#15466 - Loan Finance - Corporate Finance

Corporate Finance: SGS 8: Loan Finance

INDEX OF ABBREVIATIONS

- RIE – Recognised Investment Exchange

- IPO – Initial Public Offering

- PR – Prospectus Rules

- LR – Listing Rules

- DTR – Disclosure Guidance and Transparency Rules

- LP – Listing Principles

- PLP – Premium Listing Principles

- FSMA 2000 – Financial Services and Markets Act 2000

- RAO – Financial Services and Markets Act 2000 Regulated Activities Order 2001

- FPO – Financial Services and Markets Act 2000 Financial Promotions Order 2005

- MAR – Market Abuse Regulations

- CJA – Criminal Justice Act 2002

- FSA – Financial Services Act 2012

- UK CGC – UK Corporate Governance Code

- RCF – Revolving Credit Facility

- LSE – London Stock Exchange

- AIM – Alternative Investment Market

- FCA – Financial Conduct Authority

- MAC - Material Adverse Change

- EoD – Event of Default

OVERVIEW OF BANKING SYSTEM

- Individuals – Deposit money with banks through savings/current accounts – banks use money deposited with them to lend to other individuals/companies and invest in securities.

- Banks – Act as conduit for lending – take money deposited with them and lend it to other individuals/companies and/or invest in securities.

- Interbank Market – Banks seeking to provide loans but which lack sufficient funds to make the loan may borrow money from other banks with surplus deposits in order to fund provision of loan to the 3^rd party.

- London Interbank Offered Rate (LIBOR) – Rate at which banks in London are prepared to lend to each other – determines amount of interest a bank will pay on amounts it borrows from other banks.

- LIBOR rate can affect rate of interest paid by borrower (i.e. individual/company) as bank will seek to pass on cost of interbank loan to its own customers.

- Interest periods in loan agreement between bank/borrower mirrors those applicable to bank’s own interbank loan so that bank immediately able to pass on changes in interest payable on interbank loan to its borrower’s.

- Business Relationships – Bank will seek to maintain relationships with key customers in order to enhance bank’s ability to sell products to such borrowers in future + increase chances of becoming that customer’s ‘relationship bank’ (bank to which borrower first turns when requiring loans/financial products).

- Importance of customer to the bank + extent of bank’s desire to preserve relationship with that customer will influence what action bank takes in respect of that customer (e.g. how bank deals with occurrence of event of default under loan agreement).

- Credit Risk – Lending bank takes risk that borrower will not be able to satisfy interest/capital repayment obligations – banks seek to mitigate against credit risk by:

(a) conducting due diligence on potential borrower before agreeing to make the loan (including source of funds borrower will use to make capital/interest repayments);

(b) drafting loan agreement to include provisions which will increase likelihood that bank will be able to recover sums due to it before borrower becomes insolvent (e.g. events of default + security + guarantees); and

(c) demanding higher rate of interest (i.e. greater returns for bank) as condition of entering into higher risk loans.

- ‘Recourse’ – Bank’s claim on certain assets in order to ensure repayment of loan – bank must ensure it has recourse to sufficient assets to enable it to recover amount lent to borrower (i.e. security over assets of borrower).

- Lending to Corporate Group – Subsidiary company may operate business of group + generate revenue + own productive assets whilst holding company merely holds shares in subsidiaries + does not conduct business on its own account.

- Bank lending to non-business operating holding company must determine, in course of due diligence, how holding company will acquire funds to repay loan (e.g. via dividends paid to it by revenue generating subsidiaries) + location/ownership of assets over which it may take security + may demand guarantees from subsidiaries.

- Bank Profits – Amount by which price of financial products provided by banks exceeds cost to bank of providing those products.

- LIBOR Rate Fluctuations – Rate of interest payable on an interbank loan as determined by LIBOR may fluctuate during life-time of loan – increase in rate of interest payable by bank on its interbank loan may wipe-out bank’s profits on loans made at fixed rate of interest where cost of interbank borrowing to fund that loan exceeds amount recovered by way of interest from the borrower.

- ‘Cost-Plus’ Loans – Used by banks to mitigate against risk of increases in LIBOR – interest rate on loans made by banks to customers is variable and is calculated as sum of LIBOR + bank’s other costs (mandatory costs) + bank’s profit (margin) – interest rate payable by the customer will vary as LIBOR/mandatory costs fluctuate but bank’s margin will remain fixed in order to generate consistent revenue stream for lending bank.

- Lender-Borrower Relations: Lender’s Perspective – Bank takes credit risk whenever it makes it a loan + takes measures to minimise credit risk based on assumption that borrower will remain virtually the same entity with same assets throughout duration of loan and bank will attempt to draft loan agreement to provide it with power to ensure that this remains the case (e.g. change of control + change of business + substantial transaction clauses + undertakings + financial covenants etc.).

- Lender-Borrower Relations: Borrower’s Perspective – Borrower seeks to obtain loan finance at cheapest possible rate with maximum degree of flexibility/least amount of lender interference or control over the borrower.

- Bargaining Positions – Relative bargaining strengths of parties will vary according to state of lending market – lenders in stronger position where borrowers are seeking funds (higher fees/interest rates + more restrictive covenants in loan agreement) BUT borrowers in stronger position where banks are keen to lend money (lower fees/interest rates + less restrictive covenants in loan agreement).

TYPES OF LOAN FACILITY

(1) Overdraft

- Characteristics – Overdraft allows borrower to borrow money by ‘overdrawing’ on balance of their account up to a specified sum + interest charged on daily overdrawn balance of the account.

- Borrower can repay, in whole/part, the balance of the overdraft and then draw on it again up to the specified amount.

- Overdrafts usually an UNCOMMITTED FACILITY where bank NOT obliged to continue lending under terms of contract and retains discretion as to whether/not to advance funds to borrower.

- Overdraft usually granted on bank’s STANDARD TERMS + CONDITIONS which are NOT negotiated between the parties + requires very little formal documentation with a FACILITY DOCUMENT being the only document produced in majority of cases.

- Accounting for Overdrafts - Overdraft is legally REPAYABLE ON DEMAND so bank does NOT have to wait for an event of default/breach of overdraft agreement/prescribed period of time before demanding repayment of overdraft - means overdraft listed as CURRENT LIABILITY on borrowing company’s balance sheet.

- Function – Overdraft used as short-term measure to assist cash flow by providing reserve of readily available funds to meet any shortfalls in borrowing company’s working capital.

- Known as ‘WORKING CAPITAL FACILITY’ due to use as means of ensuring that borrowing company has funds available to allow it to continue to operate its business even where it is facing a lack of working capital/cash flow issues.

(2) Term Loan

- Characteristics – Term loan involves lender providing fixed amount of funds to borrower over a fixed period of time with funds advanced repayable by the end of the fixed term in accordance with agreed repayment timetable as set out in loan agreement.

- COMMITTED FACILITY whereby bank obliged by terms of loan agreement to advance funds with no discretion as to whether/not to lend and repayments of capital prior to final repayment date are final and cannot be redrawn by borrower.

- Borrower charged interest on amount of funds advanced throughout duration of loan.

- Repayments – Schedule of repayments set out in loan agreement + can be structured in different ways:

(a) Amortisation – Repayment of regular amounts at fixed regular intervals throughout term of loan.

(b) Balloon Repayment – Repayment over several instalments throughout term of loan but with a final larger repayment at the end of the loan term.

(c) Bullet Repayment – Repayment of whole of capital sum borrowed in 1 or 2 instalments at the end of the loan term.

- Function – Term loan most appropriate where borrower requires specific sum of money in connection with specified event and seeks to use loan to provide the capital required in the short-term, whilst using a prospective regular source of income/revenue to repay the loan over the medium/long-term (e.g. property purchase/acquisition of another company/expansion of business).

(3) Revolving Credit Facility (RCF)

- Revolving Credit Facility (RCF) – Commitment by a bank to lend to borrower on a recurring basis, over a defined period on pre-determined terms so that a specific amount of money is available to borrower over a specific period (e.g. 3-5 years).

- Allows borrower to draw down and repay tranches of money (up to specified amount) as/when it chooses during the loan period with no fixed amount of money advanced to the borrower at outset of loan and no pre-established timetable for repayment of the loan.

- Characteristics – Loan monies made available by lender for set AVAILABILITY PERIOD...