ECM, DCM and LevFin

Question 1

What is a leveraged loan?

Answer 1

Commercial loan provided by a group of lenders. It is first structured, arranged and administered bygone or several commercial or investment banks, known as arrangers. It is thens old or syndicated to other banks or institutional investors.

Question 2

What characteristics are normally seen on leveraged loans?

Answer 2

Some may use a spread cut-off for example, any loan with a spread of at least LIBOR + 125, or maybe +150, would classify as leveraged.

Others may use reading criteria: any loan rated BB+ or lower would qualify.

A more complex definition:
* Rated BB+ or lower or
* It is not rated or rated BBB- or higher but has
1) A spread of LIBOR +125 or higher and
2) Is secured by a first or second lien

Question 3

What is the approximate amount outstanding of the leveraged loan market in the US?

Answer 3

Approximately $1.3-1.4T

Question 4

What is the approximate amount outstanding of the leveraged loan market in Europe?

Answer 4

Approximately $260bn

Question 5

What was the first initial drive of the leveraged loan market?

Answer 5

Started booming with the large leveraged buyout loans of the mid-1980s

Question 6

Why would issuers prefer leveraged loans over traditional bilateral credit lines?

Answer 6

Syndicated loans are more efficient as risk is distributed over a wider variety of parties; hence, they can also offer more competitive pricing to borrowers

Question 7

What determines the size of the financing fee that an investment bank may charge?

Answer 7

• The complexity of the transaction
• How strong market conditions are at the time
• Whether the loan is underwritten

Question 8

What reasons are there for issuing leveraged loans?

Answer 8

1) To support an M&A-related transaction
2) To back a recapitalisation of a company’s balance sheet
3) To refinance debt
4) To fund general corporate purposes or project finance

Question 9

There are three main types of LBO (buyout) deals. What are they?

Answer 9

Public-to-private: Private equity firm purchases a publicly traded company via a tender offer. In some P2P deals a stub portion of the equity continues to trade on an exchange. In others the company is bought outright

Sponsor-to-sponsor: One private equity firm sells a portfolio company to another

Non-core acquisitions: In which a corporate company sells a division to a private equity firm

Question 10

What is a recapitalisation

Answer 10

Significant change in the composition of an entity’s balance sheet mix between debt and equity

This can be done by either issuing debt to pay a dividend or repurchase stock or selling new equity to repay debt

Question 11

There are three main types of LBO deals. What are they?

Answer 11

Public-to-private: Private equity firm purchases a publicly traded company via a tender offer. In some P2P deals a stub portion of the equity continues to trade on an exchange. In others the company is bought outright

Sponsor-to-sponsor: One private equity firm sells a portfolio company to another

Non-core acquisitions: In which a corporate company sells a division to a private equity firm

Question 12

What is a refinancing?

Answer 12

Entailws a new loan or bonds issue to refinance existing debt

Question 13

What is a build-out financing in a debt issuance?

Answer 13

Build out financing supports a particular project, such as a utility plant, a land deveoplemnt deal, a casino, or an energy pipeline

Question 14

In debt issuance, what is a debt repricing?

Answer 14

Issuer approaches institutional investors, via an arranger (often an investment bank), to lower the interest rate on an existing credit, as opposed to refinancing an existing deal, which requires a more formal syndication process and documentation

Question 15

Why would institutional investors agree to a repricing?

Answer 15

Even though the lower interest rate means they will get less money, in times of high demand for leveraged loan paper, the investors may have little choice but to accept (else the loan may be refinanced

Question 16

What does underwriting debt mean?

Answer 16

An arranger guarantees the entire amount committed, then syndicates the loan

If the arrangers cannot get investors to fully subscribe the loan, they are forced to absorb the difference, which they may later try to sell. The sale will be achievable, in most cases, if market conditions (i.e. decrease in rates) or the credit fundamentals improve. If not, the arranger may be forced to sell at a discount and, potentially, even take a loss on the paper..

Question 17

Why do investment banks underwrite loans?

Answer 17

1) Can be a competitive tool to win other mandates
2) Underwritten loans usually require more lucrative3 fees because the agent is on the hook if potential lenders do not want the paper

Question 18

What is price-flex in the context of leveraged loans?

Answer 18

Flexible interest rates/terms that change depending on investor demand. This decreases the risk of underwriting to investment banks.

Question 19

What is a club deal? (In debt markets)

Answer 19

A smaller loan (usually $25m to $100m, but can be was high as $150m) that is pre-marketed to a group of relationship lenders.

Question 20

What is an IM in the context of leveraged loans?

Answer 20

Information memo that describes the terms of the transaction. The IM will typically include an executive summary, investment considerations, a list of terms and conditions, an industry overview, and a financial model.

Question 21

In an information memo, what sort of things come under terms and conditions?

Answer 21

A preliminary term sheet describing the pricing, structure, collateral, covenants, and other terms of the credit (covenants are usually negotiated in detail after the arranger receives investor’s initial feedback)

Question 22

What are CLOs

Answer 22

Special-purpose vehicles set up to hold and manage pools of leveraged loans.

The SPV is financed with several tranches of debt (typically a ‘AAA’ rated trance, a ‘AA’ tranche, a ‘BBB’ tranche, and a mezzanine tranche) that have rights to the collateral and payment stream, in descending order.

Question 23

In a CLO, which tranche has the highest interest rate?

Answer 23

The lowest rated / most junior debt, because these investors are least likely to get their entire investment back

Question 24

What are loan-orientated mutual funds?

Answer 24

Mutual funds that invest in leveraged loans, which is how retail investors can access the loan market.

Question 25

What is default risk?

Answer 25

The likelihood of a borrower being unable to pay interest or principal on time

Question 26

What does default risk depend on?

Answer 26

Issuers financial condition, industry segment and conditions in that industry, as well as economic variables and intangibles (such as company management)

Question 27

What is the cut-off for investment grade bonds?

Answer 27

Loans to issuers rated BBB- or higher

Question 28

What is the cut-off for leveraged loans?

Answer 28

Borrowers rated BB+ or lower

Question 29

What is the most common place for leveraged loans in the capital structure?

Answer 29

Typically senior, secured instruments and rank. highest in the capital structure

Question 30

What does loss-given-default mean?

Answer 30

Measures how severe a loss the lender is likely to incur in the event of default.

Investors assess this risk based on the collateral (if any) backing the loan and the amount of other debt and equity subordinated to eh loan.

Question 31

What is a facility/commitment fee?

Answer 31

Annual fee based on unused amounts of the RCF

Question 32

In debt facilities, what are acquisition/equipment lines?

Answer 32

Credit lines that may be drawn down for ag even period to purchase specified assets or equipment, or to make acquisitions.

Question 33

In DCM or levfin, what are bridge loans?

Answer 33

Intended to provide short-term financing to provide a “bridge” to an asset sale, bond offering, stock offering, divestiture, etc.

Question 34

In LBO financing, what is a equity bridge loan?

Answer 34

A bridge loan provided by arrangers that is expected to be repaid by a secondary equity commtiemtn in an LBO. This product is used when a PE firm wants to close on a deal that requires a significant amount of equity, but they ultimately want to hold less than the entire equity check.

Therefore, they use this loan as the financing in the mean time, until the additional investor provides the equity.

Question 35

What are covenant-lite loans?

Answer 35

Loans that have bond-like financial incurrence covenants, rather than traditional maintenance covenants that are normally part and parcel of a loan agreement.

Question 36

What are maintenance covenants?

Answer 36

Require an issuer to meet certain financial tests every quarter, whether or not it does any unusual action.

Question 37

What is an interest-rate floor in context of leveraged loan?

Answer 37

If a loan is floating-rate, i.e. linked to a rate such as LIBOR or SONIA, there may be a limit to how low the interest on the loan goes, despite the underlying rate being lower.

Question 38

What are affirmative covenants

Answer 38

State what action the borrower must take to be in compliance with the loan.

These covenants are usually pretty cookie cutter and require a borrower to pay the bank interest and fees, for instance, or to provide audited financial statements, maintain insurance, pay taxes, and so forth.

Question 39

What are negative covenants?

Answer 39

Negative covenants limit the borrower’s activities in some way, such as undertaking new investments.

They can be highly structured and customised to a borrows specific condition, and limit the type and number of acquisitions and investments, new debt issuance, liens, asset sales, and guarentees

Question 40

What are financial covenants?

Answer 40

Enforce minimum financial performance measures against the borrower, such: the company must maintain a higher level of current assets than of current liabilities

Broadly speaking, there are two types of financial covenants: maintencae and incurrence

Question 41

Examples of maintenance covenants?

Answer 41

Issuers must pass agreed-to tests of financial performance such as minimum levels of cash flow coverage and maximum levels of leverage. If an issuer fails to achieve these levels, lenders have the right to accelerate the loan. In most cases, though, lenders will pass on this draconian option and instead grant a waiver in return for some combination of a fee and/oir spread increase; a repayment or a structuring concession such was additional collateral or seniority.

Question 42

Explain incurrence covenant?

Answer 42

Tested only if an issuer takes an action, such as issuing debt or making an acquisition. If,m on a pro forma basis, the issuer fails the test then it is not allowed to proceed without permission of the lenders

Question 43

Examples of financial covenants?

Answer 43

Coverage
Leverage
Current ratio
Tangible net worth
Maximum capital expenditures

Question 44

In levfin, what are equity cures?

Answer 44

Allows issuers to fix a covenant violation by making an equity contribution.

These provisions are generally found in private equity backed deals because they are a right, not an oblifgation. Therefore, a private equity firm will want these provision, which, if they think it is worth it, allows them to cure a violation without going through an amendment processs, during which lenders will often ask for wider spreads and fees, in exchange for waiving the violation, even with an infusion of new equity.

Question 45

In debt markets, what is a technical default?

Answer 45

Occur when the issuer violates a provision of the loan agreement. For instance, if an issuer does not meet a financial covenant test or fails to provide lenders with financial information or some other violation that does not involve payments.

In these cases, the issuer and lender typically agree on an amendment that waives the violation in exchange for a fee, spread increase, and/or tighter terms

Question 46

Got to DIP loans

Answer 46

Got to DIP loans

Question 47

What is LIBOR?

Answer 47

Longstanding interest rate benchmark and is the average interest rate at which leading banks charge one another to borrow.

LIBOR is a forward looking estimate; banks are asked to provide submission s on what rate they believe they can brorrow unsecured from other banks

Question 48

What was the issue with LIBOR?

Answer 48

Because it is a forward looking measure, banks can understate borrowing costs for LIBOR to give the false impression that they were in better financial health then they were in reality

Question 49

In debt markets, what is an alternative risk-free rate?

Answer 49

Alternative risk-free rate, which are alternatives to LIBOR

Question 50

What is SONIA?

Answer 50

Backward looking measure that reflects interest rates that banks pay to borrow sterling overnight from other banks

Question 51

What is tenor of debt?

Answer 51

Length of time the debt is outstanding

Question 52

What is call protection?

Answer 52

A company could be prohibited from repaying the full principal before a specified time§

Question 53

What is a real-world example of a PIK loan?

Answer 53

Student loan!

Question 54

How does PIK interest work in a debt schedule?

Answer 54

Interest adds onto the amount outstanding at the start of the period.

Question 55

How does PIK interest affect the income statement?

Answer 55

Although there is no cash interest expense impact, for book purposes you can expense the PIK interest on the income statement.

Question 56

How does PIK interest affect the cash flow statement?

Answer 56

Added back as a non-cash expense

Question 57

When doing back of the envelope modelling, do you include all rules / accounting practices related to debt?

Answer 57

Usually no, because a lot of these rules make a tiny difference on the financial statements, so you often simplify and skip items like the debt issuance fees and the related amortisation and loss line items

Question 58

How would you define ‘influence’ over a company if you had an equity investment (i.e. less than 50%)?

Answer 58

Usually when a parent company owns a minority stake in another company, such as 20% or 40% of its common shares outstanding.

Technically, companies use the equity investment method when they have significant influence over another company, but NOT control of that other company.

Question 59

What is the fulcrum security?

Answer 59

The security or debt instrument that will at least partially be converted into equity of the reorganised company

Question 60

Make notes on this

Answer 60

https://www.wallstreetoasis.com/files/265576251-LeveragedFinanceHandbook-PDF.pdf

Question 61

What is a rights issue/offering?

Answer 61

The company sells additional shares to its existing investors, and the shares are allocated according to each investor’s “subscription rights” – this deal allows investors to maintain their ownership stakes as the company raises capital.

Question 62

What is a secondary offering?

Answer 62

The company does not raise capital at all – instead, one group of investors sells its shares to another group of investors.

Question 63

What is a block trade?

Answer 63

The investment bank buys shares directly from the client and then resells them to investors. The bank takes on far more risk in this deal, so the issuance price also tends to be lower. This type of transaction is also known as a “bought deal” in some areas.