Summary
Summary LPC Debt Finance Notes 2021 (83% - high distinction) - EXAM READY
- Module
- Debt Finance
Debt Finance notes that cover every topic. Clear layout that covers exam technique. Made for BPP LPC 2021.
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Debt Finance NotesIntroduction to Debt Finance
Types of debt
1. Overdraft (assists with short-term cash flow)
• Briefly allows a borrower the flexibility to draw amounts when needed
• It is an on-demand/uncommitted facility -> the bank can withdraw the facility
at will
• This can be a downside for the borrower because…
• Less certainty
• It is repayable on demand
• High interest rates (interest is payable on the daily overdrawn
balance)
• Money can be re-drawn up to the specified amount
• Based on the standard terms & conditions of banks -> little room for
negotiation and little formal documentation
2. Term loan (suitable where a specific sum is needed for a medium to long period e.g.
purchasing a property/start-up costs)
• Traditional loan -> it provides a fixed sum over a fixed period
• The borrowed amount may be fully drawn down in one lump sum, or
in several tranches
• It is usually a committed facility
• The bank may demand repayment if there is a breach
• It is repayable by the end of the term ( a set date)
• More certainty for the borrower -> they will be borrowing a set
amount of money for a set period at a pre-determined interest rate
(which will change depending on LIBOR)
• There is more documentation and negotiation involved (e.g. for any security)
• Repayments can be structured as:
• Amortisation = amounts at regular intervals
• Balloon repayment = several instalments with one large final payment
• Bullet repayment = repayment in one instalment at the end of the
term
• Repayments = the scheduled timing of when principal has to be repaid
• Prepayments = when the borrower wishes to pay an amount of principal
earlier than the scheduled repayment date
3. Revolving credit facility (RCF) (often used for working capital as it combines
flexibility and certainty)
• The lender will make an amount of capital available over a set “availability
period” (e.g. 3-5 years), and the borrower draws down and repays individual
loans over a shorter “interest period” (e.g. 1, 3 or 6 months)
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, • The borrower will have to repay each drawdown at the end of each short,
interest period, but is allowed to reborrow amounts during the life of the
loan -> each loan has its own interest period, so different loans with different
interest periods may run concurrently
• Has some of the flexibility of an overdraft -> the borrower can borrow
amounts as they are needed during the life of the loan (subject to minimum
amount, notice and interest period)
• If no money is borrowed, the lender will have to pay a commitment fee
• This compensates the bank for having the money available
• It is a % of the undrawn amounts
• It is usually a committed facility
• There will be a cap on the number of drawdowns at any time and a minimum
amount
• There is more documentation and negotiation involved (e.g. for any security)
• While the borrower will draw down for the interest period, it may roll over
into another interest period, subject to a clean down provision (i.e. it is
deemed to simultaneously repay and drawdown)
• Seeks to ensure the RCF does not become a long-term core debt
• The lender may require the borrower to repay the whole
facility and retain a ‘nil’ balance for at least 5 business days in
any 12 month period
• At each drawdown/rollover the borrower is deemed to repeat certain
representations (repeating representations)
• Any outstanding drawdowns will be repayable in full at the end of the
availability period
4. Capital markets instruments
• E.g bonds
Key business issues for banks
• Relationship
• Banks and businesses want to maintain relationships
• The bank wishes to become the borrowers ‘relationship bank’
• May have an impact on the action the bank will take if the borrower
defaults
• Credit risk
• This is the risk that the borrower will not repay the loan
• The higher the risk, the higher the interest rate
• Recourse
• Need to ensure there is always a way for the bank to get its money back
• The bank will claim on certain assets for the repayment of the loan
through security
• The borrower may seek to limit the bank’s access to assets by using an SPV
(special purpose vehicle)
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