Comparing alternative financing options for leveraged borrowers
The financing landscape for leveraged borrowers and sponsor-backed companies has significantly changed over the last ten years. Alternative credit providers have established a strong presence in the financing market that was previously dominated by banks. This has been made possible, among other things, by low interest rates and stricter regulations regarding banks’ capital requirements. In keeping with this trend, leveraged borrowers now have more options than ever before for traditional bank lending, with high yield bonds, unitranches, and term loans B taking center stage.
Even though these instruments are becoming more similar, each still has unique qualities and disadvantages of its own. This means that selecting the best financing option necessitates thorough planning, analysis, and upfront communication with a variety of possible financier groups. This article can act as a starting point for borrowers by comparing the salient characteristics of these products.
Term Loan B (TLB) is a type of term loan financing that is usually offered by institutional investors (i.e., insurance companies, debt funds, pension funds, and CLOs) as opposed to banks. In the European market, TLBs are recorded in facility agreements that resemble LMAs. Before beginning a wide-ranging syndication process, one or more banks typically serve as mandated lead arrangers and bookrunners and agree on the terms. TLBs therefore have certain capital market components, frequently involving significant “flex rights.”
TLBs are designed to mature between five and seven years, and they typically have a minimal amount of amortization (1% of the principal amount annually, if any) prior to a bullet repayment upon maturity. These characteristics set the TLB apart from the Term Loan A, which is normally held by one or more banks and usually amortizes in full over the course of the loan. Furthermore, TLBs frequently permit borrowers to take on sizable amounts of additional debt, either as side-car debt or in accordance with the terms of the facilities agreement. These characteristics enable the TLB loan parties to concentrate on expansion rather than debt repayment. Because of this, sponsor-backed businesses favor it as a product, and investors looking for longer-term financing find it to be an appealing choice. Pricing-wise, TLBs are substantially more costly than Term Loan A, but less expensive than Unitranche and High Yield Bonds.
Over time, the terms of TLBs and High Yield bonds have become more similar. The growing involvement of institutional investors in the leveraged financing market is crucial to this development because, on the whole, they are more familiar with the documentation of High Yield bonds than that of LMA banks. Particularly evident in the financial covenant terms is the growing flexibility in TLB terms. Most TLB deals only include one or two financial covenants (cov-loose) or, occasionally, none at all (cov-lite), in contrast to a typical bank deal that includes four financial covenants tests (a leverage ratio, interest cover ratio, debt service cover ratio, and capital expenditure limit). Although the TLB may find this flexibility appealing, each case’s specifics will determine whether a cov-loose or cov-lite transaction is possible.
Senior and junior debt are combined into a single facility in a unitranche, which is a single tranche term loan. Its interest rate is a single “blended” rate that combines the rates of the loan’s senior and junior components separately. Unitranche loans are supplied by non-traditional lending organizations (often debt funds) and are typically recorded in a single loan agreement. While unitranche loans are typically offered bilaterally by a single lender, they can also be offered by a consortium of lenders or repurchased by the original lender. When there are multiple lenders involved, the lenders typically assume varying degrees of risk (which is reflected in the pricing they receive) and determine the terms of the arrangement in an agreement among lenders rather than through a standard Intercreditor Agreement, as is the case with bank financing, TLB, or high yield bond situations.
Compared to bank facilities, unitranche facilities have fewer (if any) amortization and more flexible terms. The majority of direct lending agreements are “cov-loose,” giving the borrower a sizable increase in debt capacity. For investors looking to make acquisitions, the Unitranche product is therefore a desirable alternative, much like the TLB. Because there is usually less documentation needed and fewer participants in the transaction, executing unitranche deals can be more cost-effective and efficient than executing bank financing or TLB deals. The blended interest rate that applies to Unitranche loans is relatively high, albeit still lower than that of unsecured High Yield bonds (but either higher or similar to that of senior secured High Yield bonds), which is a glaring drawback for borrowers. Furthermore, the borrower is ignorant of the existence and terms of any agreements among lenders, if any, which could complicate matters in the context of a restructuring.
Debt securities known as “high yield bonds” are offered to institutional investors by non-investment grade issuers. High yield bonds have limited covenants (usually cov-loose or cov-lite), a bullet maturity, and generally flexible terms. High yield bonds, like the TLB or the Unitranche, typically have more forgiving default provisions than term loans, and they frequently support a relatively high leverage ratio. In addition, issuing High Yield bonds gives issuers access to a sizable investor base. High Yield bonds are securities, thus issuers need to consider any relevant securities laws, such as the U S. Securities Act 1933).
One significant distinction between term loans and high yield bonds is the initial commitment. If a term loan is involved, one or more lenders may agree to provide the loan at predetermined terms and prices, with the possibility of minor modifications if necessary for syndication. When it comes to High Yield bonds, investors only undertake to place or underwrite the bonds; the issuer bears the pricing risk. Pricing is usually decided upon a week or so prior to the transaction closing and is based on the market’s appetite for risk. High interest rates are a defining feature of high yield bonds, particularly when they are unsecured. High Yield bond transactions also have the drawback of usually having substantial call protection, being hard to modify once established, and necessitating an expensive and time-consuming documentation process that includes comprehensive disclosures and a roadshow.
Combination with revolving credit facility
Revolving credit facilities (RCFs) are occasionally provided by banks in conjunction with TLB, Unitranche, and High Yield bond products, as institutional lenders do not usually offer working capital facilities. This is a well-established practice in deals backed by high-yield bonds, and it is also becoming more prevalent in deals involving term loans. In an acquisition scenario, where the proceeds borrowed under the TLB, Unitranche, or High Yield bonds can be applied towards paying the entire purchase price at closing, the borrower appetite for RCFs is especially high. Meanwhile, the RCF provides working capital for the target group.
The supply and demand of RCFs are out of balance because banks find it difficult to make money on undrawn RCFs and it limits their capacity to lend money to other institutions. In order to increase the attractiveness of the RCF product, it is frequently incorporated into the leveraged capital structure on a supersenior basis, meaning that it ranks higher than pari passu debt (like the TLB, Unitranche, or High Yield bonds) and has precedence over the proceeds from the enforcement of security rights. A distinct intercreditor agreement governs the rights and obligations of the various lenders, and the terms of the super senior RCF are comparatively well-established in the market.
A comprehensive evaluation of the available financing options is becoming more and more necessary given the growing convergence of TLB, Unitranche, and High Yield bonds on the one hand, and their significant differences on the other. If borrowers want to enter the leveraged financing markets, we advise them to map their options and promptly get legal advice—especially if they are first-time issuers.
Click here for a table setting out the key features of each instrument.
FAQ
What is difference between term loan A and B?
Because Term Loan A has a lower interest rate than Term Loan B, it is “less risky.” The entire loan is amortized over its lifespan.
What is a term loan B transaction?
Also known as an institutional term loan or a Term B loan institutional investors’ term loan, the main objective of which is to maximize the long-term total returns on their investments
What is TLA and TLB?
Both Term Loan A (“TLA”) and Term Loan B (“TLB”) are possible forms of term loans. The amortization schedule is the main distinction between the two: TLB is nominally amortized in the first five to seven years and includes a sizable lump sum payment in the final year, whereas TLA is amortized evenly over five to seven years.
What is a term loan B listed?
A tranche of senior credit facilities made available to a borrower with the intention of being syndicated in the institutional loan market is referred to as “Term Loan B” or “TLB.” They are linked to terms that are especially favorable to sponsors, like the absence of maintenance covenants (covenant lite).
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https://www.debrauw.com/articles/comparing-alternative-financing-options-for-leveraged-borrowers