitoring fee,
CLOs and other offshore vehicles are typi- to ensure that the promised collateral is
cally brought in after the loan closes as a in place.
“primary” assignment, and they simply An LOC fee can be any one of several
buy the loan at a discount equal to the types. The most common—a fee for standby
fee offered in the primary assignment, for or financial LOCs—guarantees that lenders
tax purposes. will support various corporate activities.
● A commitment fee is a fee paid to lenders Because these LOCs are considered “bor-
on undrawn amounts under a revolving rowed funds” under capital guidelines, the fee
credit or a term loan prior to draw-down. is typically the same as the LIBOR margin.
On term loans, this fee is usually referred Fees for commercial LOCs (those supporting
to as a “ticking” fee. inventory or trade) are usually lower, because
● A facility fee, which is paid on a facility’s in these cases actual collateral is submitted).
entire committed amount, regardless of The LOC is usually issued by a fronting bank
usage, is often charged instead of a com- (usually the agent) and syndicated to the
mitment fee on revolving credits to invest- lender group on a pro rata basis. The group
ment-grade borrowers, because these receives the LOC fee on their respective
facilities typically have CBOs that allow a shares, while the fronting bank receives an
borrower to solicit the best bid from its issuing (or fronting, or facing) fee for issuing
syndicate group for a given borrowing. The and administering the LOC. This fee is
lenders that do not lend under the CBO are almost always 12.5 bps to 25 bps (0.125% to
still paid for their commitment. 0.25%) of the LOC commitment.
● A usage fee is a fee paid when the utiliza-
tion of a revolving credit falls below a cer- Original issue discounts (OID)
tain minimum. These fees are applied This is yet another term imported from the
mainly to investment-grade loans and gen- bond market. The OID, the discount from
erally call for fees based on the utilization par at loan, is offered in the new issue market
under a revolving credit. In some cases, the as a spread enhancement. A loan may be
fees are for high use and, in some cases, for issued at 99 bps to pay par. The OID in this
low use. Often, either the facility fee or the case is said to be 100 bps, or 1 point.
spread will be adjusted higher or lower
based on a pre-set usage level. OID Versus Upfront Fees
● A prepayment fee is a feature generally
At this point, the careful reader may be won-
associated with institutional term loans.
dering just what the difference is between an
This fee is seen mainly in weak markets as
OID and an upfront fee. After all, in both
an inducement to institutional investors.
cases the lender effectively pays less than par
Typical prepayment fees will be set on a
for a loan.
sliding scale; for instance, 2% in year one


From the perspective of the lender, actually, changes such as RATS (rate, amortization,
there isn’t much of a difference. But for the term, and security; or collateral) rights,
issuer and arrangers, the distinction is far but, as described below, there are occasions
more than semantics. Upfront fees are gener- when changes in amortization and collat-
ally paid from the arrangers underwriting fee eral may be approved by a lower percent-
as an incentive to bring lenders into the deal. age of lenders (a supermajority).
An issuer may pay the arranger 2% of the ● A supermajority is typically 67% to 80%
deal and the arranger, to rally investors, may of lenders and is sometimes required for
then pay a quarter of this amount, or 0.50%, certain material changes such as changes in
to lender group. amortization (in-term repayments) and
An OID, however, is generally borne by the release of collateral.
issuer, above and beyond the arrangement
fee. So the arranger would receive its 2% fee
and the issuer would only receive 99 cents for
Covenants
every dollar of loan sold. Loan agreements have a series of restrictions
For instance, take a $100 million loan that dictate, to varying degrees, how borrow-
offered at a 1% OID. The issuer would ers can operate and carry themselves finan-
receive $99 million, of which it would pay the cially. For instance, one covenant may require
arrangers 2%. The issuer then would be obli- the borrower to maintain its existing fiscal-
gated to pay back the whole $100 million, year end. Another may prohibit it from tak-
even though it received $97 million after fees. ing on new debt. Most agreements also have
Now, take the same $100 million loan offered financial compliance covenants, for example,
at par with an upfront fee of 1%. In this case, that a borrower must maintain a prescribed
the issuer gets the full $100 million. In this level of equity, which, if not maintained, gives
case, the lenders would buy the loan not at banks the right to terminate the agreement or
par, but at 99 cents on the dollar. The issuer push the borrower into default. The size of
would receive $100 million of which it would the covenant package increases in proportion
pay 2% to the arranger, which would then to a borrower’s financial risk. Agreements to
pay one-half of that amount to the lending investment-grade companies are usually thin
group. The issuer gets, after fees, $98 million. and simple. Agreements to leveraged borrow-
Clearly, OID is a better deal for the arranger ers are often much more onerous.
and, therefore, is generally seen in more chal- The three primary types of loan covenants
lenging markets. Upfront fees, conversely, are are affirmative, negative, and financial.
more issuer friendly and therefore are staples Affirmative covenants state what action
of better market conditions. Of course, during the borrower must take to be in compliance
the most muscular bull markets, new-issue with the loan, such as that it must maintain
paper is generally sold at par and therefore insurance. These covenants are usually boil-
requires neither upfront fees nor OIDs. erplate and require a borrower to, for
example, pay the bank interest and fees,
Voting rights provide audited financial statements, pay
taxes, and so forth.
Amendments or changes to a loan agreement
Negative covenants limit the borrower’s
must be approved by a certain percentage of
activities in some way, such as regarding new
lenders. Most loan agreements have three lev-
investments. Negative covenants, which are
els of approval: required-lender level, full
highly structured and customized to a bor-
vote, and supermajority:
rower’s specific condition, can limit the type
● The “required-lenders” level, usually just a
and amount of acquisitions, new debt
simple majority, is used for approval of
issuance, liens, asset sales, and guarantees.
nonmaterial amendments and waivers or
Financial covenants enforce minimum finan-
changes affecting one facility within a deal.
cial performance measures against the bor-
● A full vote of all lenders, including partici-
rower, such as that he must maintain a higher
pants, is required to approve material



level of current assets than of current liabili- mum level of TNW (net worth less intangi-
ties. The presence of these maintenance ble assets, such as goodwill, intellectual
covenants—so called because the issuer must assets, excess value paid for acquired com-
maintain quarterly compliance or suffer a panies), often with a build-up provision,
technical default on the loan agreement—is a which increases the minimum by a percent-
critical difference between loans and bonds. age of net income or equity issuance.
Bonds and covenant-lite loans (see above), by ● A maximum-capital-expenditures covenant
contrast, usually contain incurrence covenants requires that the borrower limit capital
that restrict the borrower’s ability to issue new expenditures (purchases of property, plant,
debt, make acquisitions, or take other action and equipment) to a certain amount, which
that would breach the covenant. For instance, may be increased by some percentage of
a bond indenture may require the issuer to not cash flow or equity issuance, but often
incur any new debt if that new debt would allowing the borrower to carry forward
push it over a specified ratio of debt to unused amounts from one year to the next.
EBITDA. But, if the company’s cash flow dete-
riorates to the point where its debt to EBITDA
ratio exceeds the same limit, a covenant viola-
Mandatory Prepayments
tion would not be triggered. This is because Leveraged loans usually require a borrower
the ratio would have climbed organically to prepay with proceeds of excess cash flow,
rather than through some action by the issuer. asset sales, debt issuance, or equity issuance.
As a borrower’s risk increases, financial ● Excess cash flow is typically defined as

covenants in the loan agreement become cash flow after all cash expenses, required
more tightly wound and extensive. In general, dividends, debt repayments, capital expen-
there are five types of financial covenants— ditures, and changes in working capital.
coverage, leverage, current ratio, tangible net The typical percentage required is 50%
worth, and maximum capital expenditures: to 75%.
● A coverage covenant requires the borrower ● Asset sales are defined as net proceeds of

to maintain a minimum level of cash flow asset sales, normally excluding receivables
or earnings, relative to specified expenses, or inventories. The typical percentage
most often interest, debt service (interest required is 100%.
and repayments), fixed charges (debt serv- ● Debt issuance is defined as net proceeds

ice, capital expenditures, and/or rent). from debt issuance. The typical percentage
● A leverage covenant sets a maximum level required is 100%.
of debt, relative to either equity or cash ● Equity issuance is defined as the net pro-

flow, with total-debt-to-EBITDA level ceeds of equity issuance. The typical per-
being the most common. In some cases, centage required is 25% to 50%.
though, operating cash flow is used as the Often, repayments from excess cash flow
divisor. Moreover, some agreements test and equity issuance are waived if the issuer
leverage on the basis of net debt (total less meets a preset financial hurdle, most often
cash and equivalents) or senior debt. structured as a debt/EBITDA test.
● A current-ratio covenant requires that the

borrower maintain a minimum ratio of Collateral and other protective loan provisions
current assets (cash, marketable securities, In the leveraged market, collateral usually
accounts receivable, and inventories) to includes all the tangible and intangible assets
current liabilities (accounts payable, short- of the borrower and, in some cases, specific
term debt of less than one year), but assets that back a loan.
sometimes a “quick ratio,” in which Virtually all leveraged loans and some of
inventories are excluded from the the more shaky investment-grade credits are
numerate, is substituted. backed by pledges of collateral. In the asset-
● A tangible-net-worth (TNW) covenant based market, for instance, that typically
requires that the borrower have a mini- takes the form of inventories and receivables,


Guide to Loan Market Fundamentals

Guide to Loan Market Fundamentals

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Guide to Loan Market Fundamentals