Productopedia

Product Description:

A Leveraged Loan provides debt products (primarily senior loans, though subordinated debt may also be offered) to facilitate the purchase of a company through a financial sponsor.

The bank may act as an "arranger" or "participant," lending to a business via a holding company (or its subsidiaries) in an event-driven transaction, typically an acquisition.

Sale and Purchase Agreement:

• Becomes active only after the receipt of both debt and equity by the existing shareholder.

Debt Repayment:

• Repayment profiles typically span 6–7 years.

• During this period, interest is generally paid every 1, 3, or 6 months. Debt repayment may occur quarterly, semi-annually, or as a bullet payment (i.e., at the maturity of the facility).

• Repayment may also occur in scenarios such as the sale of the business, refinancing of the facilities, or an Initial Public Offering (IPO).

Refinancing:

• If a deal requires refinancing, a new senior finance agreement must be issued, or the existing finance agreement must be amended.

Shareholder Restrictions:

• The original finance agreement often restricts shareholders from withdrawing funds from the holding company (e.g., no dividend payments) to preserve the company’s value.

• Distributions may be permitted if lenders agree, typically contingent on sufficient debt capacity (e.g., improved trading performance or debt repayment).

Role of the Financial Sponsor:

• A private equity firm acts as the financial sponsor, investing in the business by taking an equity stake.

Intercreditor Agreement:

• Governs the repayment hierarchy among different lenders, based on the seniority waterfall agreed upon (e.g., senior, second lien, mezzanine).

Role of the General Partner:

• Acts on behalf of investors throughout the life of the acquisition.

Additional Information: A deal typically consists of three stages:

1. Acquisition of the business (involving the simultaneous transfer of equity and debt into a holding company).

2. Syndication.

3. Loan Repayment.

Example:

Purchase ABC Ltd. for £100m

• XYZ Private Equity contributes £45m.

• Management contributes £5m.

• The bank provides £30m in debt as senior lenders.

• Mezzanine financing contributes £20m. XYZ Private Equity retains ownership of the company through a holding company.

Inherent Risk Rating: Medium (57.8%)

Risk Indicators:

• Can be used as collateral or security for a loan and/or placed in a discretionary or other increased-risk trust.
• Source of payment is not available.
• Transactions can be conducted on behalf of a respondent's customers.
• Product ownership can be moved or allocated from one firm or person to another easily.
• The product favours anonymity where something or someone is unknown, hidden or opaque.
• Can be used to finance goods subject to trade embargoes or financial sanctions.
• Involves transfers through multiple jurisdictions that are 'friendly' to countries subject to sanctions or that do not enforce United Nations sanctions.
• The product involves the shipment of goods using a vessel with flags of convenience registered in a different country.
• Can be used to finance activity-based prohibitions in Iran/DPRK.
• Related transactions are not bound by jurisdictional restrictions or currency controls.
• Allows payments to be processed from firms in medium- or higher-risk jurisdictions.
• Can be used to make direct or indirect payments to a designated or sanctioned target or country.
• Facilitates significant withdrawals, deposits, or placement of funds of unknown origin into the firm.
• Provides substantial flexibility to liquidate investments promptly without incurring significant losses.
• The product being financed requires an export license.

Possible mitigation controls:

• Compliance approval is required for 3rd party payment and monitoring.
• The product is not easily transferable, and payment flows are restricted due to book entry (recorded electronically) and Delivery vs. Payment (DVP), a settlement system that stipulates cash payment must be made prior to or simultaneously with the delivery of the security to a specified party.
• Legally binding agreements relevant to the service include an early termination clause for high-risk clients or sanctions breaches.
• Holds no investment value and pays out only upon the occurrence of a specific, verifiable event as determined by the product provider.
• Ongoing monitoring of a business relationship that is triggered by a specific event and includes a view of customer information, risk profile and transactions. Events can include adverse news, a change in status, a change in address, a request for a higher-risk product or service, a change in beneficial ownership or control, a type of business, a move to a higher-risk country, or unusual activity.
• Monitoring of inducements or gifts, and entertainment.
• A product or service requires entering into a legally binding agreement or contract (which can be standard or tailored) with the relevant counterparty (i.e., ISDA, Repo Agreements).
• Restricted capacity to make 3rd party payments.
• Prices are set by or marked to the market or checked against prices in the free market.
• The fee arrangement is not tied to performance.
• Entering into a transaction before completing CDD (Customer Due Diligence) or EDD (Enhanced Due Diligence), as appropriate, is not allowed.
• Daily sanctions and adverse press screening, in addition to the risk review cycle.
• Require that originator and beneficiary information be included in the payment.
• Maintains a transparent flow of funds.