In previous articles, we talked about Working Capital Loan and Trade Finance in Corporate Banking. Those are short-term financing products for small and medium enterprises. For the more sophisticated enterprises or even investment consortium, they may borrow longer term for various loan purposes like Capital Expenditure, Refinancing and even for Merger & Acquisition.
Bilateral vs. Club Financing
In general, the borrowing relationship between bank and enterprise is bilateral (i.e. 1 bank vs. 1 borrower). Given the higher risk exposure of long term financing, some banks tend not to finance the transaction solely by one bank but to share the exposure among different banks in form of a club or syndication financing. Club financing transaction is usually funded by relationship banks of a borrowing group while syndication often involves larger group of participating banks not only at home country but from the region or even around the world. Meanwhile, banks earn the title of different classes like Arranger or Mandated Lead Arranger & Bookrunner (MLAB) subject to the size of their respective lending exposure. A MLAB is necessary to lead the financing including documentation, lender pitching and Information Memomedrum write up. There is no minimum level for club or syndication financing but due to the high operating cost, the deal size is usually not less than USD50m for club or USD100m for syndication. Usually, a Facility Agent is also appointed to handle the future communications between lenders and borrower in case of Club/Syndication Financing.
Borrower can be operating entity or Special Purpose Vehicle (SPV) which is set up on purpose solely as a borrowing entity. SPV is common especially for project loan or acquisition. Depending on situation, operating entities, listed companies and/or parent companies may provide Guarantee, Keep-well Deed or Letter of Comfort to provide additional credit support. Unlike Guarantee, Keep-well is an undertaking to ensure sufficient liquidity of Borrower to repay liability in form of equity injection or standby facilities. This is commonly seen in offshore debt by Chinese enterprises where parent’s guarantee is not available due to regulatory requirement. All borrowers, guarantor and keep-well providers are altogether named as Obligor in the transaction.
Tenor and repayment
The common loan tenor is 3 years with a few amortizations starting 12-18 months after loan drawdown. However, due to keen competition among banks, sometimes bullet loan (single repayment at maturity) or longer terms like 4 or 5 years are not uncommon for quality borrower. The average loan life is the measurement of the weighted average of the loan duration considering how early, how much and how many times of repayment would be made before final maturity. For a typical 3-year term loan with 20/20/20/40 percent of repayment from 18th, 24th, 30th and 36th (final maturity) month respectively after loan drawdown, the average loan life is 2.4 years^. Bank prefers to have more repayments before maturity such that the balloon repayment (instalment at maturity) is smaller with less refinancing risk.
^ 0.2×18+0.2×24+0.2×30+0.4×36 = 28.8 months or 2.4 years
The pricing is usually the combination of arrangement fee plus interest. Conventionally, the interest is on floating basis which is LIBOR + margin if it is USD loan. As a standard comparison, the total cost will be presented as All-in pricing which is the sum of margin and fee per annum (defined as arrangement fee percentage divided by average loan life). As it is a floating rate loan, interest period (normally 1, 3 or 6 month) will be optional to Borrower for selection. To ensure making interest payment periodically, Interest Reserve Account would be created and/or charged as a security to ensure sufficient cash is maintained. If interest rate risk or currency risk is the main concern, Interest Rate Swap or Cross Currency Swap as treasury solution can be bundled for treasury risk mitigation.
Unlike short-term loan which is usually payable on demand, the term loan is a committed loan and lenders cannot demand for repayment in advance of the original schedule unless certain Prepayment requirement or Events of Default (EOD) are triggered. For example, Borrower would have to prepay in full if the control of Borrower changes or majority of asset or business is disposed because the fundamentals of the credit may have been materially changed and the original terms and conditions are no longer applicable. Apart from non-payment, there are also sets of Undertakings and Financial Covenants to control the company underlaying and monitor the business performance during the life of facility. For Undertakings, the most common ones are the supply of financial information like providing timely audited financial statements and Compliance Certificate to ensure all Financial Covenants are complied. From time to time, there could be non-compliance for the above which would lead to the one-off waiver or amendment request to seek majority or all lenders’ consent. However, this would be judgmental by lenders and each has its own merits. As a result, the negotiation of terms and conditions before the signing of Facility Agreement are instrumental to strike a balance between sufficient credit control and buffering.
Corporate Lending Future
Traditionally, the terms and conditions are offered by Lender in form of Term Sheet or Facility Agreement before and after formal credit approval. Credit information like KYC, financial and business information is turned in to banks for approval and loan document is to be signed on paper manually. The process could be lengthy range from 2months to 3 months. However, would it be possible if Borrowers are able to tailor its preferred terms, distribute loan information to various lenders securely for participation and sign off the loan document through Smart Agreement all the way in single fintech platform? This is exactly the digitalisation trend in Corporate Banking. Fintech solution powered by Distributed Ledger Technology (DLT) streamline the loan origination process while banks can focus on their specialization on credit risk and balance sheet management. We’ll share our thoughts in upcoming article. Please stay tuned with FinMonster.