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ICAS - AFin > Module 12 > Flashcards

Module 12 Flashcards

1
Q

Types of banks (4)

A
  • Commercial banks
  • Investment banks
  • Universal banks
  • Merchant banks
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2
Q

Commercial banks (3)

A
  • Accept deposits and lend money to individuals, companies and governments
  • Banks lends out money deposited in it
  • Banks borrow money from each other at LIBOR
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3
Q

Investment banks (2)

A
  • Underwrite and distribute initial bond and share issues

- Buy and sell bonds and shares once issued

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4
Q

Universal banks

A

Combine commercial and investment banking activity (although must be kept as separate parts of the business - financial crisis)

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5
Q

Merchant banks (3)

A
  • UK equivalent of US investment banks
  • Originated in UK to help UK exporters get paid by providing trade finance
  • Now form CF divisions of largest universal banks
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6
Q

Traditional role of commercial bank is to

A

Act as intermediary between individuals or companies with surplus funds (lenders) and those with funding requirement (borrowers)

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7
Q

Securitisation =

A

Process of converting illiquid assets (usually property - mortgages) into financial instruments (securities) that can be readily bought and sold in financial markets

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8
Q

Securitisation process (MBS - Mortgage backed securities)

A

1) Mortgages (100s/ 1000s) are grouped together based on yearly mortgage payments bank expects to receive
2) Rights to annual payments are sold as securities to third party eg investment bank
3) Buyers of securities gain right to collect mortgage payments

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9
Q

Two main types of bank facility in UK

A
  • Overdraft facility

- Term loan

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10
Q

Committed facility

A

Lender is contractually obliged to make funds available during the term of the agreement .

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11
Q

Features of committed facility (2)

A
  • Lender stipulates ‘events of default’ - events which trigger the ability of the bank to call for immediate repayment of facility
  • Commitment fee (non-utilisation fee) - cost to company if facility not fully drawn down/ delayed)
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12
Q

Two main types of committed facility

A
  • Term loan

- Revolving credit facility (RCF)

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13
Q

Term loan main characteristic

A

Once drawn, the amount of the loan cannot be increased again without new loan agreement

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14
Q

Four features of term loan

A
  • Maturity
  • Repayment profiles
  • Interest rate
  • Margin
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15
Q

Maturity

A

Can range from one to ten years (or longer) depending on credit standing of the borrower and condition of the bank market at the time. Full amount can be withdrawn at outset or can be made in several tranches over agreed period.

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16
Q

Repayment profiles (3)

A
  • Can be made in single lump sum at final maturity (bullet repayment)
  • OR instalments over a period (amortising)
  • OR balloon payment - smaller regular instalments + disproportionately large final repayment after smaller regular instalments
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17
Q

Interest rate (2)

A
  • Quoted as either percentage or in terms of basis points (one hundredth of one percent)
  • Fixed or floating (eg specified margin over base rate/ LIBOR)
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18
Q

Margin (3)

A
  • Depends on borrower’s credit standing and term of the loan
  • Margin need not remain constant
  • Ratchet/ two way ratchet > agreement for varying the margin in the future > usually related to trading performance
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19
Q

Revolving credit facility (RCF)

A

Provides known amount of readily available funds, which borrower can draw down, repay and redraw over term of facility (usually 1-7 years)

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20
Q

RCF are very flexible debt financing option because

A

Company can minimise interest payments because borrowing fluctuates over time, and never draw down more than needed

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21
Q

Evergreen facility

A

Subject to bank’s agreement, final maturity may be extended annually by further year (far less common today)

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22
Q

Multi-option facilities (MOFs)

A

Revolving credit facility which is available in alternative currencies

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23
Q

Uncommitted facilities =

A

Agreement where bank agrees to make flexible short term funding available to borrower on demand (usually for temporary needs) less costly to arrange

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24
Q

Effective annual cost =

A

1 - (1 + r) ^-n

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25
Q

Overdraft =

A

Overdrawn balance on a current account.

Helps manage working capital requirements

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26
Q

Overdraft facility letter includes (5)

A
  • Amount of limit
  • Period until next review
  • Basis for calc of interest (usually daily at margin over base rate or LIBOR)
  • Interval at which interest is charged
  • Provisions regarding security, guarantees or default
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27
Q

In UK, generally overdrafts are

A

Repayable on demand

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28
Q

Washout clause

A

Requirement for overdraft facility to operate in credit for a specified period of time

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29
Q

Cross default clause

A

Provision that states that a default or demand for repayment on any one facility will constitute an event or default on all committed facilities in question.

Allows bank to take control at first signs of trouble rather than waiting until it’s too late - highly unlikely it can be negotiated away

30
Q

Cross default can be

A

Major threat to continued existence of a company

31
Q

Borrower should seek in cross default clause (2)

A
  • To introduce a materiality limitation

- Exclude overdrafts provided by the same lender from the provisions

32
Q

Lenders’ objectives (2)

A
  • Adequate return

- Repayment of principle on maturity (longer the maturity > greater the risk)

33
Q

Bank credit process > stage 1

A

Request for facilities

From existing or new customer

34
Q

Bank credit process > stage 2

A

Submission of business plan

Initial information sent to bank, and meeting arranged to meet management and discuss plans for future. May visit premises if new client

35
Q

Bank credit process > stage 3

A

Credit sanction considered and documented

Bank manager prepares paper summarising proposed transaction and assessments of likelihood of repayment. Manager may be able to sign off, or use credit committee. Bank will perform due diligence

36
Q

Bank credit process > stage 4

A

Credit sanction granted

Sanction may be conditional on obtaining certain amendments to proposed terms

37
Q

Bank credit process > stage 5

A

Funding provided

May need to go back to stage 3 for revisions, otherwise funding is provided

38
Q

Principle areas considered by lending banker (6)

A
  • Transaction
  • Management
  • The business (market position, industry, performance etc)
  • Forecasts
  • Financial analysis (sensitivity analysis)
  • Security
  • Remuneration
39
Q

Two basic approaches to credit appraisal

A
  • Asset-based lending

- Cash flow lending

40
Q

Asset based lending considerations (3)

A
  • Useful life of asset (vs debt length)
  • Realisable value of asset
  • Other lenders with security over same asset
41
Q

Cash flow lending considerations (eg bus with low fixed assets eg intangibles such as human) (2)

A
  • Is cash flow sufficient to repay?

- Cash flow forecasts and assumptions upon which they’re based

42
Q

Lender’s attitude towards loss > must weigh up

A

Absolute amount of indebtedness versus likely recovery amount

43
Q

Key points for borrower to consider when approaching lender (5)

A
  • Financing purpose
  • Timing
  • Preparation
  • Bank selection
  • Transferability
44
Q

Tender document (bank to client) should include (3)

A
  • Services provided
  • Key contacts
  • Industry knowledge
45
Q

Bilateral facility

A

Bilateral loan involving two parties (lender and borrower)

46
Q

Where company wishes to raise sum in excess of capacity of single bank, can use (2)

A
  • Series of bilateral loans
    OR
  • Syndicated loan
47
Q

Series of bilateral facilities > advantages (4)

A
  • Borrower maintains direct operational relationship with each bank
  • Arrangement offers flexibility
  • Lower front-end fee structure should be achieved
  • Possible to play banks off against each other
48
Q

Series of bilateral facilities > disadvantages (2)

A
  • Time consuming and complex to develop documentation for each bank
  • Involves much greater workload to manage multiple lenders
49
Q

Syndication =

A

Group of banks work together to provide funds for a borrower.

Required agent bank (arranger) responsible

50
Q

Agent bank > syndication (3)

A
  • Acts as arranger
  • Responsible for administration of credit
  • Negotiates with borrower
51
Q

Syndication > advantages (3)

A
  • Gives access to larger amount of finance where exposure for individual bank too large
  • Faster process than bilateral
  • Logistics or raising large amounts more straightforward
52
Q

Syndication > disadvantages (2)

A
  • Borrower negotiates with agent instead of lenders

- Renegotiation, extension, revisions are difficult to arrange as require agreement from all syndicate members

53
Q

Tender panel facilities (syndication)

A

Borrower agrees facility limit with group of banks, but no pricing agreed. Borrower then contacts agent bank when needs facility, and syndicate banks tender how much of drawing they’d be willing to fund and at what price

Only available to largest corporate borrowers

54
Q

Fees and expenses of arranging credit facility (5)

A
  • Commitment fees
  • Agency fees (agent bank)
  • Legal fees (own + cost of lenders)
  • Advertising costs
  • Prepayment fees (penalty for early cancellation)
55
Q

Borrower must ______ answers made to banks regarding their initial screening questions

A

Warrant

56
Q

Two types of representations and warranties

A
  • Legal validity and enforceability

- Financial and commercial condition

57
Q

Representation and warranties required (4)

A
  • At signing of agreement
  • Subsequent draw down
  • Rollover
  • Interest payment date
58
Q

Guarantee

A

Sought when lender is unsure of the borrower’s ability to repay a loan. In the event of a default, the lender seeks repayment from the guarantor

59
Q

Need for guarantee (3)

A
  • Parent company guarantee may be sought for borrowing by a subsidiary
  • Upstream guarantees required where the borrower is a holding company whose assets are primarily shareholdings in asset-owning subsids
  • Multiple guarantors may be involved in borrowings made by joint venture subsidiaries
60
Q

Breach of covenant =

A

Event of default

61
Q

Examples of covenants

A
  • Provision of information
  • Negative pledges
  • Asset disposal restrictions
  • Restrictions on business acquisitions
  • Financial covenants
62
Q

Provision of information

A

Provide bank with copies of published financial information

63
Q

Negative pledges

A

Prevents other creditors from obtaining a preferred claim over the assets of the borrower in the event of an insolvency

64
Q

Asset disposal restrictions

A

Borrower required to guarantee it will not dispose of a material part of its assets without prior consent of the bank

65
Q

Financial covenants

A

Clauses under which the borrower undertakes that it will conduct its financial affairs within certain specified limits or constraints

66
Q

Four common covenants

A
  • Minimum tangible net worth
  • Maximum borrowing ratio or limit (max debt: equity ratio)
  • Minimum interest cover
  • Maximum debt to cash flow from operations limit
67
Q

Tangible net worth =

A

Value of a company’s total tangible assets minus total liabilities

68
Q

When event of default occurs, bank has legal right to

A

Demand immediate repayment of any outstanding amounts lent, and to cancel obligation to make further loans

69
Q

Loan documentation will include in relation to default (6)

A
  • Grace periods
  • Materiality
  • Cross default
  • Change of control
  • Enforcement and waivers
  • Material adverse change
70
Q

Miscellaneous changes in loan circumstances (4)

A
  • Increased costs
  • Illegality
  • Taxes
  • Market disruption
71
Q

Operating credit facilities (2)

A
  • Relationship banking

- Fintech

ICAS - AFin (21 decks)

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