A Leveraged Lending Overview from a Lender's Perspective, Part 2

Posted by Nicole Coffey on Jan 06, 2016 06:00:00 AM

Topic: ALL

Business team looking over lending reports

Continued from Part 1.

Now let’s breakdown what this additional guidance is:

1. Completion of an Overall Comprehensive Analysis

Every borrower must go through a thorough analysis upfront, this is nothing new. But to what extent the level of thoroughness that was being done prior to the recession is still debatable. Either way the analysis being done today includes reasonable levels of historical cash flow to support proforma debt, liquidity analysis, and review of a reasonable expectation of forecasted results. While it was common to see aggressive forecasts prior to the recession, it is recommended today to provide a more realistic forecast as this will be used as a benchmark in measuring the borrower’s future performance. This could mean that any significant variance to plan would need to be explained and if not done so sufficiently could restrict the borrower’s ability to locate future sources of funds if needed.

2. Adequate Leverage

Leveraged lending assists in providing funding for a buyout, acquisition, or capital distributions. With that said, it is also fair to assume that leverage ratios are also higher when it comes to these loans but what are the parameters? In a majority of industries, leveraged loans to borrowers would often have a total leverage ratio of greater than 4.0x (total debt to EBITDA), senior leverage greater than 3.0x (senior debt to EBITDA), or also other leverage ratios such as total liabilities to total assets that significantly exceed industry norms or historical levels. This is a good indicator of what is typically classified as a leveraged loan but there is also an unspoken limit as to what one would consider to be ‘adequate leverage’. For most industries a rule of thumb is that total leverage (total debt to EBITDA) of 6.0x or less would be adequate for a leveraged loan. Any ratio above this may raise additional concern and potentially require a different deal structure at the onset. It is important to note though that while these may be general guidelines, specific industries such as food and energy, may result in higher accepted ratios.

3. Do The Borrowers Have The Capacity To Repay and De-Lever In A Reasonable Period Of Time?

Everyone understands that it’s essential and the number one rule for future cash flow to support proforma deb requirements; however under the’guidance’, leveraged loan transactions must take this a step further. As new deals are structured, it is important to understand and be able to demonstrate the borrower’s ability to de-lever within a reasonable amount of time. Again one may ask what is considered a reasonable amount of time. For most ;borrower’s, this would be their ability to payoff senior debt completely or 50% of total debt over five to seven years. If the borrower is incapable of accomplishing that at the onset the deal may be difficult to obtain.

As mentioned earlier, in 2006-2007, loans with overly extended amortizations were getting done which has become a hot topic for regulators in today’s market. As you can see, there are many items that have changed in the leveraged lending arena from where we were pre-2008.

Despite these changes and the additional attention on leveraged lending market, financing is readily available for new opportunities. In fact, most lenders in the market are looking for more and more deals due to excess liquidity at some of their institutions. However, at the same time it’s essential to have a lender or other M&A advisor that fully understands the market and the ‘guidance’ surrounding it so that you have the ability to achieve success today and in the future.

Learn more about Bank Mutual’s Commercial team.