weighting which attaches to a loan will ultimately determine how
DEBT FINANCE much capital a bank needs to have in reserve to back up the loan.
1 X 3-hour exam, MCQ and long form
A bank will then have to raise more capital (issuing shares) or
Debt Finance: investors provide capital for a limited period in transfer existing loans off the balance sheet.
return for periodic interest payments.
KEY ISSUES FOR BANKS
THE BANKING SYSTEM – AN OVERVIEW The bank wants to:
DEBT PROVIDERS preserve a healthy relationship with its customers so
Individuals and companies deposit with banks through savings and that it can sell further products
current accounts. Banks then use this money to lend to companies protect itself against the credit risk of non-payment
and individual. Individuals are the real debt providers. provide a method of recourse in case of non-payment
provide a method of recourse in case of non-payment
made a viable profit on their products based on the
Banks interest rates charged.
Banks act for a conduit for lending. They take deposits and lend
them on. A bank may find that it identifies a profitable lending
opportunity but that it does not have enough in the way of These elements will have an impact on the choices a bank makes.
deposits to make the loan. In that case, it can borrow from other
banks which have surplus deposits available. This is the interbank THE LENDER/BORROWER RELATIONSHIP
market.
LIBOR AND INTEREST RATE BENCHMARKS Lending produces a steady stream of income for banking
Interest rates are expressed at a % above the LIBOR. Interest is institutions. A facility describes the various forms of commercial
counted as a function of LIBOR, margin (e.g., 3%) and mandatory lending. This is done on standard Ts&Cs.
costs.
A bank will have a relationship manager for each client, who
LIBOR: This is the rate at which banks are prepared to lend to provides the primary point of contact between the bank and the
others in the interbank market and will differ between different client. They will suggest financing options and help with future
markets. The London rate is LIBOR – London Interbank Offered plans for financing. The relationship is key to ensure the bank can
Rate. maximise the products it sells to the client and maximise profits.
LIBOR can be affected by the credit rating of the bank, the LENDER AND BORROWER TENSIONS
currency of the loan, the length of the loan and the liquidity in the
interbank market. Lender Perspectives
Lending money carries an inherent risk of a borrower not being
In a syndicated loan, each bank will have a different LIBOR. Thus, able to repay the loan, the bank always intends to get its money
an average rate will be calculated and published by the financial back. The bank would want to ensure the security is watertight so
data firm – ICE benchmark Administration Limited. This is called if anything went wrong it would get its money back.
the ICE LIBOR or “screen rate”.
The bank will do sufficient due diligence to make sure they
Manipulation of LIBOR is a criminal offence under FSMA. The FCA minimise the risk of not getting the money back.
is responsible for regulating and supervising LIBOR.
There will be an internal credit assessment to determine the level
LIBOR is limited to the most common interbank funding periods of of interest and fees charged. The higher the risk the higher the
one, three or six months. fees and interest and the more onerous the provisions in the
documentation. The risk will be assumed on the kind of business
Mandatory: Syndicate lenders have these options: and the asset.
use a mandatory cost schedule
require each syndicated lender to calculate their own The loan agreement will state the purpose of the loan and will
mandatory costs and pass this information on to the restrict the use of the money for any other purpose. It will restrict
Agent any change in the nature of the borrower or its assets and
Remove mandatory costs generally prohibit any significant disposal of its assets. It will also
prevent any security so no other interested party will take priority
Margin: fixed rate – designed to ensure the bank has profit above over or compete with the bank’s claim against the borrower’s
its costs. assets. Particularly if unsecured.
REGULATION OF BANKS Borrower’s perspective
Authorisation and supervision A borrower will want the cheapest available funds from a lender
Banks are regulated by the PRA and the FCA. The Financial Policy while retaining flexibility and longevity. The borrower will want a
Committee has the objective of identifying, monitoring, and taking wide purpose clause, the freedom to charge its business or assets
action to remove or reduce systemic risk. The PRA and FCA are and the ability to create security to obtain further loans to expand
part of the bank of England. or develop.
FCA: responsible for authorisations of activities, the prudential The compromise position
supervision of financial services firms not supervised by the BoE
and the protection of consumers in the context of financial
services. It is also responsible for approving bond prospectuses.
“Accepting deposits by way of business” is a specified activity,
lending is not.
Capital adequacy: basic principles
The more share capital a company has the more losses it can
make before its creditors lose out as SH are paid last on
insolvency.
Capital adequacy rules require banks to maintain a sufficient
proportion of capital, compared to the amount lent by the bank,
to protect depositors if loans are not repaid. They affect the
relationship between banks and borrowers as the requirement to
maintain capital represents a cost to the bank.
The rules work by assigning a risk weighting to each loan made to
a bank. This reflects the risk of default on that loan. The risk
,The state of the lending market may impact this – banks may be
keen to lend (borrower in a stronger position), or borrowers may
be desperate for funds (and allow for higher fees and interest
rates).
KEY CONCEPTS:
Drop dead fee: Costs and expenses of the bank that are paid
regardless of whether the transaction signs.
Cross default provisions: Defaults the Borrower under the LA it
defaults under another (possible unrelated) agreement
Condition precedents: CPs are steps and documents which, if not
completed or in place to the bank’s satisfaction when the
Borrower wishes to drawdown, enable the bank to refuse to
advance funds.
How can a borrower ensure that it can raise the full amount? TYPES OF FACILITY
Ask the Arranger to underwrite the loan or arrange for a small The type of facility is crucial depending on the purpose for which
group of Lenders to underwrite. If the syndicate fails, the the money is required and the size of the capital sum.
underwriters makes up any shortfall.
Overdraft Term Loan Revolving
Credit Facility
Why are syndicated loans based on LMA standard documents? Function Permits the Lender provides Committed by a
To facilitate the development of the secondary market, the loan borrower to a fixed sum Lender to lend
documents used in the initial syndication needed to be borrow up to a over a fixed on a recurring
standardised to enable banks to trade debt quickly and cheaply. specified limit period. The basis on
F or a Borrower, however, standardised documentation means borrower predefined
It assists cash amount can be terms. Specific
they have less scope for negotiation. drawn in a lump amount
flow and
provides a sum or in available over a
What is amortisation? Repayment of amounts at regular intervals reserve of several tranches specified period
accessible (3-5 years
money to meet Most suitable typically).
What is a balloon repayment? Repayment in several instalments any shortfalls in for medium to Borrower can
where the final payment is bigger than the rest. working capital. long periods draw down and
e.g., purchase repay capital
of property, almost as it
What is a bullet repayment? Repayment in one instalment at the acquisition, or chooses.
end of the term start-up costs.
Used for
working capital.
Can Agents take unilateral action? Yes. This is useful if things combines
need to be done quickly and there is a large syndicate that would flexibility of
make it impractical or impossible to obtain proper approval. overdraft and
certainty of a
term loan.
Interest Charged on the As determined Each loan has
daily overdrawn by a Loan its own interest
Difference between availability period and the acceptance balance Agreement (LA) period. A bank
period? will charge a
The availability period is the period in which Borrower can draw commitment
down money. The acceptance period is the time Borrower has to fee, which is a
accept the terms of term sheet, and sign the LA. % of the
undrawn
amounts of the
facility from
time to time
If one syndicate lender receives an amount directly from the
borrower, does it have to pass this share on? Only draws
Yes. down when
needed so
keeps interest
What happens if syndication does not go well? to a minimum.
Commonly, a ‘market flex’ clause in the mandate letter will allow Committed? Uncommitted: Usually Usually
the Arranger to increase the pricing and/or fees of the loan to the bank can committed: committed:
enhance the prospects of a successful syndication. In extreme withdraw at any contractually contractually
time based, can be based provided
circumstances, a material adverse change provision in the demanded as a there is no
mandate letter may allow the Arranger to terminate its arranging result of default.
mandate and walk away from the deal. default.
Flexibility Granted on the The most Relatively
bank’s standard inflexible inflexible. RCF
terms. Little will cease to be
What is a clear market provision? room for available at the
negotiation end of the
his is a clause in the mandate letter of a Syndicated Loan that period. Allows a
restricts the borrower from issuing bonds or taking out loans until Borrower to
the loan being arranged by the Arranger has been signed. This draw loans
satisfies the Arranger that it is not competing with another when it needs
arranger to supply a debt facility. capital and only
for a period it
needs capital.
Exam: Repayments & Legally Repayable by Each loan has
(i) think about who the parties are to the transaction Repayments repayable on the end of the its own
(who is your client/what is your client’s profile) and demand – there term. repayment
(Repayment does not need Repayments period.
how that will impact the terms of the finance being to be a breach. can be via Borrower is
given/raised. relates to
scheduled amortization, deemed to
(ii) what is the deal (assess why the borrower is timing of when The borrower balloon repeat certain
borrowing the money, what the transaction issues principal has to can repay the repayment, or representations
are, has the borrower been assessed as risky etc); be repaid. loan and then bullet
Prepayments redraw it to the repayment. Money can be
and are where the B specified limit. drawn down
(iii) think about what the commercial environment is wishes to pay Any when needed
like – are banks keen to lend? an amount a prepayments and paid back
principal earlier are usually final. when not. Can
than the include a “clean
, scheduled down” lender and borrower will sign
repayment provision where this. A LA is a contract and thus you need
date) the Borrower is to ensure you have all the factors in
required to Non-binding, except for place which make a contract legally
retain a nil provisions relating to binding.
balance for a confidentiality and costs
set period (5 (morally binding only).
business days).
Documentation Little formal LA LA Lawyers not usually involved at
documentation: this stage, but this will become
Often merely a the basis of their drafting
facility letter
Purpose Helps cash flow Suitable where Often used for Found in bilateral and
and keep the the borrower working capital. syndicated loans, setting out
business liquid. needs a specific A syndicated the principal terms of the loan
A reserve of sum of money RCF can be agreement.
easily accessible for a medium- exceptionally Function The term sheet provides an It deals with who owes what to when,
money. to-long period large. overview of the deal before the where, and why.
parties start working on the
loan agreement. No detailed The banks are objectives are that its
RCF: each time funds are drawn down; the borrower is deemed to drafting. fees are paid, interest is paid, and
repeat certain representations. Borrowers need to check that loan capital is repaid.
these can be given or risk triggering an EoD. It serves as the initial summary
of the fundamental terms of This is achieved by ensuring that loan
the loan. monies can only be used for specific
purpose outlined in the agreement;
Assists the solicitors in the borrower’s financial health is
estimating fees. monitored (by financial covenants)
and security is taken over the
Used with the IM to sell the borrowers’ assets for the loan monies.
facility to potential members of
a syndicate of banks.
BILATERAL AND SYNDICATED LOANS
A bilateral loan is a contract between two parties (borrower and The borrower will want to have
lender). A syndicated loan is a loan made by two or more lenders a detailed term sheet to agree
certain points. The bank will
(together called the syndicate) on the same terms and governed counter argue that the
by a single LA. transaction needs to be
negotiated as a whole.
Contents The term sheet comprises Operating clauses about the use and
WHY SYNDICATION? clauses which are boiler plate repayment of loan monies:
Banks may choose to syndicate because: and deal specific. The terms will amount and purpose, fees,
it allows them to cover large amounts that would be include: interest payments, repayment
date, parties, amount, and prepayment, maturity.
infeasible for a single lender duration, guarantors Boilerplate clauses: provisions
their internal risk policies may prohibit taking on such repayment and pre- for transferring the loan,
concentrated lending. payment of interest regarding service of notices,
conditions precedents, governing law clauses
the capital requirements directive prohibits the bank representations and Info and monitoring clauses.
from taking so much risk with a single borrower; and warranties, Includes, conditions
being a party to a syndicate is a good way of being undertakings, events precedents, representations,
introduced to a borrower, particularly as being Agent or of default covenants and undertakings,
confidentiality events of default.
Arranger provides both fees and prestige undertaking
Costs
Boilerplate clauses
Common Features Key differences Once agreed and signed, work
on drafting the LA will begin.
Due Diligence: The presence Confidentiality: in a syndicate loan,
and purpose of DD remains to confidentiality is more of a risk as
flush out potential future the Borrower needs to give info to LMA; produce a recommended form of the loan agreement.
problems to assess overall multiple prospective Lenders to
credit risk. Initial DD is carried get them to sign up Mandate Letter:
out by the bank and legal DD These are found in syndicated loans, setting out the terms on
will be carried out a later which the borrower appoints the arranger, and the basis on which
stage. the arranger has agreed to arrange the syndicated loan. The term
Term Sheet: Both begin with a Mandate Letter: A syndicated loan sheet is often to the mandate letter and legally binding provisions
term sheet. This is an overview will require additional provisions are often set out in the mandate letter rather than the term sheet.
of the deal, serving as an initial related to the arrangement of the
summary of the loan’s loan, contained in the Mandate
fundamental terms. it is Letter. This is provided by the Legal opinions
generally non-binding, save for lender who is arranging the loan A legal opinion is a letter confirming the corporate capacity of the
the provisions for (‘arranger’) and the basis of the borrower (and, if relevant, any guarantor or security provider) and
confidentiality and costs, such that the finance documents are legally valid, binding, and
loan e.g., best efforts or enforceable. It is another way for the bank to reduce the risk of
as a ‘drop dead’ fee. underwritten. non-payment.
Other documentation: Both Liability: In a syndicated loan, the
require a LA and may require banks have several but not joint It is usually the bank’s solicitors who will be asked to give the
legal opinions liability. if one Lender fails to make opinion, but it may, on occasion, be the borrower’s solicitors. In a
its participation available, the bilateral loan the opinion will be addressed to the bank whereas in
others are not obliged to make up a syndicated loan it will be addressed to the agent and may also
the difference. be addressed to the original syndicate lenders.
The opinion will only apply to matters of law and not of fact. Legal
Investigation and credit approval opinions will always contain qualifications limiting the scope of the
There is an initial investigation (credit analysis) and credit legal opinions and assumptions as to certain facts by the lawyers
approval. Then there is legal due diligence. providing them.
Initial investigation: this confirms the size of the loan,
type of the loan, whether it is secured, whether the
borrower is known to the bank, whether the loan is part They are required:
of a larger transaction Secured lending: re the enforceability of the security and
any risks
Credit approval: ultimate say on whether they will lend Overseas jurisdictions: if the assets are in a foreign
– credit committee of the bank. The banks internal limits jurisdiction, then a local lawyer will give a legal opinion
must not be breached. covering the corporate capacity, and the enforceability,
Legal DD: detailed DD will happen with the lawyers. This legality, and priority of the documents the company is
will involve a number of searches; they will want to entering into.
check the AoA has no restrictions on the ability to
borrow or give security. It will cover finances,
constitutional and asset specific.
PARTIES TO A SYNDICATED LOAN
DOCUMENTATION IN DEBT FINANCE Both types of loans have similar parties, although there are more
Term Sheet Loan Agreement in a syndicated loan.
Definition and This is a document that sets out Las are about credit not just
legal effect the terms of the loan. Both the repayment.
THE ARRANGER
, The bank is usually the Arrangers, appointed to arrange the raising must be created in favour of the security trustee for the benefit of
of the required amount of debt by organising a syndicate of banks the ‘Lenders’. This is for the benefit of the syndicate as a whole.
to provide the funds. Arrangers are appointed by way of the Local legal advice should be taken if security is being created other
Mandate Letter, and their role will cease when the Loan than under English law.
Agreement is signed. They will charge an arrangement fee.
Advantage: where the syndicate lender transfers its participation,
Their tasks include: the benefit of the security can be also transferred without the
putting the Syndicate together by going to the market need for a separate formal arrangement.
and seeking potential Lenders.
advising the Borrower as to the most appropriate How to ensure the borrower raises the money it needs?
structure. • When a loan is mandated on a best-efforts basis, the
agreeing the term sheet arranger will promise to use its ‘best efforts’ to assemble a
performing DD and preparing the Information syndicate of banks willing to lend the required amount. This
Memorandum (‘IM’) these docs help market the loan. does not amount to a guarantee that the full amount will
The credit committee will then approve/amend/reject be raised. If the arranger does not succeed in raising the
depending on the overall lending of the bank. funds, the borrower will not have access to them.
drafting the loan documentation and negotiating with • If a borrower wants to be certain that the money will be
the Borrower for security on behalf of the syndicate. raised, it can ask the arranger to underwrite the entire loan
agreeing to underwrite the Syndication or organise it by or arrange for a small group of lenders to underwrite the
best efforts; and loan. This means that if the full syndicate of banks cannot
requiring potential lenders to enter ‘back-to-back’ be put together in time, the arranger (and any fellow co-
confidentiality agreements between the Arranger and arrangers) will be obliged to make up any shortfall in the
those Lenders to preserve confidentiality. amount the borrower wishes to borrow. The borrower will
have to pay an underwriting fee for this in addition to the
If the Borrower wants to be certain that the money will be raised, usual arrangement fee. Acquisition finance transactions will
it can ask the Arranger to underwrite the entire loan or arrange usually be underwritten by the arranger as the borrower
for a small group to underwrite the loan. The Borrower will have needs to be certain that it will have funds available to
to pay an additional underwriting fee for this service. On a ‘best complete the acquisition.
efforts’ basis, the Arranger will use their best efforts to secure • Best efforts basis
funding but does not guarantee that it will raise the full amount. • Acquisition Finance always want an underwritten facility
The Mandate Letter covers underwriting provisions.
Termination of obligations
The arranger’s obligation to arrange will terminate once the loan
agreed is signed and the arranger has no ongoing obligations
under the loan agreement. However, the arranger will commonly
then act as agent. LIABILITIES OF THE ARRANGER
Liabilities
Other business: If any inaccurate information is provided, then there will be an
The arranger will want to ensure that it can enter into other EoD by virtue of the borrower being in breach of specific
business with the borrower, and a provision to this effect should representations in the facility agreement (C.19.10 LMA). The
be included in the LA. This is important for-profit margins on loans facility can be accelerated and immediately reclaimed.
that are small and lenders hope will turn into future business.
It may be that the borrower is insolvent or in financial difficulty, so
THE AGENT the lenders will turn to the arranger to see if they are liable to pay
Agents are often the same party as the Arranger. However, the compensation for misrepresenting the borrower’s financial
Agent’s role starts when the Loan Agreement is signed and condition in the IM.
continues for the duration of the Loan.
The most significant liability against an Arranger is Negligent
Agents are appointed by, and act on majority lenders instructions Misstatement (Hedley Byrne v Heller). This will be particularly
(2/3rds of total syndicate commitments) the Syndicate, not the relevant for the contents of the Information Memorandum, which
Borrower. The Agent is an intermediary between the Borrower the Arranger prepares with the Borrower. The Arranger may be
and the Syndicate. Their duties tend to be mechanical in nature liable if the Syndicate Lenders can show that the Arranger owed
and will be precisely defined and documented in the facility. These them a duty of care in providing this information and breached
duties include: that duty.
acting as paying agent and ensuring that the parties
make the appropriate payments (such as the sums made
available by the Syndicate to the Borrower, and the Other:
interest and capital payments from the Borrower to the Fraudulent or Negligent Misrepresentation: The
Syndicate). Arranger may be liable if they knew or were reckless as
to the facts that they made false statements to the
determining the appropriate interest rate that applies Syndicate Lenders or had no reasonable grounds to
for each interest period and notifying the parties of this believe that the statements were true.
rate. This is particularly important if there is a floating
rate of interest linked to LIBOR, as the interest rate will Fiduciary Duties: The Arranger is potentially liable for
vary according to the rate of LIBOR used to help breach of fiduciary duties. Fiduciary duties are generally
calculate it for each interest period. inappropriate in an international syndicated LA.
Nevertheless, the Information Memorandum will state
dealing with all documents and notices under the that the Arranger is not a fiduciary specifically to
facility, including administering any transfers between prevent this liability.
existing and new syndicate members - For example,
through the use of transfer certificates if the loan is
novated. Protection:
a limited amount of monitoring of the Borrower. The main protection against liability is an ‘Important Notice’ at the
acting in accordance with the instruction of the Majority start of the IM. This will include statements that:
Lenders - Most actions are on Majority Lender the Borrower is solely responsible for the IM and the
instructions. ‘Majority’ is normally 2/3 of the total Arranger is not responsible for the information
commitment. contained in it (the facility agreement should also clearly
taking unilateral action in emergency cases; and state this).
signing off on the initial CPs. Agents will be very the Arranger has not independently verified the
reluctant to take unilateral action because there is a risk contents.
that the Lenders disagree with this action and claim the Syndicate Lenders will not rely on the memorandum
against the Agent at a later time. to make their investment decision, and each bank
should undertake its own assessment in deciding
whether to participate in the loan (this, again, should be
THE SECURITY TRUSTEE repeated as an obligation in the facility agreement).
When a syndicated loan is secured, a trustee (or security agent) the Arranger is not responsible for updating the
will be appointed to hold the security for the benefit of the information; and
syndicate lenders.
the Arranger is not a fiduciary of the Syndicate Lenders.
The Loan itself will also contain exculpatory provisions. –
The advantage of this is that it transfers its participation, the LMA Clause 26.8 and 26.15
benefit of the security can be also transferred without the need
for a separate formal arrangement. To achieve this the security
Validity of exclusion of liability
