LOAN STRUCTURING

You will be able to…

Identify the most appropriate credit facility

Determine the timing for disbursing funds and establish a repayment

schedule

Determine whether support, such as collateral, is needed and, if so, the

appropriate type

Recognize how the risk characteristics of a loan should be reflected in its

price

1
 Part 1. The Credit Facility
- Short term needs
- Long-term needs

CREDIT FACILITY
SHORT TERM NEEDS

When debt is used to finance temporary or seasonal cash requirements:

• Paying A/P during a peak period or taking advantage of any trade

discounts offered by vendors

• Acquiring seasonal inventory

• Meeting a payroll when A/R have temporarily slowed

• Carrying peak period A/R

• Meeting intermonth “timing difference” between the payment of A/P

and accrued expenses and the collection of A/R

2
 CREDIT FACILITY
SHORT TERM NEEDS
Credit Facility Borrowing Amount Disbursement Maturity Examples
Frequency
Short – term needs
Short-term loan One-time or Face value of One-time for the Specific, pre-  Single
occasional note full amount set maturity payment loan
date of one  90-day note
year or less
Uncommitted Seasonal or Various Restricted to one Payment is due  Foreign
line of credit periodic amounts up to draw or may on demand exchange
the line limit permit borrowing, lines are often
repayment, and uncommitted
re-borrowing
Committed line Seasonal or Various Permits borrowing, Outstanding  Accounts
of credit periodic amounts up to repayment, and amounts due receivable or
the line limit; re-borrowing on maturity inventory line
some sub- date, usually
limits may apply 364 days; may
or may not
require annual
cleanup

CREDIT FACILITY
LONG TERM NEEDS

When debt is used to finance permanent working investment, purchase

PPE, or replace Equity.

• Supplementing permanent working capital in a growth situation

• Acquiring fixed assets

• Partially financing the purchase of a business

• Retiring or refinancing a long-term debt, or replacing equity with debt

3
 CREDIT FACILITY
LONG TERM NEEDS
Credit Facility Borrowing Amount Disbursement Maturity Example
Frequency
Long – term needs
Revolving credit Seasonal or Various Permits Outstanding  Accounts
periodic amounts up to borrowing, amounts due receivable or
the line limit; repayment, and on maturity inventory
some sub- re-borrowing date, more financing with
limits may than one year borrowing
apply from effective base formula
date

Term loan One-time or Face value of One-time for the Specific  Amortizing
occasional note or full amount OR maturity with term loan
increasing in periodically, as set repayment  Mortgage loan
increments up needed during schedule,
to the face agreed draw- longer than one
value of the down year
note or
commitment

Part 2. What is the Appropriate

Credit Facility?

4
 Purpose?
Borrowing cause?
Repayment source?
Long – term need
Short-term need
Purpose: Long-term benefit
Purpose: Short-term benefit Borrowing cause: Long-term sales growth,
Borrowing cause: Temporary timing purchase long-term assets or other investment,
difference replace equity
Repayment source: Cash flow from
Repayment source: Cash flow from operations,
conversion of assets, Type B cash flow
Type A cash flow

Borrowing Disbursement
frequency? period?
Fluctuation of
need?

One – time or Periodic or

occasional seasonal Long disbursement One – time or short
period disbursement period
Fluctuation of need Constant need

Credit
Cash flow sufficient to amortize
quality
loan? Benefit of term loan justifies
cost?
Satisfactory, but less Strong, stable and
No
than strong growing
Yes

Uncommitted Line Committed Line Revolving

Short – term Loan Term Loan
of Credit of Credit Credit

EXAMPLE 1

Company A is requesting a credit facility to finance

seasonal buildups of current assets. The company’s
projections show a seasonal low period of about 3
months.

What type of facility would you recommend?

Would you recommend a cleanup period on the line
of credit? If yes, how long should the cleanup period
be?

10

5
 EXAMPLE 2
A borrower has requested a loan to acquire an asset that
will have a useful life of at least 6 years. The loan is to be
repaid in equal payments over a 3-year period. Your
analysis of historical cash flow demonstrates that the
company has been able to generate sufficient cash from
operations to service all existing obligations, plus the
interest and principal payments on the proposed loan.
However, the company’s projections indicate a debt
service coverage ratio (cash available for principal and
interest, divided by the total of principal and interest) less
than the 1.5 times you would normally like to see.

How could you alter the repayment schedule?

11

EXAMPLE 2

A rapidly growing and profitable company needs financing

to support its growth in trading assets. Asset quality is
good, and you have confidence in management. However,
if the company continues to grow as projected, cash flow
is not sufficient to amortize a term loan within the maturity
your bank requires.

What should you do?

12

6
 Part 3. Loan Support
Collateral
Guaranties
Subordination agreements

13

LOAN SUPORT
COLLATERAL
When:

• The borrower is new to the bank

• The borrower’s sales and earnings are erratic

• The borrower cannot meet the cleanup period on a line of credit

• The borrower’s sources of repayment are limited or weak

• The borrower is too highly leveraged to assure payment of all

creditors

Choose the asset(s) that will make a reliable secondary repayment source, that is,
those most marketable, most liquid, and of the highest quality.

14

7
 LOAN SUPORT
COLLATERAL – FACTORS TO CONSIDER
Deposit account • Location of deposit
• Maturity date
• Amount of the deposit
• Assignability
Marketable securities • Current value
• Strength of issuer, quality rating
• Historic price fluctuation
• Interest rate (bonds)
• General economic conditions
• Where it is traded
• Assignability
Accounts Receivable • Agings (current one and past ones)
• Dollar value of acceptable amounts
• Financial strength of debtors
• Concentration of A/R
Inventory • Mix (% of raw materials, finished goods)
• Versatility of use of raw materials
• % of damaged or obsolete inventory
Fixed assets • Degree of specialization of equipment
• Age & condition of asset, obsolescence factor
• Appraised market value / liquidation value
• Adaptability of plant to other industry use

15

LOAN SUPORT
GUARANTIES

An agreement by a third party to repay a loan in the case of default or

nonpayment by the borrower.

Can be structured as either an unsecured obligation or a secured

obligation with specific assets.

When and from whom?

• From the general partners of a partnership

• From the officers and principal stockholders of a closely held
corporation
• From the parent company of a borrowing subsidiary.

16

8
 LOAN SUPORT
CONTRACTUAL SUBORDINATION

A subordination agreement places other creditors of the borrower in

a secondary position to repayment of debts to a single creditor (a
senior creditor).

• Total subordination agreement: NO principal or interest payments

can be made on the subordinated loan until the borrower has repaid
the senior creditor.

• Partial subordination agreement: interest payments and regular

principal reductions can be made on the subordinated notes, but the
senior creditor’s loan would be paid before the subordinated note in
the case of a bankruptcy or liquidation of the company.

17

Part 4. Credit Agreement

18

9
 CREDIT AGREEMENT
COMPONENTS

• The loan: the amount, price, repayment schedule, security…

• Warranties: statements of existing conditions
• Affirmative covenants: conditions the borrower must create and
maintain
• Negative covenants: conditions or actions the borrower must
prevent
• Conditions of lending: a statement of the events that must occur
before the loan can begin
• Events of default: the point at which the borrower will be outside the
bounds of the agreement
• Remedies : what the institution can do if the borrower defaults
• Definitions : explanations of the key terms used to describe
conditions, events, remedies, and so on…

19

CREDIT AGREEMENT
WHICH COVENANTS DO YOU NEED?

Short-term loans : focus on covenants on liquidity and

ability to pay interest.

Long-term loans (whether amortizing term loans or

revolving credits): focus on covenants such as leverage,
EBITDA coverage of total debt or senior debt.

20

10