Leveraged Lending

Appendix B: Appendix B

Glossary

Acquisition — When one company purchases a majority interest in the acquired. Acquisitions can be either friendly or unfriendly. Friendly acquisitions occur when the target firm agrees to be acquired; unfriendly acquisitions don’t have the same agreement from the target firm.

Airball — The portion of a loan whose value exceeds the value of its underlying collateralized assets, and dependent upon support provided by the company’s enterprise value. Also know as the “financing gap.”

Best efforts syndication — This refers to a type of loan syndication. See also underwritten deal and club deal. In a best efforts syndication, the underwriter agrees to use all efforts to sell as much of the loan as possible. If the underwriter is unable to sell the entire amount of the loan, it is not responsible for any unsold portions. However, flex (see also) language may be negotiated to facilitate the arranger(s) gaining market acceptance for the credit.

Bookrunner — The lead bank on a deal.

Bridge equity — A short term equity investment in a company that is expected to be replaced by future equity sales to permanent investors. Bridge equity is provided, at times, by a bank holding company or subsidiary to facilitate the underwriting process.

Bridge loan — A short term loan or security which is expected to be replaced by permanent financing (debt or equity securities, loan syndication or asset sales) prior to the maturity date of the loan. Bridge loans may include an unfunded commitment, as well as funded amounts, and generally mature in one year or less.

Buyback — The buying back of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies will buyback shares either to increase the value of shares still available (reducing supply), or to eliminate any threats by shareholders who may be looking for a controlling stake. A buyback is a method for company to invest in itself since it can’t own itself. Thus, buybacks reduce the number of shares outstanding on the market, which increases the proportion of shares the company owns. Buybacks can be carried out in two ways:

Shareholders may be presented with a tender offer whereby they have the option to submit (or tender) a portion or all of their shares within a certain time frame and at a premium to the current market price. This premium compensates investors for tendering their shares rather than holding on to them.

Companies buy back shares on the open market over an extended period.

Club deal — This is a type of loan syndication. See also best efforts syndication and underwritten deal. A club deal is usually a smaller credit, $25 million to $50 million, which an arranger markets to a small group of relationship lenders. A club deal may not be governed by a single loan agreement; however, participating lenders usually have very similar, if not identical, terms.

Covenant lite — Refers to syndicated loans that have bond-like incurrence covenants (see also), if any covenants, rather than traditional maintenance covenants (see also).

Covenant headroom — Covenant headroom compares the credit statistics from the projected financials (one year out) with the first covenant compliance levels. For example, for a transaction that provides pro forma financials as of July 31, covenant headroom analysis is based upon the projected debt/EBITDA ratio from the financial model at December 31 versus the maximum debt/EBITDA covenant level allowed on the same date. Covenant headroom analysis calculates how much performance can deteriorate before the covenant is tripped or violated.

Convertible bond — A bond that can be converted into a predetermined amount of the company’s equity at certain times during its life, usually at the discretion of the bondholder. Issuing convertible bonds is one way for a company to minimize negative investor interpretation of its corporate actions. For example, if an already public company chooses to issue stock, the market usually interprets this as a sign that the company’s share price is somewhat overvalued. To avoid this negative impression, the company may choose to issue convertible bonds, which bondholders will likely convert to equity anyway should the company continue to do well. From the investor’s perspective, a convertible bond has a value-added component built into it; it is essentially a bond with a stock option hidden inside. Thus, it tends to offer a lower rate of return in exchange for the value of the option to trade the bond into stock.

Cross default — A provision in a bond indenture or loan agreement that puts the borrower in default if the borrower defaults on another obligation. Also known as “cross acceleration." This provides more security to the lender. This provision can be considered as an "out-clause" to the contract.

Debt/Equity swap — A refinancing deal in which a debt holder gets an equity position in exchange for cancellation of the debt. There are several reasons why a company may want to swap debt for equity. For example, a firm may be in financial trouble and a debt/equity swap could help avoid bankruptcy, or the company may want to change capital structure to take advantage of current stock valuation. Bond indenture covenants may prevent a swap from occurring without consent.

Dividend recapitalization — When a company incurs a new debt in order to pay a special dividend to private investors or shareholders. This usually involves a company owned by a private investment firm, which can authorize a dividend recapitalization as an alternative to selling its equity stake in the company (also known as a “dividend recap.") The dividend recap has seen explosive growth, primarily as an avenue for private investment firms to recoup some or all of the money they used to purchase their stake in a business. It is generally not looked upon favorably by creditors or common shareholders because it reduces the credit quality of the company while only benefiting a select few.

EBITDA — Earnings Before Interest, Taxes, Depreciation, and Amortization. EBITDA can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. EBITDA is a good metric to evaluate profitability, but not cash flow as it leaves out the cash required to fund working capital and the replacement of old equipment.

Enterprise value — A measure of a company’s value as a going concern. Three primary approaches are commonly used for valuing closely held businesses – asset, income, and market. The asset approach method looks to an enterprise’s underlying assets in terms of its net going concern or liquidation value. The income approach method looks at an enterprise’s ongoing cash flows or earnings and applies appropriate capitalization or discounting techniques. The market approach method derives value multiples from guideline company data or transactions.

Equity financing — The act of raising money for company activities by selling common or preferred stock to individual or institutional investors. In return for the money paid, shareholders receive ownership interests in the corporation (also known as “share capital.") This is when a company raises money by issuing stock. The other way to raise money is through debt financing, which is when the company borrows money.

Equity kickers — Also called equity sweetener, offer ownership in exchange for a loan or other debt instrument. Convertible features (stock options) and warrants are offered as equity kickers by a company to a lender or other party as an inducement to lend money to a company or provide some other value. In a leveraged buy out transaction, equity kickers give potential additional returns to mezzanine financers if the transaction is successful.

Financing gap — See “Airball.”

Fixed Charge Coverage Ratio (FCCR) — A financial ratio used to measure earnings before income taxes, interest payments, and noncash expenses to fixed charges. Fixed charges usually include CAPEX, taxes, debt repayment, interest, and dividend payment requirements.

Flex language — Contract terms negotiated between the borrower and syndicate arranger prior to syndication. Such language may refer to price, structure or both and is put in place to help ensure the deal will clear market, e.g., successfully syndicate. Price flex allows the arranger to adjust credit pricing, usually within a specified range, to ensure successful syndication. Structure flex allows the arranger to adjust deal structure within certain pre-negotiated parameters to ensure market clearance. Structural flex provisions may allow the arranger to reallocate amounts between tranches, add or remove covenants, adjust covenant levels, etc.

Fronting/Fronted facilities — Fronting is an arrangement in which the lender advances loans or foreign currencies or issues L/Cs on behalf of a consortium. Immediately upon issuance of the advance, L/C or other instrument, the risk is prorated to the consortium. Each lender in the lender group is deemed to have purchased from the fronting bank a participation in that advance, in an amount equal to that lender’s applicable commitment percentage. For L/Cs, although the agent bank issues the L/C for the full amount, immediately after issuance of the L/C the risk is prorated out to the consortium.

Headroom — See covenant headroom.

Highly leveraged transaction (HLT) — Term referencing the following rescinded regulatory definition of a leveraged loan. “(A)n extension of credit to or investment in a business by an insured depository institution where the financing transaction involves a buyout, acquisition, or recapitalization of an existing business and one of the following criteria is met: (1) The transaction results in a liabilities-to-assets leverage ratio higher than 75 percent; or (2) The transaction at least doubles the subject company’s liabilities and results in a liabilities-to-assets leverage ratio higher than 50 percent; (3) the transaction is designated an HLT by a syndication agent or a federal bank regulator.” (Rescinded Banking Circular 242, “Definition of Highly Leveraged Transactions.”)

Incurrence covenants — Loan covenants that generally require if an issuer takes an action (paying a dividend, making an acquisition, issuing more debt), the resultant position would need to remain in compliance. An issuer that has an incurrence test that limits its debt to 5x cash flow would only be able to take on more debt if, on a pro forma basis, it was still within this constraint. If not, then it would have breeched the covenant and would be in default. If, on the other hand, an issuer found itself above this 5x threshold simply because its earnings had deteriorated, it would not violate the covenant.

Initial public offering (IPO) — The first sale of stock by a private company to the public. IPO’s are often issued by smaller, newer companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded.

In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market.

Institutional loan — See also pro rata. Those tranches (see also) in a syndicated credit that are specifically structured for institutional investors (primarily collateralized loan obligations (CLOs) insurance companies, and pension funds), although there are some banks that may buy institutional credits. Traditionally, institutional loans were referred to as term loan B’s (TLBs) because they were bullet payment or with nominal (1 percent per annum was common) amortization. Now institutional loans refer to tranches other than the revolver and term loan A (TLA).

Junk bond — A bond rated “BB” or lower because of its high default risk. Also known as a ”high-yield bond“ or ”speculative bond.” These are usually purchased for speculative purposes. Junk bonds typically offer interest rates three to four percentage points higher than safer government issues.

Leveraged buyout (LBO) — The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Often, the assets of the company being acquired are used as collateral for the loans in addition to the assets of the acquiring company. The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital.

Leveraged loan — A term broadly applied to a type of loan where the obligor’s post-financing leverage, when measured by debt to assets, debt to equity, cash flow to total debt, or other such standards unique to particular industries, significantly exceeds industry norms for leverage. The proceeds for such loans are generally used for buyouts, acquisition, or recapitalization.

Loan syndication — The process of involving multiple lenders in providing various portions of a loan. A syndicated loan is structured, arranged and administered by one or several commercial or investment banks known as arrangers. Syndication allows any one lender to provide a large loan while maintaining a more prudent and manageable credit exposure because it isn’t

the only creditor. The bank regulatory agencies define a shared national credit as a loan of $20 million or more syndicated among three or more regulated institutions.

Loss given default — The amount of loss recognized by a bank or other financial institution when a borrower defaults on a loan.

Material adverse change (MAC) clause — The term, also sometimes called “material adverse effect,” describes an occurrence, event or condition that could or would likely cause a long-term and significant diminution in the earnings power or value of a business. The phrase is commonly used in venture investment or merger and acquisition transactions in connection with a closing condition whereby the investor/acquirer has the benefit of a ”walk” right if the target company experiences a serious adverse change between the date the contract is signed and the transaction closing date.

Maintenance covenants — Loan covenants requiring an issuer to meet certain financial tests every reporting period, usually quarterly. If a borrower’s loan agreement contains a maintenance covenant, which limits debt to cash flow, the borrower would violate the covenant if debt increased or earnings deteriorated sufficiently to breach the specified level.

Merger — The combining of two or more companies, generally by offering the stockholders of one company securities in the acquiring company in exchange for the surrender of their stock. This decision is usually mutual between both firms.

Mezzanine financing — A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing is debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies.

Since mezzanine financing is usually provided to the borrower very quickly with little due diligence on the part of the lender and little or no collateral on the part of the borrower, this type of financing is aggressively priced with the lender seeking a return in the 20 to 30 percent range. Mezzanine financing is advantageous because it is treated like equity on a company’s balance sheet and may make it easier to obtain standard bank financing. To attract mezzanine financing, a company usually must demonstrate a track record in the industry with an established reputation and product, a history of profitability and a viable expansion plan for the business (e.g. expansions, acquisitions, IPO).

Pari passu — A Latin phrase meaning “by an equal progress” or “without preference.” The term’s use by creditors reflects that lenders share equally in the collateral or other asset pool.

Payment in kind (PIK) — The capitalization of interest. The use of additional debt as payment for interest instead of cash.

Private equity — Equity capital that is made available to companies or investors, but not quoted on a stock market. The funds raised through private equity can be used to develop new products and technologies, to expand working capital, to make acquisitions, or to strengthen a company’s balance sheet.

Probability of default — The degree of likelihood that the borrower will not be able to make scheduled payments. Should the borrower be unable to pay, it is then said to be in default of the debt, at which point the lenders of the debt have legal avenues to attempt obtaining at least partial repayment.

Pro rata — See also institutional loan. A Latin phrase meaning “proportionately.” For example, the creditors of the same class are to be paid pro rata; that is, each is to receive payment at the same ratio to their claim that the aggregate of assets bears to the aggregate of debts. In syndicated lending, pro rata debt usually refers to the revolving credit and the amortizing TLA.

Recapitalization — Historically, recapitalization frequently referred to injecting some form of capital into a distressed company to improve its condition. Currently when used in relation to a leveraged loan, recapitalization (also referred to as a dividend recap, see also) usually means to extract funds from a company by using debt to pay a dividend. Financial sponsors are motivated to take this action to extract their investment and increase their return. Existing company management sometimes takes this step as a defensive measure. By doing a dividend recap, they return money to current shareholders by levering the company, making it unattractive as a take over candidate and consequently protecting current management.

Revolving credit (RC) facility — A line of credit in which the customer pays a commitment fee and is then allowed to use the funds when they are needed. It is usually used for operating purposes, fluctuating each month depending on the customer’s current cash flow needs. Often referred to as a revolver or RC.

Risk of default — The risk that the borrower will be unable to pay the

contractual interest or principal on their debt obligations.

Second lien loans — Second lien loans or last-out-tranche loans are typically subordinated in their rights to receive principal and interest payments from the borrower to the rights of the holders of senior debt. As a result, second lien debt is riskier than senior debt.

Senior debt — A form of debt that takes priority over other debt securities sold by the issuer. In the event the issuer goes bankrupt, senior debt must be repaid before other creditors receive any payment.

Springing lien — A provision in a credit agreement that gives creditors a lien on specific collateral only if the borrower’s financial condition deteriorates to or beyond a specific measure of credit quality such as an outside credit agency rating.

Swing line facility — Provides the borrower with the ability to request smaller minimum advances than that allowed under a revolving credit facility, up to a maximum amount. Upon an advance under a swing line, each lender in the bank group is deemed to have purchased from the swing line lender a participation in that advance. The swing line facility typically reduces the transfers of funds between the agent and members of the bank group to such times as participations in, or refinancing of, the swing line are requested by the borrower or swing line lender. The swing line is effectively a sublimit of a syndicated revolving credit and is typically not discretionary on the part of the lenders unless so specified in the credit agreement.

Term loan (TL) — Loan made for a specific amount that has a specified repayment schedule. Term loans usually mature beyond one year with proceeds used for long-term capital needs.

Term loan B — Institutional term loans or term loans that are sold to institutional investors such as prime funds, CLOs, insurance companies, etc.

Toggle note — A toggle note gives the borrower the option of cash pay interest or payment in kind (see also). A toggle note is an institutional tranche (see also) and usually has nominal or no principal reduction until maturity. It is usually cash pay interest at inception and toggling (hence the name) the note to PIK usually results in a rate increase to compensate debt holders for no longer receiving cash interest.

Tranches — (French: slice) Piece, portion, or slice of a deal or structured financing. This portion is one of several related securities that are offered at the same time but have different risks, rewards or maturities. Tranche is a term often used to describe a specific class within an offering wherein each tranche offers varying degrees of risk to the investor or lender. For example, a structured offering might have tranches that have one-year, two-year, five-year and ten-year maturities. It can also refer to segments that are offered domestically and internationally.

Underwritten deal — This refers to a type of syndication. See also best efforts syndication and club deal. An underwritten deal is one in which the arranger(s) guarantee the entire commitment then syndicate the loan. If the arranger(s) cannot fully syndicate the loan, they must absorb the difference, which they may later try to sell to investors.

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