Bank Lending Flashcards
Types of Facility for bank lending?
- Overdraft
- Term loan
- Revolving credit facility (‘RCF’)
What does an overdraft do?
- An overdraft permits the borrower to borrow (or literally overdraw from its account) up to a specified limit and interest is charged on the daily overdrawn balance.
- The borrower can repay the loan (or repay part of it) and then redraw the money – again up to the specified limit.
How is an overdraft usually granted?
on the bank’s standard terms and conditions, so there is little room for negotiation of these
What is an ‘uncommitted’ facility for overdrafts?
i.e., the bank is not committed by any contract to continue lending the money and may decide to withdraw the facility at any time and for any reason
When is an overdrawn amount payable?
- Any overdrawn amount is legally repayable on demand. This means a bank does not have to wait for a breach of the overdraft agreement by the borrower, to require repayment of an on-demand facility.
What documentation is usually needed for overdrafts?
- Little formal documentation is required – often merely a ‘facility’ letter.
Why are overdrafts used?
- An overdraft is a tool to assist cash flow, i.e., to keep the business liquid.
- It provides a reserve of easily accessible money to meet any shortfalls in working capital. An overdraft is sometimes known as a working capital facility.
- Whilst most companies will have access to an overdraft facility, it is not intended to be a core source of funding but rather a means of dealing with short term funding requirements (e.g., resulting from irregular cash flow due to seasonal fluctuations of the business). Companies which have specific reasons for raising further finance will do so through one, or a combination, of the types of debt facility described below (term loan and revolving credit facility).
What is a term loan?
- This is the most inflexible facility of the three we are looking at.
- A term loan provides a fixed sum for a fixed period.
- The borrowed amount may be fully drawn down in one lump sum or in several ‘tranches’, depending on the terms of the loan agreement.
- It is usually a ‘committed’ facility, i.e., the bank is bound (subject to the terms of the loan agreement) to lend the money and can only demand repayment before the agreed repayment date(s) if there is an event of default under the loan agreement (events of default will be considered in Workshop 3).
- It is repayable by the end of the term according to an agreed repayment schedule set out in the loan agreement.
- Any prepayments (repayments made earlier than due) are usually final (i.e., they cannot be redrawn by the borrower).
- A term loan is most suitable where the borrower needs a specific sum of money for a medium to long period, i.e., for the purchase of property, acquisition of a company, start-up costs.
- Repayments can be structured in a variety of ways including:
· ‘Amortisation’ – repayment of amounts at regular intervals;
· ‘Balloon repayment’ – repayment in several instalments where the final payment is bigger than the rest; and
· ‘Bullet repayment’ – repayment in one instalment at the end of the term.
What is a revolving credit facility?
- A revolving credit facility (‘RCF’) is a commitment by a lender to lend on a recurring basis on predefined terms.
- The bank makes a specific amount of capital available over a specific period, typically three to five years.
- Unlike a term loan, the RCF allows a borrower to draw down and repay (and draw again) amounts of capital during the availability period (see below), subject to the terms of the loan agreement.
· Draw down is the borrower getting money under the facility agreement
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revolving credit facility
How long is the capital avaiible and should be repaid by?
- The capital is made available for a set availability period (e.g., 5 years) and, within that period, individual loans (subject to a minimum size (e.g., £500,000)) are borrowed for an ‘Interest Period’ (generally 1, 3 or 6 months at a time) and repaid at the end of that Interest Period.
Can a borrower have outstanding loans for a revolving credit facility?
- Typically, a loan agreement would specify that a borrower can have no more than a certain amount of loans outstanding (e.g., 5 loans) at any one time. The borrower usually has to give a number of days’ notice to draw down (this depends on the currency).
How do multiple interest periods work together?
- Each loan will have its own Interest Period, so it is common for more than one loan, perhaps with differing Interest Periods, to run concurrently. Different loans under a facility can be drawn down at different times.
- It is usually a committed facility so, provided there is no default, the bank is bound to lend the money and cannot demand early repayment.
What happens at the end of the avilibility period?
- The RCF will cease to be available, and any outstanding drawings will be repayable in full
How does RCF keep interest costs to a minimum?
- The RCF allows a borrower to draw down loans only when it needs the capital and only for the period it needs the capital, thereby keeping interest costs to a minimum.
What is a committment fee?
- A bank will charge a fee called a ‘commitment fee’, which is a percentage of the undrawn amounts of the facility from time to time. A bank charges a commitment fee because it has had to put aside a certain amount of capital based on the total committed facility available to the borrower in order to comply with capital adequacy rules.
What happens when funds are drawn down?
- Each time funds are drawn down (or ‘rolled over’, which means the same amount is deemed repaid and re-borrowed on the same day), the borrower is deemed to repeat certain representations (‘Repeating Representations’) which it originally gave to the lender in the loan agreement.
Why shpuld borrowers under RCF check when repeating representations can be given?
- Consequently, borrowers under an RCF need to check that the Repeating Representations can be given immediately prior to any further drawdown, or they run the risk of triggering an Event of Default. This would apply equally to a multi-tranche term loan. Also, a bank will have the right to temporarily suspend any further lending (‘drawstop’), if the borrower is in default.
Clean down provision?
- A Clean Down provision is often included in an RCF to ensure that the RCF is used to manage cash flow and does not become long term core debt. The lender may achieve this, for example, by requiring the borrower to repay the whole of the facility and retain a ‘nil’ balance for at least five business days in any 12-month period (i.e. ‘cleaning down’).
- RCF’s are often used for working capital (i.e. to provide liquidity for a company’s day to day operations). An RCF combines the:
· flexibility of an overdraft facility (allowing the borrower to withdraw capital only when it is required); and
· certainty of a term loan (an RCF is usually a committed facility).
Capital market instruments?
- Instead of taking out a loan, a borrower may decide to raise finance by issuing a capital markets instrument. The term ‘capital markets’ here refers not to a physical or even a single electronic marketplace, but to the whole global market in which investors provide finance to corporations, governments and other types of issuer in the hope of making a profit on the investment.
- Bonds are the form of capital markets instrument which we will consider on this knowledge stream.
stages of a loan transaction?
- Commonly a borrower will approach its relationship bank with a need to raise finance.
- The arranger bank will commence an initial due diligence process (investigation and credit analysis) with the relationship manager putting together an initial package of terms for the loan.
- The lender’s credit committee will then be consulted for approval of the lending terms.
- A term sheet will be agreed between the lender and the borrower. Solicitors will be instructed by both parties. (NB: in some circumstances a formal term sheet will not be used).
- Solicitors commence due diligence & drafting / negotiation of documentation.
- Signing and completion. Provided any conditions precedent are satisfied, the borrower can draw down funds.
- What is the purpose of due diligence?
- Due diligence by the lender is simply a fact-finding exercise. The purpose of collecting information is to ensure the company’s financial information is as accurate as possible and to focus attention on factors in the business that will be critical to its future success. The lender will want to ensure that the company will be able to pay the principal amount requested and the interest payments payable under the loan. Due diligence is an exercise carried out by or on behalf of the lender.
- The aim is to assess the overall risk of the borrower and any other entity providing security or giving a guarantee for the payment of the loan. Together we call the borrower any such security/guarantee provider the ‘Obligors’. This will be a defined term in the loan agreement.
- Legal due diligence will be carried out at a later stage by the lender’s solicitors. This will involve carrying out a number of searches on the obligors and, if the loan is to be secured, searches on the assets that will be subject to security.
- At some point, the information may reveal that the risk is too great for a bank to lend unless it is able to take security.
- In such cases, due diligence would extend to ascertaining what assets are available for the lender to take as security and the value of those assets.
- The higher the chance of default, the larger the fees and margin a lender will charge to compensate for this risk and the more stringent the documentary provisions it will seek.
- Credit analysis?
· There is no ‘standard’ due diligence procedure. The format and extent of due diligence will vary with the identity of the lender and other factors including:
- Size of the loan;
- Type of loan (committed / uncommitted);
- Whether the loan is to be secured;
- Identity of the borrower (credit rating, jurisdictions involved, whether the borrower is known to the lender) ; and
- Whether the loan is part of a larger transaction.
· The lender will then put together a ‘basic package’ with the borrower, including the headline terms of the deal such as amount and term, repayment dates and main covenants to be given by the borrower in the loan agreement.
· For the purposes of this knowledge stream , this ‘basic package’ will be set out in a term sheet, but other formats could be used by lenders in practice.