Dimension 6 - Repayment Sources, Structure, & Documentation Flashcards
Covenant Default
Failing to give notice to your customer of a covenant default may make your institution’s
future enforcement of the covenant difficult.
Types of Loans
- Seasonal Line of Credit
- RLC
- Term Loans
- Leases
- Bridge Loans
- Mortgage Financing
- Special Programs
Seasonal Line of Credit
- Short-term loan, usually less than one year, used to finance inventory and/or accounts receivable for a company with a seasonal financing need.
- Purpose: To finance the cash cycle
- May be secured by a perfected security interest in accounts receivable and inventory, at a minimum, and plant and equipment, at a maximum.
Sources of payment: • Contraction of current assets, specifically accounts receivable and inventory. • Conversion to long-term debt. • Liquidation of assets. • Additional equity.
Three types of lines of credit
1) Unadvised Credit Line or Guidance Line - created when you obtain approval for a loan amount greater than the amount requested because you anticipate that the client will have a financial need in the near future. No “commitment” or “terms and conditions” letter is sent to the customer.
2) Discretionary Lines of Credit
- Expresses your intention to extend credit as required by the borrower at your sole discretion.
- Has the widest latitude in adjusting or terminating the line.
- The written agreement must make it clear that you have no legal obligation to honor a request made by the borrower.
3) Committed Line of Credit - evidenced by a written agreement signed by you and the borrower in which you commit to advance funds on specific terms at their request.
Revolving Lines of Credit
- contractual agreement whereby the bank agrees to make loans up to a specified maximum for a specified period, usually a year or more.
- credit with advance rates and liens on current assets are also referred to as Asset-Based Financing in some banks.
- Purpose: to finance permanent working capital needs
- may be secured by a perfected security interest in accounts receivable and inventory, at a minimum, and plant and equipment, at a maximum. This
Sources of payment:
- Earnings and effective conversion and/or contraction of working capital.
- Conversion to term debt.
- Additional equity.
- Liquidation of assets
Term Loans
- Structured as intermediate to long-term facilities, usually two to ten years.
- To finance the long-term needs of the company, including acquisitions, purchase of equipment or fixed assets
- First lien on fixed assets or a first or second lien on current assets
Sources of payment:
- Operating cash flows
- Liquidation of assets.
- Additional equity.
Leases
- Contract granting the use of real estate, equipment or other fixed assets for a specified time in exchange for payment.
Forms of leases
1) Financial or Capital Lease - The service provided by the lessor to the lessee is limited to the financing of the equipment.The lessee acquires essentially all of the economic benefits and risks of the leased property. The lease must be reflected on the company’s balance sheet as an asset with corresponding liability.
2) Operating Lease - Generally involving equipment, this contract is written for considerably less than the life of the equipment and the lessor handles all maintenance and servicing. Form of financing does not appear on the balance sheet of the lessee, but is a contingent liability
3) Sale and Leaseback - company sells an asset to another party in exchange for cash, then contracts to lease the asset for a specified term.
Bridge Loans
- Short-term loan, also called a swing loan, made in anticipation of intermediate-term or long-term financing
Loan Purpose: Acquisition, Construction Projects
Sources of payment: Asset sale or refinancing through debt or equity
Mortgage Financing
- Long-term loan that provides the lender with a lien on property as security for the repayment of the loan.
- For property such as machines, equipment, or tools, the lien is called a chattel mortgage.
- Sources of payment:
a) Cash Flow for property of a business or owner-occupied real estate,
b) Cash flow provided by the tenant leases will be key to repayment for investment property
Industrial Revenue Bond Financing
- Involves the issuance of tax-exempt bonds by a public entity (ie. city)
• To finance the acquisition, construction, rehabilitation, improvement, equipping, and/or furnishing of facilities for qualifying companies
• To refinance outstanding tax-exempt bonds
Subordinated Debt
- Usually placed for a longer-term (7-12 years) than senior debt and interest is payable at a fixed rate.
- sometimes referred to as mezzanine debt if there are equity warrants or convertible features attached to the subordinated debt.
- Sometimes referred to as mezzanine debt if there are equity warrants or convertible features attached to the subordinated debt.
- Sources of payment:
Cash Flow
Private Placements
- Sale of debt or equity to a private or institutional investor, including individuals, insurance companies, pension funds, and investment companies.
- The placement agent (investment banker) plays an important role in explaining the company’s strategy to investors.
- Sources of payment:
Cash Flow
Loan Syndications
- ## Credit facility that is originated by one or more lead banks acting as agents and sold to a group of financial institutions as participants.
Loan Syndications
- Credit facility that is originated by one or more lead banks acting as agents and sold to a group of financial institutions as participants.
The following structuring options are typical: • Secured revolving lines of credit or term loans • Floating rates • 7-8 year terms • Varying amortization schedules Facilities can be structured as: • Revolving or term senior • Preferred stock • Private equity • Subordinated debt
- bank can participate in a syndicated loan either as a participant or an assignee.
Difference between participant and assignee in Syndications?
Participants purchase shares in the transaction, but do not have a contractual relationship with the borrower.
Assignees purchase shares in the transaction after the closing and do become party to the credit agreement.
High Yield Debt
Involves underwriting public debt issues for non-investment grade companies.
Typical buyers of this debt are mutual funds, insurance companies, pension funds, and individual investors.
Commercial Paper
- financing vehicle for companies with investment grade credit ratings (AAA to BBB) that need low-cost, short-term, unsecured financing.
- Corporations issue commercial paper directly to investors who may have temporary idle cash to invest.
- unsecured and generally discounted
- provides short-term working capital funding with flexible maturities and lower rates (than bank funding) for investment grade corporations
Letters of Credit
- An instrument issued by a bank on behalf of its customer that gives someone (beneficiary) the right to draw funds upon the presentation of papers or documents in accordance with its stipulated terms and conditions.
Documentary L/Cs
- Typically used in international trade where the customer is not well known or the customer’s credit is suspect.
- The L/C essentially substitutes the issuing bank’s credit for that of the importer.
Standby L/Cs
- issued in lieu of a guarantee and protect the beneficiary financially in the event the bank’s customer defaults.
- used in commercial transactions, as enhancements in municipal bond transactions, and to guarantee performance on construction contracts.
Banker’s Acceptance
- a time draft (signed, written order by which one party instructs another party to pay a specified sum to a third party on a certain date) drawn on and accepted by a bank. It is the customary means of effecting payment for merchandise sold in import-export transactions and a source of financing used in international trade.
- primarily used to finance international trade.
Asset Securitization
pooling homogeneous groups of assets, such as credit card receivables, mortgages, corporate accounts receivable, auto, or consumer loans and financing them with securities (credit instrument that signifies ownership) that are sold to investors.
When is a Guarantee Required?
- The borrower’s form of organization influences whether a guarantee may be needed.
- Generally, for privately held borrowers a guarantee is highly desirable whenever the form of organization does not already incorporate personal liability (i.e. the borrower is not a proprietorship or a general partnership). In addition, guarantees are highly recommended when there are multiple legal entities sharing the same ownership, and when it is possible for the borrower’s financial resources to be easily redistributed within those entities.
Corporation - Guarantee
- most lenders require that a corporation’s major stockholders guarantee a loan to a closely held corporation.
- Sometimes, a corporation may be asked to guarantee the debt of another entity.
- The shareholders, directors, officers and employees are not otherwise liable for corporate debt.
Limited Liability Company - Guarantee
- most lenders also require that a limited liability company’s members guarantee a loan to the limited liability company.
- members have no individual liability for the debts of the company
Limited Partnership and General Partnership - Guarantee
- General partners may be required to guarantee a partnership debt, even though the general partners are legally liable for partnership debt. The guarantee agreement allows you to act sooner.
Limited Liability Partnership and Limited Liability Limited Partnership - Guarantee
- Most banks’ loan policies require that partners in the limited liability partnership guarantee a loan to the partnership and that the general partners in a limited liability limited partnership guarantee a loan to the partnership.
- partners have no individual liability for partnership debts incurred by the partnership after registration as a limited liability partnership or limited liability limited partnership.
Spouses - Guarantee
- Spouses of the original borrower and guarantors should be required to execute a guarantee in community property states.
- In community property states, if an applicant requests unsecured credit, federal law permits requests for a guarantee from a spouse.
- In non-community property states, federal law prohibits requests for a guarantee from a spouse. A lender may request “more creditworthy co-guarantors” and may accept guarantees of spouses if the guarantors volunteer them.
Collection from a Guarantor in Event of Default
Most states provide guarantors with legal defenses and claims against the lender that can make collection difficult. Your position is strengthened if you obtain evidence that the guarantor understands the terms of the loan.
You should not make subsequent changes to the loan without a written statement of understanding and consent by the guarantor, as well as a written confirmation that the guarantee is not affected by the change. You should also notify the guarantor of any defaults that occur in the underlying credit transaction.
A guarantee, by its terms, can be revoked at any time but only as to debt incurred after the revocation.
Special Consideration for Enforcing Small Business Association (SBA) Guarantees
- Did you close the loan in accordance with the SBA authorization letter, as appropriately amended?
- Did you comply with the monitoring and credit management requirements of the authorization?
- Did you act with normal prudence for the industry and comply with the rules and regulations of the SBA in managing the liquidation?
Comfort Letters
- letters issued to lenders by companies to indicate support for another entity borrowing from the lender.
- most often issued by parent companies in connection with subsidiary borrowings.
- generally fall short of an absolute promise to pay the borrowing entity’s debt.
- companies that favor comfort letters are generally public companies that do not want to have to include contingent liabilities in their financials.
- Comfort letters are enforceable.
Loan Covenants
- designed to protect the bank
- should identify key risk points in the company’s operating profile
- identify the specific risks against which the bank needs to be protected and to prevent certain actions by the company that could jeopardize the timely repayment of the loan.
- should be those that the bank expects to enforce-
- Covenants provide timely warning signs.
Covenants bring the borrower back to the table.
Covenant Objectives
- Full Disclosure of Information
- Protection of Net Worth
- Protection of Cash Flow
- Protection of Asset Quality
- Control Growth
- Maintenance of Key Management
- Assurance of Legitimacy and the Company as a Going Concern
- Profitability for the Bank
Sole Proprietor
- an individual operating as a business. There is no separate business entity, only the individual operating the business.
- personally liable for all debts of the business.
- If the borrower is doing business under an assumed name (also known as a d/b/a, a tradename, or fictitious name), obtain a copy of the assumed name filing permitted
- An individual “doing business as” (d/b/a) another name should sign his or her correct legal name with the d/b/a noted only if required elsewhere in the loan documents–not in or above the signature line. The d/b/a should be noted in the loan documents only if requested by the customer.
General Partnership
- business operated by two or more general partners.
- individual partners are liable for the partnership debts, and their personal assets are exposed to liability for the debts.
Identification needed: Obtain the agreement from the partnership. If there is no formal written
agreement, obtain a written statement that none exists.
Authorization: obtain a partnership resolution to borrow, guaranty or grant collateral interests,
