Term Loan A

Introduction

What is Term Loan A?

• A type of amortizing term loan commonly used in corporate finance
• Particularly in leveraged finance transactions such as LBOs, acquisitions, and recapitalizations
• Represents the senior-most tranche of term debt in a capital structure

Introduction

What is Term Loan A?

• Characterized by scheduled principal amortization payments throughout its life
• Distinguishes it from other term loan types that may have bullet or minimal amortization structures

Key Characteristics

Amortization Schedule:

• Features regular, scheduled principal repayments (typically quarterly)
• Begin shortly after closing and continue throughout the loan's tenor
• Amortization typically ranges from 5% to 20% annually in the early years
• Loan fully repaid by maturity

Key Characteristics

Maturity:

• Generally has a tenor of five to seven years
• Shorter than Term Loan B or institutional term loans
• Longer than typical working capital facilities

Key Characteristics

Lender Base:

• Primarily held by commercial banks and financial institutions
• Maintain active lending relationships with borrowers
• Rather than institutional investors

Key Characteristics

Priority:

• Ranks pari passu (equally) with revolving credit facilities in the capital structure
• Senior to Term Loan B, second lien debt, mezzanine financing, and equity

Key Characteristics

Pricing:

• Carries lower interest margins compared to junior debt tranches
• Due to its senior position, amortization profile, and shorter maturity
• Typically ranging from 200 to 400 basis points over the benchmark rate
• Depends on credit quality

Key Characteristics

Transferability:

• Generally less liquid than institutional term loans
• Transfers subject to borrower consent and minimum hold requirements
• Favoring relationship lenders

Structure and Components

Principal Amount:

• Determined based on leverage multiples
• Typically measured as debt-to-EBITDA ratios
• Term Loan A may represent 1.0x to 3.0x EBITDA
• Depending on the overall capital structure and credit profile

Structure and Components

Interest Rate Mechanism:

• Most Term Loan A facilities use floating rates
• Based on benchmarks such as SOFR, EURIBOR, or prime rate
• Plus a credit margin
• Some facilities include interest rate floors to protect lenders in low-rate environments

Structure and Components

Amortization Profile:

• Straight-line amortization: Equal payments
• Graduated amortization: Increasing over time
• Back-loaded amortization: Minimal early payments with larger later payments
• Specific profile is negotiated based on projected cash flows

Structure and Components

Prepayment Terms:

• Typically allows voluntary prepayments without penalty
• Some facilities impose minimum prepayment amounts or notice requirements
• Mandatory prepayments from excess cash flow, asset sales, or debt issuance are common

Structure and Components

Financial Covenants:

• More stringent than those in institutional term loans
• Including maintenance covenants tested quarterly
• Maximum total leverage, senior leverage
• Minimum interest coverage and minimum fixed charge coverage ratios

Structure and Components

Security:

• Usually secured by first-priority liens on substantially all assets
• Including accounts receivable, inventory, equipment, intellectual property
• And equity interests in subsidiaries

Comparison with Other Term Loan Types

Term Loan A vs. Term Loan B:

• Term Loan B has minimal amortization (often 1% annually)
• Longer maturity (typically seven to eight years)
• Higher pricing

Comparison with Other Term Loan Types

Term Loan A vs. Term Loan B (continued):

• Held primarily by institutional investors rather than banks
• TLB offers more call protection and trades in the secondary market more actively

Comparison with Other Term Loan Types

Term Loan A vs. Revolving Credit:

• Both are bank-held and senior-ranking
• Revolvers are committed facilities allowing draws and repayments
• With no scheduled amortization
• Used for working capital rather than financing specific transactions or assets

Comparison with Other Term Loan Types

Term Loan A vs. Senior Notes:

• Senior notes are typically longer-dated (seven to ten years)
• Have bullet maturities with no amortization
• Contain incurrence covenants rather than maintenance covenants
• Held by bond investors rather than banks

Role in Capital Structure

Leveraged Buyouts:

• In LBO transactions, Term Loan A provides a significant portion of senior debt financing
• Alongside revolving facilities and Term Loan B
• The amortization profile helps reduce overall leverage over time
• Improving credit metrics

Role in Capital Structure

Acquisition Financing:

• Companies use TLA to fund acquisitions while maintaining financial flexibility
• The amortization demonstrates deleveraging commitment to stakeholders and rating agencies

Role in Capital Structure

Refinancing Transactions:

• Borrowers may refinance existing debt with TLA to:
• Extend maturities
• Reduce interest costs
• Modify covenant packages while maintaining bank relationships

Role in Capital Structure

Recapitalizations:

• In dividend recapitalizations or ownership transitions
• TLA provides permanent financing
• While enabling cash distributions to equity holders

Advantages for Borrowers

Lower Cost:

• Senior position and amortization result in lower interest rates compared to junior debt tranches
• Reducing overall borrowing costs

Advantages for Borrowers

Relationship Benefits:

• Bank lenders provide not just capital but also:
• Operational banking services
• Advisory capabilities
• Potential future financing flexibility

Advantages for Borrowers

Covenant Negotiability:

• Relationship lenders may offer more flexibility in:
• Covenant negotiations
• Amendments and waivers
• Compared to broadly syndicated institutional debt

Advantages for Borrowers

Refinancing Flexibility:

• Borrowers can often refinance or amend TLA more easily than institutional debt
• Due to smaller, relationship-focused lender groups

Advantages for Borrowers

Credit Profile Enhancement:

• Regular amortization improves leverage metrics over time
• Potentially enabling credit rating upgrades
• And reducing refinancing risk

Advantages for Lenders

Principal Reduction:

• Scheduled amortization reduces credit exposure over time
• Lowering risk as the loan ages

Advantages for Lenders

Senior Security:

• First-priority liens on assets provide strong recovery prospects in default scenarios

Advantages for Lenders

Covenant Protection:

• Maintenance covenants enable early intervention if financial performance deteriorates
• Protecting lender interests

Advantages for Lenders

Relationship Value:

• TLA positions create deeper relationships with corporate clients
• Generating opportunities for additional fee-based services

Advantages for Lenders

Regular Monitoring:

• Quarterly compliance testing and financial reporting
• Provide ongoing visibility into borrower performance

Common Covenants and Terms

Total Leverage Ratio:

• Maximum permitted ratio of total debt to EBITDA
• Typically stepping down over time as amortization reduces outstanding debt
• Common ranges are 4.0x to 6.0x depending on credit quality

Common Covenants and Terms

Senior Leverage Ratio:

• Maximum ratio of senior secured debt to EBITDA
• Often set 0.5x to 1.0x below total leverage
• To protect senior lenders

Common Covenants and Terms

Interest Coverage Ratio:

• Minimum ratio of EBITDA to interest expense
• Typically ranging from 2.0x to 4.0x
• Ensuring sufficient cash generation to service debt

Common Covenants and Terms

Fixed Charge Coverage Ratio:

• More comprehensive than interest coverage
• Including principal amortization, capital expenditures, and taxes in the calculation

Common Covenants and Terms

Capital Expenditure Limits:

• Restrictions on spending beyond budgeted amounts
• With potential baskets for growth or maintenance capex

Common Covenants and Terms

Restricted Payments:

• Limitations on dividends, share repurchases, and other distributions to equity holders
• Often tied to leverage thresholds or excess cash flow

Common Covenants and Terms

Additional Debt Restrictions:

• Limits on incurring additional secured or unsecured debt
• That could impair TLA lenders' position

Amortization Examples

Standard Profile:

• A $500 million seven-year Term Loan A might amortize:
• 5% in year one, 5% in year two
• 10% in year three, 10% in year four
• 15% in year five, 25% in year six, and 30% in year seven

Amortization Examples

Cash Flow-Based Profile:

• Amortization may be structured to align with projected free cash flow generation
• With lower payments in early years when integration costs or growth investments are higher

Amortization Examples

Seasonal Business Profile:

• Companies with seasonal cash flows might negotiate quarterly amortization
• With payments concentrated in high cash generation periods

Mandatory Prepayment Provisions

Excess Cash Flow Sweep:

• A percentage (often 25% to 75% depending on leverage) of annual excess cash flow must be applied to prepay the loan
• With the percentage potentially stepping down as leverage improves

Mandatory Prepayment Provisions

Asset Sale Proceeds:

• Net proceeds from asset sales above certain thresholds must be used to prepay the loan
• Subject to reinvestment rights within specified periods

Mandatory Prepayment Provisions

Debt Issuance:

• Proceeds from certain debt issuances must prepay the loan
• Particularly those ranking pari passu or junior to the TLA

Mandatory Prepayment Provisions

Insurance and Condemnation Proceeds:

• Casualty insurance or condemnation proceeds exceeding thresholds trigger mandatory prepayment
• Unless reinvested

Mandatory Prepayment Provisions

Equity Issuance:

• Some facilities require a portion of equity proceeds to prepay the loan
• Beyond amounts needed for specific purposes

Pricing Mechanisms

Grid-Based Pricing:

• Interest margins often adjust based on leverage ratios
• With margin decreasing as leverage improves
• And increasing as leverage deteriorates
• Grids typically span 50 to 100 basis points

Pricing Mechanisms

Market Flex Language:

• In underwritten transactions, arrangers reserve rights to adjust:
• Pricing, structure, or terms
• Based on market conditions during syndication

Pricing Mechanisms

Most Favored Nation (MFN) Protection:

• If the borrower issues similar debt at more favorable terms
• TLA lenders may receive pricing or covenant adjustments
• To maintain competitive positioning

Syndication Process

Underwriting:

• Lead arrangers commit to the full TLA amount
• Assuming market risk during syndication

Syndication Process

General Syndication:

• Banks receive allocations based on:
• Relationship strength
• Commitment to the overall credit
• Desired hold amounts

Syndication Process

Hold Levels:

• Individual banks typically hold $10 million to $100 million positions
• Depending on facility size and relationship depth

Syndication Process

Administrative Agent:

• One lender serves as administrative agent
• Managing payments, compliance monitoring, and lender communications

Default and Remedies

Events of Default:

• Common triggers include:
• Payment defaults, covenant breaches
• Cross-defaults to other material debt
• Material misrepresentations, bankruptcy, and judgment defaults exceeding thresholds

Default and Remedies

Acceleration:

• Upon event of default, lenders can declare all amounts immediately due and payable
• Though cross-acceleration to other debt is considered carefully

Default and Remedies

Remedies:

• Lenders can exercise rights under security documents, including:
• Foreclosing on collateral
• Appointing receivers
• Or pursuing other legal remedies

Default and Remedies

Amendment and Waiver Process:

• Typically requires majority lender consent (often 50.1% or more of commitments)
• Though certain fundamental changes require unanimous consent

Risk Considerations

Refinancing Risk:

• Although shorter than TLB, five to seven-year maturity requires eventual refinancing
• Market conditions or credit deterioration can make refinancing challenging

Risk Considerations

Interest Rate Risk:

• Floating rate exposure means payments increase when benchmark rates rise
• Potentially straining cash flow

Risk Considerations

Covenant Risk:

• Quarterly maintenance covenants create ongoing compliance obligations
• Breaches can trigger defaults even if the company remains operationally healthy

Risk Considerations

Asset Coverage Risk:

• In industries with rapidly depreciating or volatile asset values
• Collateral coverage can deteriorate over time

Risk Considerations

Amortization Burden:

• Required principal payments can constrain cash available for growth investments
• Particularly if business performance underperforms projections

Best Practices for Borrowers

Negotiate Appropriate Cushions:

• Build adequate headroom into covenant levels
• To absorb normal business volatility without triggering breaches

Best Practices for Borrowers

Model Amortization Impact:

• Carefully project cash flows to ensure amortization payments don't constrain operational or strategic flexibility

Best Practices for Borrowers

Maintain Lender Relationships:

• Regular communication with agent and key lenders
• Facilitates amendment negotiations and builds goodwill for future needs

Best Practices for Borrowers

Plan Refinancing Early:

• Begin exploring refinancing options 12 to 18 months before maturity
• To avoid time pressure and market timing risk

Best Practices for Borrowers

Optimize Prepayments:

• Use discretionary prepayments strategically to:
• Improve leverage metrics
• Reduce interest costs
• And create covenant headroom

Best Practices for Borrowers

Understand Amendment Requirements:

• Know which changes require majority versus unanimous consent
• To facilitate efficient negotiations

Market Trends and Evolution

Covenant-Lite Expansion:

• While less common than in TLB markets
• Some TLA facilities have adopted lighter covenant packages
• Particularly for stronger credits

Market Trends and Evolution

SOFR Transition:

• The market has largely transitioned from LIBOR to SOFR-based pricing
• With various conventions for credit adjustments and mechanics

Market Trends and Evolution

ESG-Linked Pricing:

• Increasingly, margins adjust based on achievement of environmental, social, and governance targets
• Creating pricing incentives for sustainability improvements

Market Trends and Evolution

Portability Provisions:

• Some facilities include change of control carve-outs for sponsor-to-sponsor sales
• Facilitating private equity exit transactions

Conclusion

• Term Loan A represents a foundational component of leveraged finance capital structures
• Providing senior secured financing with balanced interests between borrowers seeking cost-effective capital and lenders requiring amortization and covenant protection

Conclusion

• Its bank-held nature fosters relationship-based lending with negotiation flexibility
• Scheduled principal reduction demonstrates deleveraging commitment and reduces credit risk over time

Conclusion

• Understanding TLA structure, covenant mechanics, and strategic positioning within the broader capital structure is essential for both borrowers and lenders
• Success with Term Loan A requires careful cash flow planning, proactive covenant monitoring, and maintaining strong lender relationships to optimize financing costs while preserving operational and strategic flexibility