BPP University College Of Professional Studies Limited (BPP)
Concentrated notes for BPP's Debt Finance Elective Module. Contains key things you need to know from the course across all the seminars. These notes are distinction level in detail and useful for online exams.
BPP University College Of Professional Studies Limited (BPP)
BPP University College Of Professional Studies Limited
Debt Finance
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● Bank always intends to get its money back regardless of risk – various
1. OVERVIEW OF A BANKING TRANSACTION, provisions of the loan agreement reflect this
SYNDICATION AND TERM SHEET o Lenders aim: protect its investment whilst maximising the probability
of being repaid and turning a profit
BANKING SYSTEM o Borrowers aim: cheapest available funds whilst retaining flexibility
and longevity concerning the running of its business
Banks act as conduit for lending: ● Compromise position: various factors influence the conclusive position and
● Utilise deposits and interbank market for lending opportunities the result differs from deal to deal:
o Party bargaining strength
LIBOR “London interbank Offered Rate”:
o Market conditions
● “Interbank Offered Rate” is the rate in which banks are prepared to lend to
other banks on the (interbank) market (amount of interest to pay v amount
TYPES OF FACILITY
borrowed)
● LIBOR’s vary depending on credit rating, loan term length and interbank
market liquidity. 1. OVERDRAFT
● Syndicate lenders use ICE LIBOR – average LIBOR rate (or “Screen rate”); A corporate overdraft is very similar to a personal overdraft (apart from size):
the interest rate due to each syndicate member separately is usually ● Permits the borrower to borrow up to a limit and interest is charged daily
calculated by the Agent. on the overdrawn balance
Regulation: ● ‘Unaccommodated facility’: bank is not committed by contract and may
● Manipulation of LIBOR is a criminal offence (s.91 FSA) withdraw the facility at any time (banks standard terms and conditions)
● A person carrying on a ‘specified activity’ in relation to a ‘specified ● Little negotiation and formal documentation involved, and the facility is
investment’ in the UK requires authorisation from the FCA under FSMA legally repayable on the banks demand
2000 ● Function: tool to assist cash flow problems – easily accessible money and
o Lending is not a ‘specified activity’, but ‘accepting deposits by way not intended as a core source of money
of business’ is – no FCA authorisation is a criminal offence
2. TERM LOAN
CAPITAL ADEQUACY RULE: A term loan is the most inflexible facility a bank offers:
● Fixed sum over a fixed period
● Principle: The more share capital a company has the more losses it can
● Can be fully drawn (lump sum payment) or in several tranches
make before its creditors lose out (insolvency priority)
● ‘Committed Facility’: Bank is bound to lend (loan agreement) and can only
● The capital adequacy rules require the banks to maintain a certain level of
demand acceleration if an EOD occurs
share capital vs the amount of debt they lend, to protect depositors in an
● Sum is fully repayable at the end of the term
EOD
● Any repayments are usually not returnable and structured variously:
● Risk weighting is assigned to each loan made by the bank to reflect risk of
o Amortisation: repayment amounts in regular intervals
an EOD by the borrow
● Risk weighting determines how much capital the bank needs available: o Balloon Repayment: several instalments, with a final big one
insufficient capital means the bank will either: o Bullet Repayment: repayment in one lump sum at end of term
o Raise further capital (issuing shares); or ● Function: most useful for a borrower needing a specific sum for a fixed
o Transfer debts off its balance sheet medium/long term (property, acquisitions and start-ups)
● Basel Accords – currently Basel II – encourage a common international
approach to risk sensitivity of capital adequacy requirements using either:
3. REVOLVING CREDIT FACILITY (RCF)
o The “Standardised” Approach – external credit rating agencies An RCF is a commitment to lend on a recurring basis on predefined terms:
o The “Internal Ratings Based” Approach – internal assessment ● Lender makes a specific amount of capital available over a specified period,
normally between 3 and 5 years
KEY BUSINESS ISSUES FOR BANKS: ● Borrower draws-down & repay as it chooses in the period
● Lender/borrower relationship – loans are a financial product therefore ● Limitations in the agreement reduce administrative burden on lender:
desirability of an ongoing relationship is paramount o E.g. set availability period, de minimus loan size, predefine interest
● Risk – banks need to ensure that they are protected against credit risk – risk period (1-6 months per loan), repaid at end of period
is correlated with return (high risk loan = high Interest) o Typically, also specified that a maximum number of loans may be
● Recourse – banks needs to ensure there is sufficient assets as a ‘recourse’ outstanding (e.g. 5) before one must be repaid to allow a new draw-
for a potential failure to repay the loan (effects structuring of agreement) down
● Profit: Cost-Plus Loans – banks want to turn a profit on their investments o Notification for draw-down usually required
based on interest rates charged: ● Individual draw-downs are therefore short-term in nature
o Cost – cost of lending money (cost of funds on depositor’s money ● Draw-downs can be ‘rolled-over’ so as to continue as opposed to being
used and any interest on interbank borrowing) repaid and immediately redrawn (flexibility for borrower)
o Cost-Plus Basis: LIBOR fluctuates therefore cost is calculated as: ● ‘Committed Facility’: Bank is bound to lend (loan agreement) and can only
▪ LIBOR + Mandatory Costs + Profit Margin demand acceleration if an EOD occurs
o Mandatory Costs: costs associated with certain regulatory funding ● Commitment Fee: Fee charged; a percentage of the undrawn amounts that
requirements (e.g. FCA fees) the lender is required to put aside from its capital to facilitate the loan
o Profit Margin: reflects risk attached to loan ● Repeating representations can cause issue (discussed later)
● Clean Down Provision: often included at lenders wish – may require
LENDER/BORROWER RELATIONSHIP borrower to repay full amount for at least 5 business days per 12 months
(prevents RCF turning into a long-term core debt)
Loans are a bank’s assets and represent a steady stream of income ● Function: RCF’s are often used to facilitate working capital struggles –
‘Facility’: a generic term used to describe various forms of commercial lending combines flexibility of overdraft and certainty of a term loan
o Borrower can borrow and repay correlating with need for funds
Relationship Tension:
thereby potentially reducing interest payable
1
, ● Term Sheet: Key terms starting point for bilateral/syndicated loans;
contains both deal specific and boilerplate clauses:
o The term sheet is normally attached to the mandate letter
BILATERAL LOANS V SYNDICATE LOANS with any legally binding provisions being set out in the
mandate letter (confidentiality and costs etc.)
Bilateral Loan: Contract between a lender and borrower o Sets out the principal key terms of the loan that are not
Syndicate Loan: Contract between several lenders (syndicate) and a borrower on meant to be non-legally binding but morally enforceable
the same terms in single loan agreement ▪ Apart from confidential undertakings and ‘drop-dead
● Syndicate facilities can range from between small sums (£20m) to huge fee’ (i.e. costs and expenses of the bank that are paid
‘jumbo’ facilities (200 lenders+) whether or not the transaction signs) which are usually
● Syndicate (due to the several lenders involved) bring added features and expressed as legally binding.
considerations regarding roles such as ‘agent’ and ‘arranger’ o Function: provides an overview of the deal serving as an initial
● Provisions of the loan agreement govern the responsibilities and liability summary of the fundamental terms of the loan
Negotiation of Finance Documents
COMMON FEATURES OF LOANS ● Loan Agreement, any guarantee’s, the debenture and the fee letter
Borrower Satisfies Condition Precedent
● Often dealt with in the legal opinion
STAGES OF A LOAN
Legal opinions
Initial Investigation: Credit Analysis ● Legal Opinion: letter confirming the corporate capacity of the
● No standardised approach to the procedure; varies having regard to borrower and the finance documents are legally valid, binding and
factors such as loan size, term length, type of loan, security, enforceable:
relationship and overall facility structure o Lenders solicitor usually give the legal opinion
● Relationship Manager puts together an initial basic package of o Addressed to the lender (bilateral) or agent (syndicate)
headline terms (Inc. amount, term, repayment dates and main o Applies to matters of law, not question of fact
covenants) set out in a term sheet
o Not a guarantee of the borrower’s ability to service the loan
Credit Approval
o Contains qualifications to limit scope (limit liability of solicitor)
● Banks Internal Credit Committee has the ultimate say on whether the
● Should include:
loan can be made (having regard to the banks overall position)
o Borrower is properly incorporated and not in liquidation
● Approval is not automatic; factors considered include industry sector
o Borrower has the power to enter the contract
risk, type of facility, type of borrower, internal limits etc.
o All necessary registration, licenses & consents to validate the
● Credit Committee may approve, amend or reject the lending proposal
documents have been obtained
Legal Due Diligence
o Documents are fully binding
● Fact-finding exercise; flushes out any potential problems; assesses the
Completion
overall credit risk attached to lending to the borrower
● The finance documents will be signed
● Involves numerous searches (e.g. Companies House) and assessment
Utilisation
of the company’s ability to receive the loan (e.g. restrictions in articles
● The first draw-down of funds occurs. Notice of utilisation is required
concerning ability to give security etc.)
by the borrower (i.e. 3 business days). In its utilisation request, a
● Further DD may be undertaken (e.g. Property: report on title, review
borrower must confirm there is no current default (and that utilisation
of contracts and licenses, assessment of assets given in security etc.)
will not result in a default).
● DD supports the assumptions the bank has made about the borrower
and its ability to repay the loan
Mandate Letter
LOAN AGREEMENT CONSIDERATIONS
● Mandate Letter (Commitment Letter): Provided by the ‘arranger’
WHO | are the parties to the agreement?
where syndication is used, inclusive of additional provisions including:
WHAT | what is the loan for and what TYPE of loan is it? E.g., Term loan or RCF?
o Role of Arranger: Best efforts vs underwritten
o Marketing of the Loan/Setting up the Syndicate SECURED/GUARANTEED? | If so, who are these parties and what assets are the
● It is legally binding (unlike the term sheet which is usually appended security over?
to it) and so it contains any terms which need to be legally binding WHEN | is the loan to be repaid? Fixed payment dates?
before the loan itself is executed. Key points covered in the letter: WHY| why has the loan been structured in this particular way? Why are certain
a) whether the bank’s obligation to arrange the facility is ‘best provisions in the loan?
efforts’ or ‘underwritten’
b) any general conditionality to the offer to arrange, e.g. time limit ANATOMY OF A LOAN AGREEMENT
for executing the facility document, obtaining credit committee
approvals, completion of satisfactory due diligence, etc; LMA – Loan Market Association:
c) a material adverse change provision allowing the bank to ● Pre-written market acceptable provisions
withdraw from the offer if there is a material adverse change to ● The use of the LMA provision promotes certainty for both parties and
the market generally (known as the ‘market mac’) or to the makes the documentation process more efficient
borrower’s situation specifically (known as the ‘business mac’);
d) a ‘clear market’ clause in which the borrower agrees not to raise LA
other finance whilst this facility is being arranged;
e) a ‘market flex’ clause which allows the bank to change aspects of
the negotiated facility agreement if it is necessary to attract 3. Boilerplate Clauses
1. Operating Clauses 2. Information &
other banks to participate; and (Use & Repayment) Monitoring Clauses (Relationship &
Enforcement)
f) provisions for the bank to recover fees, costs and expenses if the
deal does not go ahead, as well as an indemnity for any losses The Loan agreement (LA) is simply a contract, and therefore offer, acceptance,
the bank might suffer. consideration and intention to create legal relations should be present
Term Sheet
WHY SYNDICATE LOANS?
2
, Lenders are often limited by various factors which makes syndicate lending an OTHER BUSINESS (CLAUSE 26.6):
attractive alternate if a bilateral loan is not a viable option:
● A further potential business provision will be included in the LA to ensure
● Large Loans: Allows several lenders to combine; more money available;
the arranger can enter into further business later on
● Internal Risk Policy - Syndication is a method of risk diminution;
● Large Exposure Regulations - Capital Requirements Directive and the FCA Protection Clauses:
restrictions may apply ● LMA 26.5(a): No fiduciary duty to any other party
Lenders Perspective: Syndication allows banks to earn fee’s and prestige from ● LMA 26.5(b): Not obliged to account to other lenders for any profit made
participating in high-profile loans leading to follow up business ● LMA 26.6: Arranger may pursue business with the borrower
o These allow the arranger to create/enhance the relationship with
Borrowers Perspective: The more lenders, the bigger potential amount to be
the borrower
borrowed, but also the more unwieldy the syndicate becomes to manage
PARTIES TO A SYNDICATE LOAN 2. AGENT
The agent is a bank (usually part of the syndicate and commonly the same bank
as the arranger) is appointed by the syndicate lenders (∴ agent represents and
Parties To Syndicate acts in the interest of the lenders), upon the advice of the arranger, to
administer the facility:
● The agent is formally appointed ( LMA clause 26.1) and administers the
Arranger Agent Security Trustee mechanics of the of the loan, and will be the main point of contact
between the syndicate and the borrower
● Agent can act unilaterally, but is usually unwilling to assume any
1. ARRANGER
discretionary power, to avoid liability from acting on its own. In practice,
The borrower appoints a bank to act as the ‘arranger’ to arrange the financing the agent will take instructions from the Majority Lenders which absolves
of the required amount of debt, by organising a syndicate of banks their liability (clause 26.2(a)(ii)).
● Confirmation of the role is included in the mandate letter ● Clause 26.2(e) - in the absence of instructions, the Agent may act (or refrain
● The arranger usually provides a substantial proportion of the total loan from acting) as it considers to be in the best interests of the Lenders.
facility ● Agency fee’s; low and do not reflect risk
● An arrangement fee will be charged for the provision of the role
● Confidentiality - Arranger has to ‘sell’ the loan and provide information to AGENT DUTIES:
potential loan banks/syndicate members through e.g., the Information
Memorandum. LMA 26.3(a): Agency duties are defined and documented and are mainly
administrative tasks and include:
o Due to the risk of leaks of confidential information, the borrower will
require a confidentiality agreement between itself and the arranger ● LMA 29: Paying Agency; receives loan advances from syndicate lenders and
as well as ‘back-to-back’ confidentiality agreements between the forward the onto the borrower; also receive the repayment and interest
arranger and potential lenders. from the borrow and distributes these to the syndicate
● LMA 4.1: Check the CP’s; agents’ responsibility to be satisfied with the form
and content of the borrower’s documents to satisfy the CP’s
SCOPE OF ARRANGER DUTIES: ● LMA 26.3: Postman; receives and forwards documents and notices to the
● Advise borrower on loan structure, the purpose and the market conditions intended recipient
● Due diligence and preparation of the information memorandum ● LMA 9.4: Banking Duties; agent determines the applicable interest rate;
(marketing tool used to market the loan to other banks) relevant LIBOR etc. and notifies borrower of interest payable
● Drafting the loan documentation and negotiating with the borrower ● LMA 26.3(d): Monitoring; distribute financial information from borrower to
● Best efforts v Underwritten – included in the mandate letter, which helps the syndicate lenders
ensure the borrower will raise the full capital it needs from a syndicated ● LMA 26.3(e & f): Action on Default; duty to inform the syndicate of a
loan: borrower default or a non-payment under the LA
o Best efforts = arranger will use its ‘best efforts’ to secure the full ● LMA 26.7(c-e): Interpretation; interpreting the provisions under the loan
funds, but not obliged to provide further funding if target not met. agreement; e.g. no prohibition for a potential transaction
o Underwritten agreement = borrower has certainty that the full ● LMA 24 and Schedule 5 and 6: Administering Loan Transfers; all transfer
amount of funds will be acquired due to the arranger underwriting to certificates or assignments must be executed by the agent
meet the shortfall of the target amount, if not fully raised by the ● LMA 28: Pro-Rata Sharing; an exception to the basic concept that the
syndicate of banks (although borrower will have to pay an additional syndicate lenders obligations are several and independent – any recovered
underwriting fee to the arranger for this). amount by any syndicate lender to be distributed pro-rata between all; the
▪ If the facility is not underwritten, the arranger will usually sharing is administered by the agent
promise to use its ‘best efforts’ to arrange a syndicate of
lenders willing to lend the required amount. This does not
3. SECURITY TRUSTEE
amount to a guarantee that the full amount will be raised. If Where the syndicate loan is secured, a security trustee will be appointed to hold
the arranger does not succeed in raising the funds, the the security for the benefit of the syndicate lenders
borrower will not have access to them. ● One major advantage of this is when a syndicate lender transfers its
o Parties can agree a combination of best effort and underwriting participation, the benefit of the security can also be transferred without
arrangements (e.g., underwriting to a certain amount). the need for a separate formal arrangement
● The security must be granted in favour of the security trustee for the
benefit of the ‘Lenders’ (defined as “from time to time” in the LA); this is
TERMINATION OF OBLIGATION (CLAUSE 26.4): sufficiently certain, notwithstanding the identity of the lenders may change
● The obligation of the arranger will terminate once the LA is signed, and
there are no continuing obligations under the LA (however the arranger LIABILITY OF ARRANGER
will also commonly act as the agent)
Two types of liability; misinformation and breach of fiduciary duties
MISINFORMATION
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