Late Night Debt Question

Hey guys, I rarely work in anything related to nuances in debt, and I'm here all night working through a project that requires a better-than-decent understanding. Brilliant.

My questions are related to classification, so not bad...but resources online aren't super clear:

Are investment grade syndicated loans senior secured or unsecured? What about leveraged syndicated loans? Also, how does this differ from investment grade and junk bonds?

Finally, are revolver, Term-A, Term-B, etc. always fall under the umbrella of either investment grade or leveraged? If so, which one? If not, does it just all depend on the loan specifics and the market's appetite for credit?

Really appreciate it. Crossing my fingers someone from Lev Fin is on here...

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Comments (11)

May 22, 2014 - 5:57am

Hi Smokey, if you're still working on it, I can shed some light on the classification issue. I spent a summer working in a distressed HF a couple of years back.

In a general sense, what determines the classification of a loan or bond by company is twofold:

1.) Credit Rating - I'm sure you know that credit ratings are issued to both the issuer and the bond itself. To be determined as being 'investment grade' a company's rating must be BBB or higher (on an S&P scale). However, credit ratings for companies and their obligations can differ considerably - depending on the 'security' of the loan, its covenants, DSCR ratios, where it sits in the overall capital structure.

2.) What the yield on the bond actually is - although we have seen yield compression (due entirely to the Fed's distortion of prices through QE) across the spectrum, high-yield bonds typically trade at a yield premium to other corporate debt. In the case of a loan, this can be LIBOR + 200 bps + (whereas many investment-grade companies would be trading much closer to LIBOR).

Of the two, the credit rating (of the company) is largely what determines whether the company is considered 'junk' or 'investment' grade.

Right, onto some of the specifics you mentioned:

Revolver - as an RCF - these are typically not tradeable, and don't have a rating per se - but they are the first to be paid back.

Syndicated Loans/ Term Loan A - (Practically) always, these are secured, senior in the capital structure, and are (originally) intended for Banks. Whether this is considered investment-grade or not is dependent on the two factors I mentioned above - typically for 6 years or less, and they amortise.

Term Loan B - similar to TLA, but lower in cap structure, bullet repayment, not just for banks. Again, grade is dependent on issuer, loan rating and yield itself.

PIK - always considered high-yield.

In short, company creditworthiness (and ability to service each portion of debt) determines the classification.

I hope this is of some help, and good luck with the model!

May 22, 2014 - 7:14am

RCFs aren't "first to be paid back". The structure of a super snr RCF is common but the norm is to have it share the same credit docs as the term debt. It may only get paid back sooner due to the revolving nature, not it's seniority in the cap structure. TLA and TLB are pari. TLA gets paid out quicker, but on enforcement they are pari, along with the RCF. These facilities will all share the same security package / documentation, sometimes, as noted above, the RCF will have priority on enforcement (i.e., super snr).

There are many many nuances of debt so it is very hard to truly generalise. Honestly there is just too much to write out. get a book.

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
May 22, 2014 - 8:05am

Oreos:

RCFs aren't "first to be paid back". The structure of a super snr RCF is common but the norm is to have it share the same credit docs as the term debt. It may only get paid back sooner due to the revolving nature, not it's seniority in the cap structure. TLA and TLB are pari. TLA gets paid out quicker, but on enforcement they are pari, along with the RCF. These facilities will all share the same security package / documentation, sometimes, as noted above, the RCF will have priority on enforcement (i.e., super snr).

There are many many nuances of debt so it is very hard to truly generalise. Honestly there is just too much to write out. get a book.

Good stuff - easy way to view cap structures is to look @ Moody's/S&P ratings for starters - will give you a sense of overall structure

speed boost blaze
May 22, 2014 - 9:18am

Oreos:
RCFs aren't "first to be paid back". The structure of a super snr RCF is common but the norm is to have it share the same credit docs as the term debt. It may only get paid back sooner due to the revolving nature, not it's seniority in the cap structure.

Maybe he/she meant maturity rather than seniority? Almost all RCFs I see have maturity 1 year before the senior secured gets repaid. In practice, the debt is usually refinanced around years 3 - 4, 2 - 3 years before RCF or senior maturity.

Otherwise, agree that RCF ranks pari passu with the senior term loan. Sometimes you see terms where senior lenders have to stand still on an EOD until required majority of RCF lenders approve acceleration - this doesn't impact recovery following acceleration, but does give RCF lenders a better position/more bargaining power in a default scenario. Someone posted an example of that type of clause last week.

Those who can, do. Those who can't, post threads about how to do it on WSO.
May 22, 2014 - 2:53pm

Thanks for the help guys. I didn't end up having to do as much as I thought, but for future reference I want to clear something up: Are investment grade loans always either secured or unsecured? Or can they be both? Also, if an investment grade is unsecured, but a leveraged loan is secured, what's going on there? I thought investment grade loans had a low spread, but being unsecured would up the risk and increase the spread.

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May 22, 2014 - 3:21pm

Secured doesn't mean lower risk unless all other things are equal.

For example, unsecured debt over a company with strong free cash flow, diversified sources of revenue, low capex and low debt is a better credit than a secured debt over a company with very high leverage, low free cash flow, low quality or low liquidity assets that the security is over (eg a plant that cost $100m that is only of value for that borrower who makes widgets that are in declining demand, so the next best use of the plant is scrap).

Those who can, do. Those who can't, post threads about how to do it on WSO.
May 22, 2014 - 3:59pm

SSits:

Secured doesn't mean lower risk unless all other things are equal.

For example, unsecured debt over a company with strong free cash flow, diversified sources of revenue, low capex and low debt is a better credit than a secured debt over a company with very high leverage, low free cash flow, low quality or low liquidity assets that the security is over (eg a plant that cost $100m that is only of value for that borrower who makes widgets that are in declining demand, so the next best use of the plant is scrap).


Brilliant, this is what I needed to tie it all together. Strongly appreciate it.
May 22, 2014 - 4:21pm

Oreos had a great point too. A "senior secured" position over holdco assets = security over holdco's shares in the opcos. That means that, on default, lenders to holdco only end up holding shares in opcos ie they have an equity claim on opcos, sitting behind all opco creditors (secured and unsecured, lenders and other creditors eg accounts payable claims, employee claims).

So your "secured" position in holdco is shitty and is equivalent to a preferred equity position (ie equity claim on opcos, preferred to ordinary equity holders in holdco) and you'd normally expect an equity-like return on the debt appropriate for the equity-like risk you're taking.

On the other hand, you can have a loan into holdco where the opcos grant security to the holdco lenders, which means holdco lenders rank ahead of opco creditors on a default, at least in relation to the opco assets they have security over.

You'll frequently hear the first type referred to as "holdco debt", which is flagging that the debt is higher risk than even unsecured opco debt.

The second type would be seen as true "senior secured" and is common in deals like LBO financing where banks lend to the acquiring SPV, which will become the holdco when it buys the target.

Those who can, do. Those who can't, post threads about how to do it on WSO.
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May 22, 2014 - 3:29pm

Also totally depends on what you are secured. A holdco snr secured (limited to share pledge and accounts of the issuer) deal vs. opco unsecured, which one do you take?

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
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