ECM, DCM and LevFin Flashcards
What is a leveraged loan?
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.
What characteristics are normally seen on leveraged loans?
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
What is the approximate amount outstanding of the leveraged loan market in the US?
Approximately $1.3-1.4T
What is the approximate amount outstanding of the leveraged loan market in Europe?
Approximately $260bn
What was the first initial drive of the leveraged loan market?
Started booming with the large leveraged buyout loans of the mid-1980s
Why would issuers prefer leveraged loans over traditional bilateral credit lines?
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
What determines the size of the financing fee that an investment bank may charge?
- The complexity of the transaction
- How strong market conditions are at the time
- Whether the loan is underwritten
What reasons are there for issuing leveraged loans?
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
There are three main types of LBO (buyout) deals. What are they?
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
What is a recapitalisation
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
There are three main types of LBO deals. What are they?
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
What is a refinancing?
Entailws a new loan or bonds issue to refinance existing debt
What is a build-out financing in a debt issuance?
Build out financing supports a particular project, such as a utility plant, a land deveoplemnt deal, a casino, or an energy pipeline
In debt issuance, what is a debt repricing?
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
Why would institutional investors agree to a repricing?
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
What does underwriting debt mean?
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..
Why do investment banks underwrite loans?
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
What is price-flex in the context of leveraged loans?
Flexible interest rates/terms that change depending on investor demand. This decreases the risk of underwriting to investment banks.
What is a club deal? (In debt markets)
A smaller loan (usually $25m to $100m, but can be was high as $150m) that is pre-marketed to a group of relationship lenders.
What is an IM in the context of leveraged loans?
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.
In an information memo, what sort of things come under terms and conditions?
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)
What are CLOs
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.
In a CLO, which tranche has the highest interest rate?
The lowest rated / most junior debt, because these investors are least likely to get their entire investment back
What are loan-orientated mutual funds?
Mutual funds that invest in leveraged loans, which is how retail investors can access the loan market.
What is default risk?
The likelihood of a borrower being unable to pay interest or principal on time
What does default risk depend on?
Issuers financial condition, industry segment and conditions in that industry, as well as economic variables and intangibles (such as company management)
What is the cut-off for investment grade bonds?
Loans to issuers rated BBB- or higher
What is the cut-off for leveraged loans?
Borrowers rated BB+ or lower
What is the most common place for leveraged loans in the capital structure?
Typically senior, secured instruments and rank. highest in the capital structure
What does loss-given-default mean?
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.
What is a facility/commitment fee?
Annual fee based on unused amounts of the RCF
In debt facilities, what are acquisition/equipment lines?
Credit lines that may be drawn down for ag even period to purchase specified assets or equipment, or to make acquisitions.
In DCM or levfin, what are bridge loans?
Intended to provide short-term financing to provide a “bridge” to an asset sale, bond offering, stock offering, divestiture, etc.
In LBO financing, what is a equity bridge loan?
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.
What are covenant-lite loans?
Loans that have bond-like financial incurrence covenants, rather than traditional maintenance covenants that are normally part and parcel of a loan agreement.
What are maintenance covenants?
Require an issuer to meet certain financial tests every quarter, whether or not it does any unusual action.
What is an interest-rate floor in context of leveraged loan?
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.
What are affirmative covenants
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.
What are negative covenants?
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
What are financial covenants?
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
Examples of maintenance covenants?
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.
Explain incurrence covenant?
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
Examples of financial covenants?
Coverage
Leverage
Current ratio
Tangible net worth
Maximum capital expenditures
In levfin, what are equity cures?
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.
In debt markets, what is a technical default?
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
Got to DIP loans
Got to DIP loans
What is LIBOR?
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
What was the issue with LIBOR?
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
In debt markets, what is an alternative risk-free rate?
Alternative risk-free rate, which are alternatives to LIBOR
What is SONIA?
Backward looking measure that reflects interest rates that banks pay to borrow sterling overnight from other banks
What is tenor of debt?
Length of time the debt is outstanding
What is call protection?
A company could be prohibited from repaying the full principal before a specified time§
What is a real-world example of a PIK loan?
Student loan!
How does PIK interest work in a debt schedule?
Interest adds onto the amount outstanding at the start of the period.
How does PIK interest affect the income statement?
Although there is no cash interest expense impact, for book purposes you can expense the PIK interest on the income statement.
How does PIK interest affect the cash flow statement?
Added back as a non-cash expense
When doing back of the envelope modelling, do you include all rules / accounting practices related to debt?
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
How would you define ‘influence’ over a company if you had an equity investment (i.e. less than 50%)?
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.
What is the fulcrum security?
The security or debt instrument that will at least partially be converted into equity of the reorganised company
Make notes on this
https://www.wallstreetoasis.com/files/265576251-LeveragedFinanceHandbook-PDF.pdf
What is a rights issue/offering?
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.
What is a secondary offering?
The company does not raise capital at all – instead, one group of investors sells its shares to another group of investors.
What is a block trade?
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.
