HOFIS 13 - Leveraged Loans

Question 1

Leveraged Loans

Answer 1

A loan made to a company whose credit rating is speculative grade.

Question 2

Speculative grade cutoff

Answer 2

Below BBB-/Baa3 (BB+ and below)

Question 3

State the key characteristics of a leveraged loan

Answer 3

1. A loan made to a company whose credit rating is speculative grade.
2. Loans that are broadly syndicated (10+ bank and nonbank investors).
3. Senior secured loans that are at the top-most rank in the borrower’s capital structure.
4. Larger loans to larger companies.

Question 4

Describe how leveraged loans can help mitigate risks for investors

Answer 4

• Covenants: must be satisfied by the loan issuer
• Senior secured loans are the top of the borrower’s capital structure
• Broad syndication spreads risk to multiple lenders
• Empirical results show that ultimate recovery rates were higher for loans compared to bonds

Question 5

Syndicated loan

Answer 5

a single loan with a single set of terms, but multiple lenders, each providing a portion of the funds

Question 6

Advantage of syndication of a loan from borrower’s perspective

Answer 6

• Allows corporate to negotiate loan terms once, while at the same time having access to multiple lenders
• Avoids conflicts in priority from arising that might otherwise occur if the borrower serially negotiated loans

Question 7

Syndicated Bank Loans Issuance Basis

Answer 7

• Underwritten: the portions that are not subscribed for are taken onto the arranger’s books.
• Best-efforts: the total size may be variable and the arranger is not obligated to reach a target level of funding.
• Market-flex language: borrowers give arrangers the flexilibility to adjust loan terms and pricing to ensure full subscription.

Question 8

Classification of leveraged loans

Answer 8

1. Pro rata loans that are distributed to banks and usually involve the revolving line of credit and shorter maturity term loans.
2. Institutional loans that are distributed to nonbank institutional investors and typically include longer-maturity term loans.

Question 9

Three forms of Loan Credit Agreement

Answer 9

1. Representations and warranties made by the borrower.
2. Affirmative covenants.
3. Negative covenants.

Question 10

Loan Credit Agreement Incurrent requirements

Answer 10

Review of specific operating measures after an issuer has taken an action to trigger to review

Question 11

Leverage Loans purposes of covenants

Answer 11

• Preservation of capital - ensure legal, valid, and enforceable pledged colleratal at both loan closing and subsequent times
• Appropriation of excess cash flow - excess cash flow from borrow is required to be used to prepay loans (e.g. cannot liquidate assets to equityholders first)
• Control of business risk - generally debtholders prefer less risk, so covenants can help monitor decision-making (if this wasn’t restricted, think of the moral hazard concerns)
• Performance requirements - if certain ratios or other requirements are not met, then the loan becomes due and must be liquidated immediately
• Reporting requirements - this helps monitor the borrower and ensure that performance thresholds are met

Question 12

Three factors influencing leverage loans’ spreads

Answer 12

1. Credit quality/rating of the borrower
2. Size of the loans
3. Supply and demand of new issues

Question 13

Two methods by which loans in the secondary market change hands

Answer 13

• By assignment - buyer becomes the lender of record with all related rights and powers
• By participation - buyer receives the right to repayment but the original lender remains the lender of record (greater credit risk)