Term Loan B

Introduction

What is Term Loan B?

• An institutional term loan that has become the dominant form of leveraged loan financing in modern capital markets
• Unlike Term Loan A, which is held primarily by commercial banks

Introduction

What is Term Loan B?

• Designed for institutional investors such as CLOs, loan mutual funds, hedge funds, and other non-bank lenders
• Features minimal amortization, longer maturity, higher pricing, and greater liquidity through active secondary market trading
• A cornerstone of leveraged buyout financing and corporate debt restructurings

Key Characteristics

Minimal Amortization:

• TLB typically amortizes at just 1% per annum (often 0.25% quarterly)
• Vast majority of principal due at maturity in a balloon payment
• This structure preserves cash flow for operations and growth rather than debt reduction

Key Characteristics

Extended Maturity:

• Standard tenors range from seven to eight years
• Significantly longer than Term Loan A
• Some facilities extend to ten years, providing borrowers with extended refinancing runway

Key Characteristics

Institutional Investor Base:

• Purchased and held primarily by CLOs (typically 60-70% of the market)
• Also held by loan funds, insurance companies, pension funds, and credit-focused hedge funds
• Rather than traditional commercial banks

Key Characteristics

Higher Pricing:

• Carries interest margins typically 50 to 150 basis points higher than Term Loan A
• Due to longer maturity, minimal amortization, lighter covenants, and greater risk profile
• Margins typically range from 300 to 500 basis points over benchmark rates

Key Characteristics

Active Secondary Trading:

• TLB trades actively in the secondary loan market
• Pricing transparency through services like the Loan Syndications and Trading Association (LSTA)
• Loans are quoted as a percentage of par value

Key Characteristics

Call Protection:

• Includes prepayment premiums or soft call protection during the first one to two years after issuance
• Protecting investors from quick refinancing and ensuring minimum return periods

Structure and Components

Principal Amount:

• Facility sizes range from $100 million for middle-market transactions to multiple billions for large corporate LBOs
• TLB typically represents 3.0x to 5.0x EBITDA
• Depending on credit quality and market conditions

Structure and Components

Interest Rate Mechanism:

• Virtually all TLB facilities use floating rates based on SOFR plus a credit spread
• Most include SOFR floors (typically 0.50% to 1.00%)
• Protecting lenders in low-rate environments

Structure and Components

Mandatory Amortization:

• The standard 1% annual amortization is split into quarterly payments of 0.25% of the original principal amount
• Some high-yield deals have zero scheduled amortization

Structure and Components

Original Issue Discount (OID):

• Borrowers may issue TLB at less than par value (e.g., 99% or 98%)
• Effectively increasing the yield to investors while maintaining the stated interest margin
• OID of 50 to 200 basis points is common in competitive markets

Structure and Components

Incurrence Covenants:

• Unlike Term Loan A's maintenance covenants tested quarterly
• TLB typically includes only incurrence-based covenants
• That restrict actions (like incurring additional debt or making acquisitions) only when leverage exceeds specified thresholds

Structure and Components

Security Package:

• Secured by first-priority liens on substantially all assets
• Alongside Term Loan A and revolving facilities
• Creating a pari passu senior secured credit group

Covenant Structure

Covenant-Lite Prevalence:

• The majority of TLB issuance is now "covenant-lite" (cov-lite)
• Containing no financial maintenance covenants
• This structure became dominant following the 2008 financial crisis
• Represents over 90% of current issuance

Covenant Structure

Incurrence-Based Restrictions:

• Rather than maintaining specific leverage ratios, borrowers face restrictions on certain actions only when leverage exceeds defined baskets
• For example, additional debt may be permitted only if pro forma leverage remains below 5.0x

Covenant Structure

Limited Restricted Payments:

• Dividends and distributions to equity holders are typically allowed through various baskets
• Including builder baskets (percentage of net income), declining leverage baskets, and available amount baskets

Covenant Structure

Incremental Facilities:

• Most TLB documents permit additional pari passu or junior debt
• Through ratio-based tests or fixed dollar baskets
• Enabling future financing flexibility without lender consent

Covenant Structure

Asset Sale Proceeds:

• Borrowers can often retain and reinvest asset sale proceeds within specified timeframes
• With excess amounts subject to offer-to-purchase requirements rather than mandatory prepayment

Comparison with Other Debt Instruments

Term Loan B vs. Term Loan A:

• TLB has minimal versus significant amortization
• Longer maturity
• Institutional versus bank investor base

Comparison with Other Debt Instruments

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

• Incurrence versus maintenance covenants
• Higher pricing
• Greater secondary market liquidity

Comparison with Other Debt Instruments

Term Loan B vs. High-Yield Bonds:

• TLB has floating versus fixed rates
• Secured versus typically unsecured structure
• Bank debt versus bond documentation
• Syndicated loan versus bond trustee administration
• Greater amendment flexibility

Comparison with Other Debt Instruments

Term Loan B vs. Second Lien Loans:

• First lien TLB has priority claims on collateral
• Lower pricing (typically 200-300 basis points lower)
• Larger market depth
• Better recovery prospects in default scenarios

Comparison with Other Debt Instruments

Term Loan B vs. Unitranche Debt:

• Unitranche combines first and second lien characteristics in a single facility with blended pricing
• While TLB maintains distinct lien priority and separate second lien or mezzanine tranches when needed

Role in Capital Structure

LBO Financing:

• TLB provides the majority of debt financing in leveraged buyouts
• Typically representing 40-60% of total transaction value
• Alongside equity, Term Loan A, revolving facilities, and potentially subordinated debt

Role in Capital Structure

Dividend Recapitalizations:

• Sponsors use TLB to extract value from portfolio companies
• Through dividend payments or equity distributions
• While maintaining operational control and management

Role in Capital Structure

Acquisition Financing:

• Companies tap TLB markets to fund large acquisitions
• Where strategic importance justifies leveraged financing
• Despite limited near-term synergies or cash flow accretion

Role in Capital Structure

Refinancing Existing Debt:

• Borrowers replace maturing debt, improve terms, extend maturities
• Or capture market opportunities when pricing or structure becomes more favorable than existing facilities

Role in Capital Structure

General Corporate Purposes:

• Some TLB issuance supports working capital, capital expenditures, or general corporate flexibility
• Rather than specific transaction financing

Advantages for Borrowers

Cash Flow Preservation:

• Minimal amortization preserves cash for business reinvestment, operational needs, and strategic opportunities
• Rather than mandatory debt reduction

Advantages for Borrowers

Extended Maturity:

• Seven to eight-year terms provide substantial refinancing runway
• Reducing near-term maturity pressure and refinancing risk

Advantages for Borrowers

Covenant Flexibility:

• Cov-lite structures eliminate quarterly maintenance covenant testing
• Reducing default risk from technical breaches
• Providing operational flexibility during business cycles

Advantages for Borrowers

Scalability:

• TLB markets accommodate very large financings
• Through syndication to broad institutional investor bases
• Enabling billion-dollar-plus transactions

Advantages for Borrowers

Refinancing Flexibility:

• Despite call protection, borrowers can often refinance opportunistically
• Through repricing amendments that maintain existing investors while reducing spreads

Advantages for Borrowers

Market Depth:

• Active secondary markets and substantial investor appetite
• Create reliable execution certainty for well-structured credits

Advantages for Investors

Higher Yields:

• TLB offers attractive risk-adjusted returns compared to Term Loan A
• With pricing reflecting longer maturity, lighter covenants, and minimal amortization

Advantages for Investors

Senior Security:

• First-priority liens provide strong recovery prospects
• Historical TLB recovery rates averaging 70-80% in default scenarios
• Compared to 40-50% for unsecured bonds

Advantages for Investors

Floating Rate Exposure:

• SOFR-based pricing provides protection against rising interest rates
• Unlike fixed-rate bonds that suffer price declines when rates increase

Advantages for Investors

Liquidity:

• Active secondary trading enables portfolio management, position adjustments, and exit flexibility
• Not available in traditional middle-market bank loans

Advantages for Investors

Call Protection:

• Prepayment premiums or soft call provisions ensure minimum investment periods
• Protect against immediate refinancing that would eliminate expected returns

Advantages for Investors

Diversification:

• Loans provide portfolio diversification benefits
• Generally exhibit low correlation with traditional fixed-income securities

Pricing Mechanisms

Base Rate Plus Margin:

• Typical structure uses Term SOFR (with defined tenors like one-month or three-month) plus a fixed spread
• Current market ranges from L+300 to L+500 for most credits

Pricing Mechanisms

SOFR Floor:

• Minimum benchmark rate (commonly 0.50% to 1.00%)
• Ensures minimum interest payments even in zero or negative rate environments
• Protecting investor returns

Pricing Mechanisms

Credit Spread Adjustments:

• Spreads adjust based on credit ratings, industry sector, leverage levels, sponsor quality
• And overall market conditions at issuance

Pricing Mechanisms

Market Flex Provisions:

• Arrangers retain rights to adjust pricing, structure, OID, or terms
• If market conditions during syndication differ from initial expectations

Pricing Mechanisms

Most Favored Nation (MFN):

• If borrowers issue additional pari passu TLB within specified periods (typically six to twelve months) at lower pricing
• Existing lenders may receive spread increases to match

Call Protection Structures

Hard Call Protection:

• Absolute prohibition on voluntary prepayment (except from excess cash flow sweeps or asset sales)
• During the first six to twelve months
• Though this structure is now relatively rare

Call Protection Structures

Soft Call Protection:

• Prepayment premiums (typically 101% in year one, declining thereafter)
• Apply to refinancing prepayments
• But not to prepayments from operational cash flow, asset sales, or equity issuance

Call Protection Structures

101/50 Structure:

• Common provision requiring 101% prepayment price
• But only if 50% or more of the facility is refinanced with same-priority debt at lower pricing
• Within specified periods

Call Protection Structures

Repricing Protection:

• More common in recent markets
• Applying prepayment premiums specifically to spread-reducing amendments
• Rather than full refinancing transactions

Syndication and Distribution

Underwriting Process:

• Lead arrangers commit to the full facility amount during the exclusivity period
• Assuming market risk and providing execution certainty to borrowers

Syndication and Distribution

Institutional Syndication:

• Distribution targets CLOs, loan mutual funds, insurance companies, BDCs, hedge funds
• And other institutional credit investors

Syndication and Distribution

Allocation Process:

• Investors submit commitments during syndication
• With lead arrangers allocating based on relationship strength, commitment size, and market conditions

Syndication and Distribution

Retail Participation:

• Loan participations and mutual fund investments enable retail investors to access institutional TLB returns
• Through regulated investment vehicles

Syndication and Distribution

CLO Dominance:

• CLOs represent the largest investor class
• With their structural demand for floating-rate senior secured loans driving market growth and liquidity

Secondary Market Trading

Market Structure:

• TLB trades through dealer networks
• With bid-ask spreads typically 25 to 100 basis points
• Depending on credit quality, liquidity, and market conditions

Secondary Market Trading

Price Quotation:

• Loans quote as percentage of par (e.g., 98.50 or 101.25) plus accrued interest
• With transactions settling T+7 (seven business days after trade date)

Secondary Market Trading

Trading Conventions:

• LSTA documentation standardizes settlement procedures, assignment mechanics, and operational processes
• Facilitating market efficiency

Secondary Market Trading

Par/Distressed Distinction:

• Credits trading near par (above 90) are considered performing
• While those below 80 enter distressed territory
• With different investor bases and trading dynamics

Secondary Market Trading

Portfolio Management:

• Active secondary markets enable investors to:
• Rebalance portfolios, adjust sector exposures
• Manage concentration limits, and harvest tax losses

Mandatory Prepayment Events

Excess Cash Flow Sweep:

• Percentage of annual excess cash flow (typically 0% to 50% depending on leverage)
• Must be offered to prepay the loan
• With lenders having the option to accept or decline

Mandatory Prepayment Events

Asset Sale Proceeds:

• Net proceeds exceeding thresholds (often $25-50 million annually)
• Trigger prepayment requirements
• Subject to reinvestment rights and declination options

Mandatory Prepayment Events

Debt Issuance:

• Certain debt issuances, particularly pari passu or senior secured debt, may require TLB prepayment
• Though modern documents often provide significant flexibility

Mandatory Prepayment Events

Insurance Proceeds:

• Casualty or condemnation proceeds above thresholds require prepayment
• Unless reinvested in the business within specified periods

Mandatory Prepayment Events

Declining Sweep Percentages:

• Excess cash flow sweep percentages often decline or eliminate entirely
• As leverage improves below specified thresholds

Amendment and Modification

Required Lender Thresholds:

• Typically 50.1% to 66.7% of outstanding commitments can consent to most amendments
• Though certain fundamental changes require higher thresholds or unanimity

Amendment and Modification

Unanimous Consent Items:

• Changes to interest rates, maturity dates, principal amounts, collateral releases, or payment priorities
• Generally require approval from 100% of affected lenders

Amendment and Modification

Yank-the-Bank Provisions:

• Allow borrowers to replace non-consenting lenders in amendment processes
• Though usually limited to non-fundamental changes

Amendment and Modification

Repricing Amendments:

• Spread reductions through amendments have become common
• Allowing borrowers to capture market improvements without full refinancing

Amendment and Modification

Amendment Fees:

• Consenting lenders typically receive consent fees (25-50 basis points)
• For approving amendments, creating economic incentives for participation

Default Scenarios and Remedies

Events of Default:

• Include payment defaults (typically with short grace periods)
• Bankruptcy events, cross-defaults to material debt
• Breach of representations, and violation of incurrence covenants

Default Scenarios and Remedies

Limited Maintenance Defaults:

• Cov-lite structures significantly reduce default risk from financial underperformance
• With defaults typically arising from payment failures or bankruptcy
• Rather than covenant breaches

Default Scenarios and Remedies

Acceleration Rights:

• Upon default, required lenders can accelerate all obligations
• Though creditors carefully consider the strategic implications of acceleration in workout situations

Default Scenarios and Remedies

Enforcement Actions:

• Secured lenders can foreclose on collateral, credit bid in asset sales
• Pursue guarantors, or negotiate consensual restructurings
• Depending on circumstances

Default Scenarios and Remedies

Intercreditor Agreements:

• First lien/second lien intercreditor agreements govern enforcement rights
• Required standstill periods, and payment priorities in default scenarios

Market Trends and Evolution

Covenant-Lite Dominance:

• Cov-lite loans now represent over 90% of institutional TLB issuance
• Marking a fundamental shift from pre-2008 markets where maintenance covenants were standard

Market Trends and Evolution

SOFR Transition:

• Markets have fully transitioned from LIBOR to Term SOFR
• With credit spread adjustments addressing any differences in rate calculation methodologies

Market Trends and Evolution

ESG-Linked Features:

• Sustainability-linked loans with margin adjustments based on ESG performance metrics
• Have grown significantly
• Reflecting investor and borrower focus on environmental and social factors

Market Trends and Evolution

Private Credit Competition:

• Direct lending funds and private credit providers increasingly compete with syndicated TLB markets
• Particularly for middle-market and sponsor-backed transactions

Market Trends and Evolution

Add-On Acquisitions:

• Modern TLB documentation facilitates bolt-on acquisitions
• Through ratio-based baskets and exception carve-outs
• Supporting private equity buy-and-build strategies

Market Trends and Evolution

Portable Debt Structures:

• Some facilities include sponsor-to-sponsor portability
• Allowing debt to remain outstanding through ownership changes
• Facilitating secondary buyout transactions

Risk Considerations for Borrowers

Interest Rate Exposure:

• Floating rate structure means payments increase when SOFR rises
• Creating cash flow variability and potential stress in rising rate environments

Risk Considerations for Borrowers

Refinancing Risk:

• Despite seven to eight-year maturity, borrowers eventually face refinancing requirements
• Market conditions, credit deterioration, or leverage limits can make refinancing difficult or expensive

Risk Considerations for Borrowers

Covenant Creep Risk:

• Market conditions fluctuate
• Borrowers issuing during tight markets may face tighter covenants than peers issuing during looser periods
• Creating competitive disadvantages

Risk Considerations for Borrowers

Call Protection Costs:

• Prepayment premiums limit ability to refinance opportunistically
• Potentially forcing borrowers to maintain higher-cost debt when market conditions improve

Risk Considerations for Borrowers

Market Timing Risk:

• TLB issuance requires favorable market windows
• Market disruptions can delay or prevent issuance, creating execution uncertainty

Risk Considerations for Investors

Credit Risk:

• Despite senior secured status, TLB carries meaningful default risk
• With historical default rates of 2-4% annually depending on credit cycles

Risk Considerations for Investors

Limited Downside Protection:

• Cov-lite structures eliminate early warning mechanisms that maintenance covenants provided
• Potentially delaying investor awareness of deteriorating credits

Risk Considerations for Investors

Recovery Risk:

• While secured, actual recovery rates vary widely
• Based on asset values, industry conditions, and capital structure complexity
• Recoveries below historical averages occur in severe downturns

Risk Considerations for Investors

Market Risk:

• TLB prices fluctuate based on credit spreads, market sentiment, and technical factors
• Prices can fall below par even for non-distressed credits during market dislocations

Risk Considerations for Investors

Documentation Risk:

• Increasingly aggressive borrower-friendly provisions in cov-lite documents
• May impair lender rights in distressed situations compared to traditional covenant packages

Best Practices for Borrowers

Maintain Financial Flexibility:

• Despite covenant-lite structures
• Preserve balance sheet capacity and liquidity buffers to navigate business cycles and market disruptions

Best Practices for Borrowers

Monitor Refinancing Windows:

• Track market conditions continuously
• And refinance opportunistically rather than waiting until approaching maturity

Best Practices for Borrowers

Build Lender Relationships:

• Even with institutional investor bases
• Maintain relationships with key holders and administrative agents
• To facilitate amendments and future transactions

Best Practices for Borrowers

Optimize Capital Structure:

• Balance TLB with appropriate levels of equity, revolver capacity, and potentially junior debt
• To create resilient capital structures

Best Practices for Borrowers

Plan for Growth:

• Ensure documentation provides sufficient flexibility
• For acquisitions, investments, and strategic initiatives contemplated in business plans

Best Practices for Borrowers

Consider Market Cycles:

• Time issuance to maximize favorable terms
• Recognizing that covenant packages and pricing vary significantly across market cycles

Best Practices for Investors

Comprehensive Due Diligence:

• Analyze credit fundamentals, industry dynamics, management quality
• Sponsor track record, and documentation terms thoroughly before committing

Best Practices for Investors

Covenant Analysis:

• Understand incurrence covenant mechanics
• Growth-oriented flexibility provisions
• And potential for value leakage despite cov-lite structures

Best Practices for Investors

Portfolio Diversification:

• Maintain appropriate diversification across industries, sponsors, vintage years, and credit qualities
• To manage concentration risk

Best Practices for Investors

Monitor Holdings Actively:

• Track financial performance, covenant compliance, market pricing, and industry trends continuously
• Despite absence of maintenance covenants

Best Practices for Investors

Participate in Amendments:

• Engage actively in amendment processes
• To protect investor interests and ensure fair economic terms for consenting parties

Best Practices for Investors

Understand Recovery Scenarios:

• Model potential recovery outcomes across various default scenarios
• Considering asset values, capital structure priorities, and industry-specific factors

Conclusion

• Term Loan B has evolved into the dominant institutional leveraged loan product
• Financing leveraged buyouts, acquisitions, and corporate growth across global markets

Conclusion

• Its minimal amortization structure preserves cash flow, extended maturity provides refinancing runway
• And covenant-lite terms offer operational flexibility, making it attractive to borrowers

Conclusion

• For investors, TLB provides floating-rate exposure, senior secured status, attractive risk-adjusted returns, and liquid secondary market trading

Conclusion

• The shift toward covenant-lite structures represents a fundamental change in market dynamics
• Transferring risk from maintenance covenant protections to deep credit analysis and careful documentation review

Conclusion

• Success in TLB markets requires borrowers to maintain financial discipline despite covenant flexibility
• While investors must conduct rigorous credit analysis and actively manage portfolios despite reduced early warning mechanisms
• Understanding TLB structure, market conventions, and evolving documentation standards is essential for all participants in modern leveraged finance markets