INTERMEDIATE TERM FINANCING: TERM LOANS AND PRIVATE PLACEMENTS Chapter 10

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INTERMEDIATE TERM FINANCING TERM LOANS AND
PRIVATE PLACEMENTSChapter 10
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INTERMEDIATE TERM FINANCING

• 3 years up to 10-15 years
• At the shorter length
• Term Loans
• Paid back in installments

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INTERMEDIATE TERM FINANCING

• Prior to 1990, most developing firms would get
  their term loans (intermediate term financing)
  from their bank or insurance company. But in that
  year, their was a flight to quality by the
  insurance companies and banks.
• Prior to 1990, life companies had about 20 of
  their portfolio of loans to BIG (below
  investment grade) companies today it is a few
  percent.
• Today its junk bond funds.

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PROWSES CREDIT MARKET CHACTERISTICS

• Characteristic Bank Loan Private
  Placement Public Bond
• Contract Terms
• Average loan size Small Medium Large
• Average maturity Short Long Longest
• Interest rate Floating Fixed Fixed
• Covenants Many, tight Fewer, looser Fewest,
  loosest
• Covenant
• renegotiation Frequent Less
  frequent Rare
• Collateral Frequent Less frequent Rare
• Liquidity of
• instrument Low Low High
• Borrowers
• Average size Small Medium to
  large Large
• Severity of info
• problems posed High Moderate Low
• Lenders

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INTERMEDIATE TERM FINANCING

• Banks like to match short term liabilities with
  short term assets insurance companies like to
  match their long term assets with long term
  loans. If banks make a fixed rate loan they can
  swap it for a floating rate.
• 80 of bank loans are for less than 1 million
  80 of all private placements were for 10 to
  100 million 80 of all bond offerings were for
  100 to 500 million.

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INTERMEDIATE TERM FINANCING

• Bank loans were usually for less than a year.
  Term loans (50) privately placed were for seven
  to fifteen years. 70 of bonds were over ten
  years to maturity.
• With small loans, collateral is very important.
  As the size of the loan increases, and the
  information problems decrease, collateral
  becomes less important. Then Cash Flow takes
  over.
• Bonds are virtually all uncollateralized.

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INTERMEDIATE TERM FINANCING

• As we got away from the credit crunch of
  1990-1991, the yields on all bonds dropped
• Also the spreads between AA bonds and BBB
  dropped dramatically.
• Today we are blessed with an abundance of debt
  money available and at lower rates than in the
  past.

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NEGOTIATING A TERM LOAN

• Despite the availability of money it is still
  necessary to negotiate a loan.
• This means that it is incumbent on a borrower to
  be as up on the process as possible.
• If nothing else, having a negotiating strategy
  will impress the lender with your management
  acumen.

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NEGOTIATING A TERM LOAN

• Affirmative Covenants Representations and
  Warranties
• Stay in the same business
• Submit periodic financial statements
• of certain type
• Proper insurance coverage
• on certain executive(s)
• Pay taxes
• Top management stay in place
• Still be Cautious
  could cause a call

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NEGOTIATING A TERM LOAN

• Negative Covenants
• CASH FLOW CONTROL - Restrictions on amount you
  Plow back or pay out.
• STRATEGY CONTROL - Does strategy match Companys
  ability and resources?
• BALANCE SHEET PRESERVATION - Excessive leveraging
  or financing L/T assets with S/T loans.
• ASSET PRESERVATION - Restrict sales of assets
• Negative Pledge Clause - cant deal w/ another
  bank
• THE TRIGGER - Banks right to call loan

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NEGOTIATING A TERM LOAN

• Learn to think like a banker - identify the
  banks objectives.
• Meet the bankers objectives - with least damage
  to your companys position.
• Set the priorities on the restrictions the bank
  wants so you can give in to one or two.
• Influence the banker to relax or withdraw
  non-crucial restrictions.

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NEGOTIATING A TERM LOAN

• FORGE YOUR OWN STRATEGY
• Consider your earnings history losses make you a
  risk.
• Will variables influencing the loan service
  change over the life of loan and cause severe
  problems?
• With the loan, how do your ratios look? Will you
  still have Debt capacity?
• Considering types of assets company owns, net
  working capital level, and margin of safety for
  creditors, could bank get repaid if companys
  assets were liquidated? If Yes, then you have a
  strong Balance Sheet.

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NEGOTIATING A TERM LOAN

• A BASIC NEGOTIATING POSTURE
• Management needs flexibility to avoid default.
• Even if some restriction is dropped, bank can
  still achieve objectives with remaining
  covenants.
• Strong balance sheet indicates good secondary
  source of repayment if income stream declines.
• Strong earnings means bank can tolerate weaker
  balance sheet. Lots of NOCF helps weak B/S.
• Banker can tolerate large payouts or other
  actions because it can pull the Trigger if need
  be.

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INTERMEDIATE TERM FINANCING TERM LOANS AND
PRIVATE PLACEMENTS
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