Structuring Corporate Loans
for
Small and Middle Market Companies
Chris Droussiotis
2013
Table of Contents
1.
Corporate Loans – an overview (Small and Middle Market transactions in the U.S.)
2.
Market Overview in the U.S.
3.
Loan Terms and Conditions (Money and Non-Money terms)
4.
Credit and RAROC Loan Analysis
5.
Marketing and Structuring a primary syndicate/club deal with other banks
6.
Structuring a Loan: Debt Capacity, Leverage, Coverage and Collateral analysis
7.
Case Studies for Debt Capacity using Cash Flow and Asset Coverage
8.
Lecturer’s Biography
1
U.S. Corporate Loans – An Overview
Two Markets Served
Investment Grade Loan Market
Leveraged Loan Market
• Rated BBB- and Higher (Corporate)
• Rated BB+ and Lower (Corporate)
• Arrangers hold Higher Exposure ($200 million +)
• Arrangers hold Lower Exposure – thus
the need to syndicate
• The majority of the Syndicate are traditional banks
• Leverage Ratios (Debt/EBITDA>3.0x)
Large Cap Market (Rated)
EBITDA > $100mm
Middle Market (Rated/NonRated)
$5mm > EBITDA < $100 mm
Small Business (Non-Rated)
$200,000 > EBITDA < $5 mm
2
U.S. Middle Market Loan Overview
Total Year
2012
$50
Total New-Issue Volume ($2.75B)
$41.3
$38.7
$40
Computers & Electronics
18.7%
Gaming & Hotel
$34.8 $34.2
$34.5
14.2%
$28.7
$26.7
13.7%
Chemicals
$26.0
7.4%
Oil & Gas
7.3%
Insurance
7.1%
Food & Beverage
$20
$17.2
$14.3
$11.9
$12.5
$11.4
$10
5.6%
3.1%
Manufacturing & Machinery
1.5%
Restaurants
0.7%
Transportation
0.7%
4Q
12
20
12
20
11
20
10
20
09
20
08
20
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
$0
19
99
6.5%
Healthcare
$2.8
19
98
6.7%
Home Furnishings
Metals & Mining
$5.3
Institutional
6.7%
Retail
$9.9
$8.0
19
97
0%
5%
10% 15% 20% 25% 30% 35% 40%
Pro Rata
EBITDA of $50 million or Less
L+700
Recap/General
Recap
4%
Total New-Issue Volume ($9.88B)
Recap/Equity Other
6%
Infusion
2%
Corp Purpose
5%
L+600
LBO
32%
Recap/Dividend
7%
L+500
L+400
L+300
L+200
L+100
L+0
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
4Q
12
In Billions
S ervices & Leasing
$30
Pro Rata
Institutional
Acquisition
18%
Refinancing
25%
3
U.S Small Business Loan Market Overview
4
Typical Leveraged Deal Term Sheet / Credit Agreement
1. Parties to the Credit Agreement:
 Borrower
 Holding Company
 Guarantor / Parent and Subsidiaries’ Guarantee
 Agent Banks (for middle market deals)
 Administrative Agent
 Collateral Agent
 Syndication Agent
 Documentation Agent
 Law Firms representing the Borrower and Agent Banks
2. Description of the Transaction / Purpose of the Loan (s) – Use of Proceeds
5
Typical Leveraged Deal Term Sheet / Credit Agreement (Continued)
3. Money Terms:

Amount / Tranches

Revolving Credit / Line of Credit

Term Loans
 Equipment Loans
 Real Estate Loans

Pricing

Interest Rate / Margin over LIBOR/Prime

Commitment Fees on unfunded portion

Maturities (months/years)

Amortization Schedule (set principal payments) /
monthly mortgage like payments (P+I) for Small
Loans and Quarterly for Middle Market Loans

Collateral
In a middle market, the company needs
100% Vote from the syndicate banks to
amend these terms
6
Typical Leveraged Deal Term Sheet / Credit Agreement (Continued)
4. Non-Money Terms:
 Financial Covenants
 Negative Covenants
Need Majority Vote (typical 51%)
from the syndicate banks to
amend these terms
 Affirmative Covenants / Management Covenants
7
Typical Leveraged Deal Term Sheet / Credit Agreement (Continued)
Typical Financial Covenants
New Terminology in 2006 and 2007:
Covenant Lite Structures (“Covy lite”)
Maximum Leverage Ratio (Total Debt / EBITDA)
Incurrence Tests Vs Maintenance Tests
Maximum Senior Leverage Ratio (Bank Debt / EBITDA
Minimum Coverage Ratio (EBITDA / Interest
Minimum Fixed Charge Ratio (EBITDA – Capex – Taxes ) / Interest + Principal Payments)
Maximum Capital Expenditures
Minimum Tangible Net Worth
Maximum Total Liabilities to Tangible Net Worth (Small Business Loans)
Typical Negative Covenants
Limitations on Additional Debt
Limitations on Asset Sales / Mergers & Acquisitions / Sale/leaseback transactions
Limitations of Dividends / Investments
Limitation on Liens / Negative Pledges
Excess Cash Sweep
Limitations of Change of Ownership
8
Typical Leveraged Deal Term Sheet / Credit Agreement (Continued)
5. Other Terms & Conditions:

Security / Liens / Guarantees

Borrowing Base

Mandatory Prepayments

Optional Prepayments / Call Protection

Financial Reporting / Maintaining Corporate Existence (“Affirmative Covenants”)

Representation and Warranties

Conditions Precedent at Closing

Events of Default

Assignments and Participations / Secondary Sales

Waivers and Amendments

Indemnification

Cross Default

Material Adverse Clause (MAC)
9
Typical Leveraged Deal Term Sheet / Credit Agreement (Continued)
Other Terminology to the Credit Agreement
 LIBOR Floor
 Original Issuer Discount (OID)
 Margin Spread
A typical calculation of Loan Yields in the secondary market for loans:
LIBOR or LIBOR Floor + Margin Spread + (100-OID)/4* years = Loan Yield
*market convention is to use 4 years as it represents the average life
Example:
LIBOR Floor = 1.00%
Margin Spread = 400 basis points (or 4.00%)
OID = 98
Then the Loan Yield is calculated to:
1.0% + 4.0% + [(100 – 98)/100]/4 = 5.0% + (2.0% / 4) = 5.0% + 0.5% = 5.5% Yield
10
Types of Loan Syndication Formats for Middle Market Deals

Underwritten deal

Best-efforts syndication

Club deal
11
Types of Loan Syndication Formats for Middle Market Deals
(Continued)
Underwritten deal

Arrangers guarantee the entire commitment, then syndicate the loan to reduce their exposure.

If the arrangers cannot fully subscribe the loan, they are forced to absorb the difference.
Reasons for Arrangers to underwrite:
•
Offering an underwritten loan can be a competitive tool to win mandates.
•
Underwritten loans usually require higher fees
New Terms:
• “Flex Language”
•
Memorandum of Understanding (MOU)
•Balancing between holding and syndicating exposure
•For preferred customers, the banks tend to hold higher exposure justifying it by additional products
offered going forward (an important variable in the banks’ profitability calculations (RAROC), though
given the size of the facility, the banks’ are phased with the dilemma of successfully syndicating and 12
holding their exposure.
Types of Loan Syndication Formats for Middle Market Deals
(Continued)
Best-efforts syndication

The Arranger commits to underwrite less than the entire amount of the loan.

If the loan is undersubscribed, the deal may not close unless the terms/pricing/structure are changed.

Best-efforts syndications were used for risky borrowers or for complex transactions.
As in the case of underwriting, for preferred customers, the banks tend to hold higher exposure
justifying it by additional products offered going forward (an important variable in the banks’
profitability calculations (RAROC).
13
Types of Loan Syndication Formats for Middle Market Deals
(Continued)
Club deal

Pre-marketed to a group of issuer’s or equity sponsor’s relationship lenders.

Typically a smaller loan (usually $25 million to $200 million but as high as $500 million)

The arranger is generally a first among equals, and each lender gets a full cut of the fees.
For preferred customers, the banks tend to hold higher exposure justifying it by additional
products offered going forward (an important variable in the banks’ profitability calculations
(RAROC).
14
Internal Application for Approval Process
Typical Internal Analysis Process by each bank
 Internal Application sent to their respected investment/credit committees. This application
includes the following:
 Requested amount that is within the rating parameters for each bank
 Recommended amounts by Tranche (Revolving Credit / Term Loans)
 Term and Conditions of the Loans (includes pricing, structure and covenants)
 Profitability (RORA and RAROC)
 Syndication strategy
 Transaction discussion including Source and Uses and Capital Structure
 Company discussion including historical performance and outlook
 Corporate Structure
 Management Biographies / Equity Sponsor Profile
 Collateral Analysis
 Industry Analysis
 Financial Analysis (Projections’ Model)
 Internal Rating Analysis
This process will be
discussed following this
 Internal Legal Review
page
 KYC (know-your-customer) and Compliance Review
15
Risk Assessment Analysis
Typical Internal Rating Analysis by each bank
 Most banks’ internal ratings are in line with the Agencies’ external ratings, though the analysis is
done independently. This analysis is based on two approaches:
 Quantitative Analysis
 Qualitative Analysis
The Typical Scale is 1-10, 1 being
with very limited risk to default and
10 the issuer being in bankruptcy
with no chance of recovery
The Quantitative Analysis for establishing the Internal rating which measures the probability of default
is based on the following parameters (each component is weighted at a specific level of importance):
 Leverage Ratio - the relationship between debt and earnings (i.e. DEBT / EBITDA)
 Capitalization Ratio – the relationship between the bank debt and the rest of the capital (Capital Leases,
Bonds, Equity)
 Coverage Ratio - Issuer’s Cash Flow covering it’s debt obligations (interest and principal payments)
 Variance of Projections – based on the projections, the model typically assumes a certain haircut (1030%) to the management’s projections and it tests it’s ability to pay its debt obligations.
 The Quantitative approach adjusts up or down based on industry characteristics (Recession resistance,
cyclical, or event driven).
 The Qualitative Analysis is subjective based on each bank’s internal policy. The Analysis would include
strength of management, support from the equity sponsor, recovery analysis (asset collateral) and
outlook.
16
Structuring a Loan – Small Business
Debt Capacity, Leverage, Coverage and Collateral analysis
Terms & Conditions:
1. Loan Amounts: SBA 7a – Up To $2,000,000.00
2. Loan Amounts: SBA 504 – Up To $5,000,000.00
3. Interest Rate: Prime Rate + Spread Which Is Adjusted Quarterly
4. Term: Maximum 25 Years Amortization
5. LTV (Loan To Value): Up To 90%
6. Debt Coverage: 1.20x
7. Assumption: Yes
8. Recourse: Yes
9. Minimum 30 day closing but probably longer
10. Down Payment: 10%-20% on acquisitions
11. Borrower must occupy at least 51% of the property
12. Minimum FICO Score Of 650
13. Minimum Loan Amount: $500,000.00
17
Structuring a Loan – Small Business
Three Factors determining Eligibility for SBA loan
1. Loan to Value
Different SBA lenders and different SBA loans have different equity requirements.
Many loans require the borrower to retain 10 to 20 percent of the equity in the
business.
2. Personal Guarantees
Many SBA loans call for personal guarantees. Some of the guarantees bind the
borrower's personal credit to the loan; others call for the borrower to pledge personal
assets to the loan. In some cases, SBA loans even require the collateral assignment
of life insurance death benefits so that if the borrower passes away, the loan will be
repaid.
3. Creditworthiness
Contrary to popular belief, SBA loans are not for borrowers with poor credit or no
business plan. The borrower must posses a valid business plan, good credit and
committed capital in the business.
18
Structuring a Loan – Middle Market (Case Study)
Debt Capacity, Leverage, Coverage and Collateral analysis
LBO Opportunity
Ares Venture Management Group (“Ares”) decided to purchase ABC hotel property and its land in Austin Texas for
$10,000,000. In addition, Areas will spend $2,000,000 for Renovations including new furniture and equipment.
Capital Raising
Bank Debt:
Amount of Loan: 3.0x ABC’s First Year’s EBITDA
Interest Rate: LIBOR + 4.5%
Term: 7 years
Schedule Principal Payments:
Year 1
300,000
Year 2
500,000
Year 3
500,000
Year 4
600,000
Year 5
700,000
Year 6
900,000
Year 7
Balance
Mezzanine:
Amount of Loan: Up to 4.0x of ABC’s First Year EBITDA (Equity - not be less than 35% of total Capital)
Interest Rate: 9.00%
Term: 10 years
Schedule Principal Payments: Years 1-9: $0 ; Year 10: The Balance
Equity: Ares’ equity contribution to the purchase will be 35% or up to total leverage of 4.0x dictated by the Mezzanine
Loan requirements.
19
Structuring a Loan – Middle Market (Case Study)
Debt Capacity, Leverage, Coverage and Collateral analysis
ABC Company
LBO Equity Analysis using CAPM
3
TRANSACTION SOURCES & USES
Debt
Capacity
(EBITDA x)
4
Sources:
Amount
% Capital
Expected
Return
Expected
Return
(After Tax)
WACC
(After Tax)
EBITDA
Multiple
5
6
7
8
9
Bank Loan
Mezzanine Note
Total Debt
Equity
Total Sources
3.0x
4.0x
6,000,000
2,000,000
8,000,000
4,360,000
12,360,000
48.5%
16.2%
64.7%
35.3%
100.0%
5.607%
9.000%
3.589%
5.760%
20.00%
20.00%
1.74%
0.93%
2.67%
7.05%
9.73%
3.0x
1.0x
4.0x
2.2x
6.2x
10
11
12
13
1st Year's
EBITDA
Multiple
Uses:
Puchase of Property
Renovation
14
15
16
Transaction Fees & Expenses
Total Uses
6.0x
3.0%
COST OF DEBT CALCULATIONS
Loan
Spread
4.00%
10,000,000
2,000,000
12,000,000
360,000
12,360,000
% of
Total
Uses
97.1%
2.9%
100.0%
WACD = 4.132%
First Year's EBITDA =
Tax Rate=
2,000,000
36.0%
COST OF EQUITY CALCULATIONS
COST OF BANK DEBT CALCULATION
(Floaring Rate)
3M-LIBOR
Assumptions
0.50%
Amount
Initial All -In
4.50%
COST OF MEZZANINE NOTE CALCULATION
9.00%
E (re) = rf + β . Pe + e
6-year Treasury Note [ rf ]
Beta for Publicly Traded Hotel [ β ]
Equity Premium [ Pe ]
Firm Specific Risk Premium [e]
Cost of Equity
1.95%
1.633x
11.05%
0.0%
20.00%
20
Structuring a Loan – Middle Market (Case Study) - (Continued)
Debt Capacity, Leverage, Coverage and Collateral analysis
18
DEBT ASSUMPTIONS & RETURN ANALYSIS
19
Bank Loan Information
Debt IRR
Amount Outstanding (End of Year)
Schedule Principal Payments
Interest Payment (Calc based on last Year's Outs)
Total Financing Payment
5.607%
Interest Rate
LIBOR RATE
LIBOR Rate Increase Assumptions
20
21
22
23
24
25
26
27
28
Corporate Bond Information
Amount Outstanding
30 Schedule Principal Payments
31 Interest Payment (Calc based on last Year's Outs)
Total Financing Payment
9.000%
32
29
33
34
35
Total Financing
Total Debt Outstanding
Terms
6,000,000
7 years
5.61%
(6,000,000)
0.50%
2,000,000
10 Years
9.00%
(2,000,000)
1
5,700,000
300,000
270,000
570,000
4.50%
0.50%
0.00%
2
5,200,000
500,000
285,000
785,000
5.00%
1.00%
0.50%
3
4,700,000
500,000
286,000
786,000
5.50%
1.50%
0.50%
4
4,100,000
600,000
305,500
905,500
6.50%
2.50%
1.00%
5
3,400,000
700,000
266,500
966,500
6.50%
2.50%
0.00%
6
2,500,000
900,000
221,000
1,121,000
6.50%
2.50%
0.00%
7
2,500,000
162,500
2,662,500
6.50%
2.50%
0.00%
2,000,000
180,000
180,000
2,000,000
180,000
180,000
2,000,000
180,000
180,000
2,000,000
180,000
180,000
2,000,000
180,000
180,000
2,000,000
180,000
180,000
2,000,000
180,000
180,000
750,000
7,700,000
965,000
7,200,000
966,000
6,700,000
1,085,500
6,100,000
1,146,500
5,400,000
1,301,000
4,500,000
2,842,500
2,000,000
21
Structuring a Loan – Middle Market (Case Study)
Debt Capacity, Leverage, Coverage and Collateral analysis
CASH FLOW & EQUITY RETURN ANALYSIS
Company Projections
Operating
Assump.
5.00%
35.0%
15.0%
50.0%
3.00%
7
Revenues
Cost of Revenues
Operating Costs
EBITDA
Less Depreciation
Less Amortization of Fees
EBIT
Less Interest (Unlevered for DCF Analysis)
EBT
Less Taxes (adj out Interest Exp)
Plus Depreciation & Amortization
Less Working Capital
Less Capex
Cash Flow Before Financing (CFBF)
Entry Year
0
growth
% of Revenue
% of Revenue
% of Revenue
years
36.0% % of EBT
1.00% % of Revenue
3.00% % of Revenue
Less Financing ( P + I )
Equity Cash Flows
Year 1
1
4,000,000
(1,400,000)
(600,000)
2,000,000
(120,000)
(51,429)
1,828,571
1,828,571
(658,286)
171,429
(40,000)
(120,000)
1,181,714
Year 2
2
4,200,000
(1,470,000)
(630,000)
2,100,000
(126,000)
(51,429)
1,922,571
1,922,571
(692,126)
177,429
(42,000)
(126,000)
1,239,874
Year 3
3
4,410,000
(1,543,500)
(661,500)
2,205,000
(132,300)
(51,429)
2,021,271
2,021,271
(727,658)
183,729
(44,100)
(132,300)
1,300,942
Year 4
4
4,630,500
(1,620,675)
(694,575)
2,315,250
(138,915)
(51,429)
2,124,906
2,124,906
(764,966)
190,344
(46,305)
(138,915)
1,365,064
Year 5
5
4,862,025
(1,701,709)
(729,304)
2,431,013
(145,861)
(51,429)
2,233,723
2,233,723
(804,140)
197,289
(48,620)
(145,861)
1,432,391
Exit Year
6
5,105,126
(1,786,794)
(765,769)
2,552,563
(153,154)
(51,429)
2,347,981
2,347,981
(845,273)
204,582
(51,051)
(153,154)
1,503,085
(750,000)
431,714
(965,000)
274,874
(966,000)
334,942
(1,085,500)
279,564
(1,146,500)
285,891
(1,301,000)
202,085
Terminal Value
EBITDA Multiple Method (initial purchase multiple)
Growth
6.0x
15,315,379
Perpetuity Method (using WACC + growth) 3.50%
9.73%
25,025,580
Average Terminal Value
Debt Outstanding
Equity Value (TV - Debt)
7
5,360,383
(1,876,134)
(804,057)
2,680,191
(160,811)
2,519,380
2,519,380
(906,977)
160,811
(53,604)
(160,811)
1,558,799
(2,842,500)
(1,283,701)
20,170,479
4,500,000
15,670,479
Equity Cash Flows
(4,360,000)
$ 1 PV Table (Expected Equity Rate)
PV Table (Expected Equity Rate)
20.00%
6,310,149
Initial Investment
NPV=
(4,360,000)
1,950,149
IRR=
431,714
x
0.8333398
359,765
274,874
x
0.6944552
190,888
334,942
x
0.5787172
193,837
279,564
x
0.4822680
134,825
285,891
x
0.4018931
114,898
15,872,564
x
0.3349135
5,315,937
28.6%
22
Structuring a Loan – Middle Market (Case Study)
Debt Capacity, Leverage, Coverage and Collateral analysis
Collateral Analysis
Advance
Rates
(ABL
Facility)
100%
85%
50%
50%
50%
Cash
A/R
6 Inventory
7 Fixed Assets
8 Investments
4
5
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
Total
BV of
Assets
($ mm)
Debt
Capacity
based on
Colateral
50.00
50.00
200.00
170.00
150.00
75.00
300.00
150.00
100.00
800.00
50.00
495.00 Debt Capacity
Cash Flow Analysis (Debt Capacity)
0
Revenue
CoGS
Oper. Exp.
EBITDA
Less Capex
Less Cash Taxes (% of EBIT)
Less WC
CFADS
Terminal Value (based on EBITDA)
PV
Inerest Rate (Cost of Funds)
Cushion
Debt Capacity
Leverage
Assumptions
5.00%
65.00%
10.00%
100.0
5.00%
40.00%
2.00%
1
2
105.0
(68.3)
(10.5)
26.3
(5.3)
(12.6)
(2.1)
6.3
3
110.3
(71.7)
(11.0)
27.6
(5.5)
(13.2)
(2.2)
6.6
4
115.8
(75.2)
(11.6)
28.9
(5.8)
(13.9)
(2.3)
6.9
5
121.6
(79.0)
(12.2)
30.4
(6.1)
(14.6)
(2.4)
7.3
6.0x
127.6
(83.0)
(12.8)
31.9
(6.4)
(15.3)
(2.6)
7.7
191.4
157.9
6.3
6.6
6.9
7.3
199.1
8.00%
20.00%
126.31
4.8x
* Adj for Depr = same as Capex
23
BIOGRAPHY OF THE LECTURER
Chris Droussiotis, MBA, C.H.E.
Chris Droussiotis has twenty five plus years of banking experience working in the
investment banking divisions of major New York money center banks, such as Bank of
America, CIBC Oppenheimer, Sumitomo Mitsui Banking Corp., Mitsui Nevitt Merchant
Bank, Mizuho Financial Group and Bank of Tokyo-Mitsubishi, specializing in the
financing and structuring of merger & acquisition, leveraged buyout and recapitalization
transactions.
Chris is currently an Executive Director and the Head of the Leveraged and Sponsor Finance Group at
Sumitomo Mitsui Banking Corporation managing a $1.4 billion investment portfolio of leveraged loan
investments.
Duties include portfolio analysis, valuation, financial projections, credit assessment, as well as interaction with
issuers, broker-dealers, investment banks, Private Equity firms and bank management.
Prior to his banking career, Chris taught mathematics and business statistics at FDU’s Sullivan Business School
in Rutherford, NJ. He holds a B.Sc. in business, an MBA from FDU’s Sullivan School of Business, was credit
trained at Bank of America, and completed advanced professional development courses in corporate taxation at
New York University.
Chris is also an Adjunct Professor of certain finance courses for undergraduate and graduate programs at
Baruch College and FDU including Investment Analysis, Quantitative Analysis in Business, Managerial
Accounting, Business Statistics, Derivatives, Debt & Fixed Income Markets and Advanced New Venture
Management.
Chris has given various lectures on various subjects including Leveraged Buyouts, Credit Markets, Capital
Markets for Baruch College, as well as companies such as Cendant Corporation, Wyndham Worldwide,
Travelocity and the Industrial Bank of Japan.
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