A Syndicated Loan Primer Managing Director S&P Capital IQ Steven C. Miller New York (1) 212-438-2715 [email protected] Follow us on Twitter LeveragedLoan.com September 2014 Contents Loan Purposes ....................................................................................... 4 Types of Syndications .............................................................................. 5 The Syndication Process ........................................................................... 5 Public Versus Private .............................................................................. 7 Credit Risk: An Overview .......................................................................... 8 Syndicating a Loan by Facility ................................................................... 10 Pricing a Loan in the Primary Market .......................................................... 10 Types of Syndicated Loan Facilities ............................................................ 11 Lender Titles ....................................................................................... 14 Secondary Sales .................................................................................... 14 Participations ...................................................................................... 15 Loan Derivatives ................................................................................... 15 Pricing Terms ...................................................................................... 16 Loan Math—The Art of Spread Calculation .................................................... 20 Default and Restructuring ....................................................................... 21 Bits and Pieces ..................................................................................... 22 2 (3) whether the loan is underwritten. Merger and A Syndicated Loan acquisition (M&A) and recapitalization loans will likely carry high fees, as will exit financings and Primer restructuring deals. Seasoned leveraged issuers, by contrast, pay lower fees for refinancings and add-on transactions. Because investment-grade loans are infrequently drawn down and, therefore, offer drastically lower yields, the ancillary business is as A syndicated loan is a commercial loan important a factor as the credit product in arranging provided by a group of lenders and such deals, especially because many acquisition-related financings for investment-grade structured, arranged, and administered by companies are large in relation to the pool of potential one or several commercial or investment investors, which would consist solely of banks. banks known as arrangers. The “retail” market for a syndicated loan consists of Starting with the large leveraged buyout banks and, in the case of leveraged transactions, fi- (LBO) loans of the mid-1980s, the nance companies and institutional investors such as mutual funds, structured finance vehicles, and hedge syndicated loan market has become the funds. Before formally launching a loan to these retail dominant way for issuers to tap banks and accounts, arrangers will often read the market by in- other institutional capital providers for loans. formally polling select investors to gauge their appe- The reason is simple: Syndicated loans are tite for the credit. Based on these discussions, the less expensive and more efficient to arranger will launch the credit at a spread and fee it administer than traditional bilateral, or believes will clear the market. Until 1998, this would individual, credit lines. have been it. Once the pricing was set, it was set, except in the most extreme cases. If the loan were undersubscribed, the arrangers could very well be left Arrangers serve the time-honored investment-banking above their desired hold level. After the Russian debt role of raising investor dollars for an issuer in need of crisis roiled the market in 1998, however, arrangers capital. The issuer pays the arranger a fee for this adopted market-flex language, which allows them to service, and, naturally, this fee increases with the change the pricing of the loan based on investor de- complexity and riskiness of the loan. As a result, the mand—in some cases within a predetermined most profitable loans are those to leveraged borrow- range—as well as shift amounts between various ers—issuers whose credit ratings are speculative grade tranches of a loan, as a standard feature of loan com- and who are paying spreads (premiums above LIBOR mitment letters. Market-flex language, in a single or another base rate) sufficient to attract the interest of stroke, pushed the loan syndication process, at least in nonbank term loan investors, typically LIBOR+200 or the leveraged arena, across the Rubicon, to a higher, though this threshold moves up and down full-fledged capital markets exercise. depending on market conditions. Initially, arrangers invoked flex language to make loans By contrast, large, high-quality companies pay little or more attractive to investors by hiking the spread or no fee for a plain-vanilla loan, typically an unsecured lowering the price. This was logical after the volatility revolving credit instrument that is used to provide introduced by the Russian debt debacle. Over time, support for short-term commercial paper borrowings however, market-flex became a tool either to increase or or for working capital. In many cases, moreover, these decrease pricing of a loan, based on investor demand. borrowers will effectively syndicate a loan themselves, using the arranger simply to craft Because of market-flex, a loan syndication today documents and administer the process. For leveraged functions as a “book-building” exercise, in issuers, the story is a very different one for the bond-market parlance. A loan is originally launched to arranger, and, by “different,” we mean more lucrative. market at a target spread or, as was increasingly A new leveraged loan can carry an arranger fee of common by the late 2000s, with a range of spreads 1-5% of the total loan commitment, generally referred to as price talk (i.e., a target spread of, say, speaking, depending on (1) the complexity of the LIBOR+250 to LIBOR+275). Investors then will transaction, (2) the strength of market conditions, and 3 make commitments that in many cases are tiered by • Sponsor-to-sponsor (S2S) deals, where one the spread. For example, an account may put in for private equity firm sells a portfolio property $25 million at LIBOR+275 or $15 million at LI- to another. BOR+250. At the end of the process, the arranger will total up the commitments and then make a call on • Noncore acquisitions, in which a corporate where to price, or “print,” the paper. Following the issuer sells a division to a private equity firm. example above, if the paper is oversubscribed at LI- BOR+250, the arranger may slice the spread further. 2) Platform acquisitions. Transactions in which Conversely, if it is undersubscribed even at LI- private-equity-backed issuers buy a business that they BOR+275, then the arranger may be forced to raise the judge will be accretive by either creating cost savings spread to bring more money to the table. and/or generating expansion synergies. 3) Strategic acquisitions. These are similar to plat- Loan Purposes form acquisitions but are executed by an issuer that is not owned by a private equity firm. For the most part, issuers use leveraged loan proceeds for four purposes: (1) supporting a merger- or acqui- Recapitalizations sition-related transaction; (2) backing a recapitaliza- tion of a company’s balance sheet; (3) refinancing A leveraged loan backing a recapitalization results in debt; and (4) funding general corporate purposes or changes in the composition of an entity’s balance project finance. sheet mix between debt and equity either by (1) issu- ing debt to pay a dividend or repurchase stock, or (2) Mergers and acquisitions selling new equity, in some cases to repay debt. M&A is the lifeblood of leveraged finance. There are Some common examples: the three primary types of acquisition loans: Dividend. Dividend financing is straightforward. A 1) Leveraged buyouts (LBOs). Most LBOs are company takes on debt and uses proceeds to pay a backed by a private equity firm, which funds the dividend to shareholders. Activity here tends to track transaction with a significant amount of debt in the market conditions. form of leveraged loans, mezzanine finance, high-yield bonds, and/or seller notes. Debt as a share Bull markets inspire more dividend deals as issuers tap of total sources of funding for the LBO can range from excess liquidity to pay out equity holders. In weaker 50% to upwards of 75%. The nature of the transaction markets activity slows as lenders tighten the reins, and will determine how highly it is leveraged. usually look skeptically at transactions that weaken an issuer’s balance sheet. Issuers with large, stable cash flows usually are able to support higher leverage. Similarly, issuers in Stock repurchase. In this form of recap deal a com- defensive, less-cyclical sectors are given more latitude pany uses debt proceeds to repurchase stock. The than those in cyclical industry segments. Finally, the effect on the balance sheet is the same as a dividend, reputation of the private equity backer (sponsor) also with the mix shifting toward debt. plays a role, as does market liquidity (the amount of institutional investor cash available). Stronger markets Equity infusion. These transactions typically are seen usually allow for