Terms of the Loan

This section include the amount of the facility as well as the amount of each tranche of the facility. If a facility has a revolving credit and a term loan, it has 2 tranches. It will also include the amortization schedule of the facility, the amount of letters of credit that are permitted to issue and other items.

The most important parts here are the mandatory and voluntary prepayments.  The mandatory section will state whether the issuer has to pay back the loan if it sells assets for cash, issues equity, or has excess cash flow.

Interest rate

Most commonly, the interest rate under a credit agreement will be floating and normally is expressed as the sum of 1) base component that is reset from time to time (LIBOR or prime) and 2) a margin (spread) that is either fixed or subject to change based on pre-agreed criteria.

Applicable margin – the applicable margin for LIBOR loans is always higher than the applicable margin for base rate (prime) loans in order to bring the two rates closer to parity. The difference has historically been 100 basis points.

The spread may be dependent on the credit rating and/or a financial test of the borrower. There rates are set forth in the credit agreement in the form of a grid that varies by type of loan.

When grid pricing is based on leverage, the relevant date on which to test leverage is usually the end of the borrower’s most recent fiscal quarter. However, changes do not take place at the end of the quarter but rather when they borrower delivers to the administrative agent financial information.

Fees

Commitment fee – compensation for the lenders contractual commitments to make loans. Typicaly, they are charged on revolving credit commitments, usually based on the daily average of the unused portion of each lender’s outstanding revolving credit commitment. The rate is either flat or subject to grid pricing.

Facility fee – based on both used and unused commitments. Commitment fees and facility fees are mutually exclusive – the same revolving credit facility would not provide for both.

Utilization fee – additional fee if utilization is higher than a specified level.

Letter of credit fee – fee paid to the letter of credit issuer to compensate for additional risk in case one of the other lenders in the group fails to meet its obligation.

Breakfunding clause – If the lender suffers a loss due to a borrower repaying the loan in the middle of an interest period or asking for a loan but does not draw it down.

Amortization and Maturity

Payments

Credit agreements stipulate that loans must be advanced to the borrower (and payments to the lenders) in funds that are immediately available. Payment by check is generally not in immediately available funds. Real time funding can be accomplished by 1) For advances of funds to the borrower, the lenders normally send money through the Federal Reserve’s wire transfer system to the administrative agent. 2) Payments by a borrower to the lenders are effected in the same way if funds come to the administrative agent from another bank. More frequently, the borrower maintains a deposit account at the administrative agent and instructs the agent to debit the account in the required amount whenever payment is to be made.

Time of payment

Credit agreements almost uniformly require that payments be made by a particular time on a specified date.

Under New York Law, if a payment is due on a day that is not a business day, then the due date is automatically extended to the next succeeding business day, but no interest is payable for the period of the extension.

Accordion feature

To confuse things, bankers also use the term accordion to describe a quite different feature whereby the maturity date for a loan is advanced because of an intervening bond maturity or other event. Lenders might want a borrower to refinance a subordinated debt that is due before the maturity of the loan. TO ensure that the borrower completes the refinancing in a timely fashion, the credit agreement may provide that, if the bonds are outstanding on the agreed date, the maturity date for the loans is automatically advanced to that date.

364 day facilities

One type of loan commitment is entitled to reduced capital requirements (for a bank)- loans with commitment of less than one year. Therefore banks would rather make a 364 day loan to the borrower.

Repayment

Credit agreements with limited exceptions, do not restrict prepayments or impose prepayment premiums. The ability to repay a loan facility is one of the big advantages of credit agreements over bond indentures. In the case of the prepayment of a loan that is otherwise payable in installments, the prepayment provision addresses how the prepayment is to be applied to the installments.

Mandatory prepayments

Clean downs – In a revolving credit facility, a clean down requirement forces the borrower, typically for a period of 30 days, during each calendar year, to have no outstanding under the revolving credit commitments. This type of mandatory prepayment requirement is customarily applied to a borrower with a seasonal business.

Borrowing base – this is the amount of collateral backing the loan. For highly leverages borrowers, the syndicate may want to implement a borrowing base structure in which the availability of loans is tied to an agreed valuation of the collateral security. Borrowing bases are used primarily in “asset backed” transactions. Normally, the credit facility is secured by the assets including accounts receivables and inventory. The borrowing base is usually calculated as the sum of an agreed percentage (the advance rate) of each class of assets included in the collateral security. When the borrowing base declines, part of the loan must be repaid.

Asset sales sweep – Depending on the strength of the borrower’s credit, lenders can be sensitive to a borrower’s sale of assets, particularly if the sale is material. Usually the credit agreement will give a specified time period for the borrower to reinvest those funds.

Casualty events – A casualty event is akin to an involuntary sale of an asset 1) Act of God – a factory burns down 2) condemnation – government act.

Equity or debt issuance sweep – issuance of equity is rarely restricted by the covenants in a credit agreement. In contrast, issuance of additional debt is routinely constrained by debt covenants or leverage ratios. However, mandatory repayments from equity or debt issues are common. The login is that any cash coming in should go to repay the loans. Since the lenders always view the credit agreement as sitting at the top of the capital food chain, they expect the loans to have first claim on that unexpected cash.

Some credit agreements are bridge facilities, which is to say that the borrowing of the loans is an interim measure bridging to a more permanent issuance of debt or equity. In this circumstance, the mandatory prepayment is simply designed to ensure that the credit facility functions as a short term agreement.

Equity carve outs are often seen where only a portion of the proceeds of the issuance is applied to the prepayment of the loans.

Excess cash sweep – the prepayment provision typically stipulates that some percentage of the borrower’s excess cash flow for an agreed accounting period is applied to prepay outstanding term loans.

Change of control – One of the fundamental principles of sound banking is the know your customer rule. This principle is the genesis of the change of control provision.

The credit agreement customarily provides that all term loans must be paid in full before any reduction of the revolving credit commitments occurs.