Term loan Debt is back in fashion | White & Case srl

Term loan A-debt returns to center stage as borrowers seek funding alternatives in increasingly volatile institutional lending market

As the Term Lending B (TLB) funding market grows more turbulent in the face of macroeconomic and geopolitical uncertainty, the Term Lending A (TLA) segment of the market is experiencing its heyday.

Unlike the TLB market, where loans are sold to institutional investors including mutual funds, insurance companies, and CLOs, TLA or “pro-rated” debt is typically held by banks and other financial institutions. This form of financing generally consists of a revolving credit facility accompanied by an amortizing term loan, with each lender holding a pro rata share of both facilities (hence the name “pro rata” facilities).

Loan tranches in value Q2 2020 – Q2 2022

Use of profits: All
Location: Western and Southern Europe and the United States Sectors: All sectors

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The institutional TLB market has grown significantly over the past decade as investors have become more comfortable with flexible debt terms (including covenant lite structures) that attract borrowers and financial sponsors . This flexibility has allowed institutional lending to gain market share and crowd out traditional TLA structures in buoyant markets in recent years.

In 2022, however, the institutional loan market has seen volatility in the face of rising interest rates and rising inflation. As a result, it has become more difficult for arrangers to fully syndicate TLB debt tranches. In the USA, institutional loan issuance in the first half of 2022 fell 60% year-on-year. Institutional loan issuance also declined in Western and Southern Europe, 72% drop from one year to the next during the same period.

calm in the storm

This decline in institutional loan issuance has seen TLA/pro rata structures gain prominence.

Rather than testing institutional appetite, which has been affected by market volatility, some borrowers in the US and Europe are now looking to raise pro rata facilities.

In H1 2022, pro rata tranches represented 67% of overall leveraged loan issuance in the United States, compared to a 35% share in 2021. In Western and Southern Europe, pro rata structures accounted for half of all emissions in the first half of 2022, compared to 43% for the whole of 2021.

The TLA debt market typically includes international and regional banks and other financial institutions. Many of these TLA players only participate in the TLB space as arrangers and underwriters (rather than investors) and represent a distinct pool of capital that borrowers can tap into.

While this cohort of lenders may be affected by macroeconomic headwinds and regulatory pressures, the TLA market is generally more resilient than the institutional lending space.

TLA lenders buy debt with the intention of holding it to maturity, unlike CLOs and other institutional investors, who are more likely to trade positions. TLA lenders will generally focus on low leverage credits, in many cases with higher credit ratings.

This credit profile, coupled with the long-term strategy of lenders, means that the TLA market tends to be less exposed to the vagaries of market cycles and provides a credible option for borrowers in times of dislocation. TLA funding also tends to be cheaper than TLB debt, although as a variable rate instrument these facilities are always exposed to increases in benchmark rates.

Restricted conditions

The tradeoff for borrowers is that while the pro rata market is more stable, TLA structures tend to offer less flexibility. In particular, pro-rata facilities will typically include a financial continuance clause, and borrowers will often have more limited flexibility to incur additional debt and make limited payments, among other things.

Amortization schedules and loan maturities are also more favorable to lenders with TLA. TLA loans typically require significant amortization payments, while TLB debt typically amortizes at only 1% per year. TLA maturities are also shorter, at five years instead of the typical seven years for institutional loans, giving borrowers a shorter time to repay or refinance debt.

In the current market environment, borrowers approaching debt maturity or needing acquisition capital should consider forgoing the flexibility of TLB structures for the certainty and stability of the TLA.

Stricter documentation may not be suitable for all borrowers, but it provides a credible option for obtaining financing in an unpredictable market.

Borrowers also have the option of anchoring a set of debt with TLA facility and then contributing additional high yield or TLB debt.

White & Case advised on a debt financing combining TLA, TLB and high yield facilities for Univision Communications, a Spanish language content and media company.

The facility included a five-year US$500 million senior secured TLA facility and a US$500 million TLB, as well as a US$500 million senior secured high yield bond. Proceeds were used to repay US$370 million of senior secured notes due 2025 and partially repay outstanding debt maturing in 2024.

In a bumpy environment, more borrowers are likely to consider these types of structures. The TLA market, somewhat neglected in recent years as borrowers have taken advantage of attractive rates and flexible terms in the dynamic TLB space, is coming back to life.

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John A. Bogar