Leveraged Commentary & Data (LCD): Leveraged Loan Primer Table of Contents Syndicated Loans: The Market and the Mechanics .................1 Loan Investors ............................................................................. 2 What Are Loans Used For? ......................................................... 3 Public Versus Private .................................................................. 5 Syndicating a Loan by Facility ................................................... 6 Pricing a Loan in the Primary Market ........................................ 6 European Investors ..................................................................... 7 Credit Risk ................................................................................... 8 Arrangers and Lender Titles ....................................................... 9 The Shapes, Sizes, and Formats of Loans .............................10 The Bank Book .......................................................................... 10 Covenants .................................................................................. 12 Types of Syndicated Loan Facilities ........................................ 14 Loan Pricing .............................................................................. 16 Fees ............................................................................................ 17 Asset-Based Lending ............................................................... 18 The Post-Launch Life of a Loan .............................................19 Secondary Sales ....................................................................... 19 Prepayments/Non-call Features ............................................ 19 Amendments and Waivers ....................................................... 20 Defaults and Restructuring ..................................................... 20 Regulatory Issues ..................................................................... 22 Loan Derivatives........................................................................ 22 Glossary ................................................................................24 Syndicated Loans: The Market and the Mechanics A syndicated loan is a commercial credit provided by a group of are large in relation to the pool of potential investors, which lenders. It is structured, arranged, and administered by one or would consist solely of banks. several commercial or investment banks, known as arrangers. The “retail” market for a syndicated loan consists of banks Since the leveraged buyout (LBO) boom of the mid-1980s in the and, in the case of leveraged transactions, finance companies U.S., the syndicated loan market has become the dominant way and institutional investors such as mutual funds, CLOs, hedge for issuers around the world to tap banks and other institutional funds, and pension funds. Before formally launching a loan to capital providers for loans. The reason is simple: Syndicated these retail accounts, arrangers will often “read” the market by loans are less expensive and more efficient to administer than informally polling select investors to gauge their appetite for the traditional bilateral—or individual—credit lines. credit. Based on these discussions, the arranger will launch the credit at a spread and fee it believes will be attractive enough In the syndicated loan world, arrangers serve the time-honored for investors. investment-banking role of raising investor dollars for an issuer in need of capital. The issuer pays the arranger a fee for this Before 1998, that would have been the full extent of deal service, and naturally, this fee increases with the complexity pricing. Once the spread and fee were set, they would not and riskiness of the loan. As a result, the most profitable loans change, except in the most extreme cases. As a result, if the are those to leveraged borrowers—issuers whose credit ratings loan were undersubscribed, the arrangers could very well be left are speculative grade and who are paying spreads (premiums above their desired hold level. above LIBOR or another base rate) sufficient to attract the After the Russian debt crisis roiled the market in 1998, interest of non-bank term loan investors (that rate is typically however, arrangers adopted market flex language to make LIBOR+200 or higher, though this threshold moves up and loans more attractive to investors by raising the spread or down, depending on market conditions). lowering the price during difficult syndication processes in By contrast, large, high quality (investment grade) companies volatile markets. Over time, however, market flex became a tool pay little or no fee for a plain vanilla loan, typically an unsecured to either increase or decrease pricing of a loan based on revolving credit that is used to provide support for short term investor demand. commercial paper borrowings or for working capital. In many Market flex allows arrangers to change the pricing of the loan— cases, moreover, these borrowers will effectively syndicate a in some cases within a predetermined range—as well as shift loan themselves, using the arranger simply to craft documents amounts between various tranches of a loan, as a standard and administer the process. feature of loan commitment letters. For leveraged issuers, the transactions are much more Market flex language, in a single stroke, pushed the loan complicated—and theoretically more risky—meaning they syndication process, at least in the leveraged arena, into a full- can be more lucrative for arrangers. A new leveraged loan can fledged capital markets exercise. It became even more carry an arranger fee of 1% to 5% of the total loan commitment, important as the leveraged loan secondary continued to grow, depending on the complexity of the transaction, the strength of as flex allowed the market to adjust deal pricing to appropriate market conditions, and whether the loan is underwritten. levels in the primary market, reducing instances of major price The more complex the transaction and situation, the higher the fluctuation once a credit frees to trade. fee. Thus, merger-and-acquisition (M&A) and recapitalization Because of market flex, the syndication of a loan today loans will likely carry high fees, as will bankruptcy exit functions as a “book-building” exercise, in bond-market financings and restructuring deals for struggling issuers. parlance. Specifically, a loan is originally launched to market at Seasoned leveraged borrowers, in contrast, pay lower fees for a target spread or with a range of spreads referred to as refinancings and transactions where the debt is simply an add- “price talk” (e.g., a target spread of LIBOR+250 to LIBOR+275). on to an existing credit. Investors then will make commitments that in many cases are Because investment grade loans are infrequently drawn tiered by the spread. For example, an account may put in for down, and therefore offer drastically lower yields, the ancillary $25 million at LIBOR+275 or $15 million at LIBOR+250. business is as important a factor as the credit product in arranging such deals. This is especially true because many acquisition-related financings for investment grade companies 1 At the end of the process, the arranger will total up the Loan Investors commitments and then make a call on where to price, or “print,” the loan. Following the example above, if the paper is There are three primary-investor constituencies: banks, finance oversubscribed at LIBOR+250, the arranger may reduce the companies, and institutional investors. spread further. Conversely, if it is undersubscribed even at LIBOR+275, the arranger may be forced to raise the spread to Banks attract additional investor interest. In this case, the term “bank” can refer to commercial banks, savings and loan institutions, or securities firms that usually Sponsorship provide investment grade loans. These deals are typically large Many leveraged companies are owned by one or more revolving credits that back commercial paper or are used for private equity firms. These firms, such as Blackstone, KKR, general corporate purposes or, in some cases, acquisitions. or Carlyle Group, invest in companies that have leveraged For leveraged loans, banks typically provide unfunded capital structures. To the extent that the sponsor group has revolving credits, LOCs, and—although they are becoming less a strong following among loan investors, a loan will be easier common—amortizing term loans (typically called a term loan A to syndicate, and can therefore be priced lower. In contrast, or TLA), under a syndicated loan agreement. if the sponsor group does not have a loyal set of relationship lenders—or has a reputation for aggressive financial Finance companies behavior—the deal may need to be priced higher to clear Finance companies exist almost exclusively in the U.S. where the market. Among banks, investment factors may include they consistently represent less than 10% of the leveraged loan whether or not the bank is party to the sponsor’s equity fund. market. They borrow money to fund their loans, and tend to play Among institutional investors, weight is given to an individual in smaller deals—$25 million to $200 million. These investors deal sponsor’s track record in fixing its own impaired deals by often seek asset-based loans (ABLs) that carry wide spreads, stepping up with additional equity or replacing a management and that often feature time-intensive collateral monitoring. team that is failing. However, they have failed to materialize