Private Credit Explained – Delayed Term Loans | Proskauer Rose LLP

A typical European LLB will consist of different tranches of debt, for different purposes, all documented under a single facility agreement. In a leveraged buyout scenario, the standard structure will be a term loan to fund the acquisition (typically a unitranche loan from one or more private credit lenders or a broadly syndicated loan (“BSL”) term loan) with, in each case, a revolving credit line provided for working capital purposes. Depending on the business model and any anticipated future acquisitions, the sponsor may also consider additional liquidity lines.

The sponsor may need committed financing for anticipated future acquisitions, but may not want to pay full interest on that portion of the committed debt until the funds are actually needed. This future funding requirement may be structured as an additional term facility with a delayed drawdown mechanism, for specific purposes, that is available for a limited period after closing (subject to certain agreed-upon parameters). This arrangement is known as a delayed term loan (“DDTL”), which is a committed line of credit. They are typically referred to as capex, CAF, or acquisition facility in the private credit market. These DDTLs provide the borrower with flexible access to additional funds at a later date, on pre-agreed terms, rather than being required to draw down the entire amount of the debt at closing.

DDTLs are a common feature of middle market private loan transactions, but are becoming increasingly popular in the large cap lending sector where private loans compete with the BSL market.

Structuring

Length of commitment/availability

The structure of each DDTL is transaction-specific, but they are generally similar to another tranche of term debt, the unitranche day one loan. DDTLs are typically committed from the time of closing (i.e., after the unitranche is fully drawn and the day one acquisition is complete). They typically have an availability period of three to four years, can be drawn in multiple tranches (subject to a minimum drawdown amount), and once drawn, cannot be re-borrowed after prepayment. DDTLs typically have the same ranking and priority as the unitranche term loan, so there will be no internal maturity allowed, and the DDTL will be due on the same final maturity date as the unitranche term loan. Voluntary and mandatory prepayments will typically be required to apply proportionally between the unitranche term loan and the DDTL.

Use of income

Given the increasingly borrower-friendly market in recent times, the purpose clause will be broadly worded. The borrower may access the DDTL for a variety of reasons, including for capital expenditure, to fund permitted acquisitions, to refinance any other existing debt, to repay the sponsor’s bridging capital used to fund a future acquisition or even simply to place cash on the balance sheet (with the future intention of using the proceeds to fund agreed purposes).

Terms of use

In addition to the customary preconditions for the drawdown of funds under a credit agreement, such as the absence of an event of default and recurring declarations, the following drawdown conditions are typically included:

• the proposed use will not result in leverage exceeding the pro forma opening leverage;
• the unitranche debt has already been fully utilized;
• a certificate from the borrower that the purpose of the DDTL is permitted; and
• in certain situations, restricting the borrower from taking out any uncommitted additional loans until the committed funds under the DDTL have been fully utilized.

Minimal use

Where DDTLs are permitted to fund capital expenditure, particularly where the size of the DDTL involved is significant, lenders will require larger minimum drawdown amounts. These will often be amounts in excess of, for example, £1 million/€1 million to avoid the administrative burden of requesting smaller amounts from the LP. However, these minimum drawdown terms may not be consistent with the specific capital expenditure requirements of the borrower. Lenders and borrowers may need to negotiate a level that balances the lenders’ operational burden with the borrower’s liquidity requirement to meet the ongoing needs of the business.

“Certain Funds” Requirements

In some situations, private lending funds may be willing to provide DDTL on a “certain funds” basis, if appropriate. From a lender’s perspective, this means that there are fewer documentation requirements that a group of borrowers must meet before lenders are required to fund. Generally, most DDTLs are documented without evidence of a specific acquisition. Therefore, a borrower may need to apply for a loan based on certain funds for a specific acquisition, but lenders typically limit this reduced conditionality to a period not to exceed six months from the date of signing of that specific acquisition.

Lenders should ensure that the requirement to meet a specific leverage test is still included in the criteria for the use of certain funds. This may sometimes be inadvertently omitted because the use of a loan at closing, on a certain funds basis, generally does not include a leverage test.

Classification

As mentioned above, DDTL loans are generally treated equally to unitranche loans in all respects (i.e. both before and after foreclosure).

Economy

Upfront Fee / Arrangement Fee

There are many ways to structure the DDTL upfront fee/arrangement fee. It may be payable upfront in full on the closing date, but more often the upfront fee is split 50:50. In a classic mid-market deal, 50% of the fee will be payable on the closing date, with the remaining 50% payable on the earliest of (i) any drawdown, (ii) the end of the availability period, (iii) any prepayment of DDTL, whether mandatory or voluntary, and (iv) cancellation of any unused DDTL. In some deals where DDTL may be used in multiple drawdowns, the remaining 50% fee is paid as part of the principal amount of each drawdown on the DDTL. Although unusual, in more aggressive deals no upfront fees are payable at closing; instead, the fee is a pro rata amount paid on each drawdown or cancellation. In a larger capitalised market, the arrangement fee may only be paid on a pro rata basis for each utilisation; no cancellation fee is charged.

Commission

There is usually a finance charge to the borrower for the availability of committed funds for the DDTL. Interest charges are not incurred until or unless the DDTL is drawn down (in part or in whole). However, lenders typically charge a non-draft or commitment fee to maintain the commitment to fund the DDTL. This fee is typically referred to as a commitment fee and is charged on undrawn DDTL commitments. These commitment fees begin accruing from the agreed time until the DDTL is fully drawn down or, if some or all of the DDTL remains undrawn, until the end of the availability period. Typically, the commitment fee begins accruing from the closing date and is payable quarterly in arrears. For larger transactions, there may be a break in the commitment fee payment when fees begin accruing only three or six months after closing.

DDTL vs. Incremental Objects

Given the recent economic uncertainty, borrowers find pre-agreed, committed facilities with fixed prices for anticipated acquisitions particularly attractive. Such facilities eliminate concerns about the borrower’s funding sources and eliminate the need to negotiate prices and terms in the future when, depending on market conditions, the economic and documentary terms may be less favorable to the borrower. Access to funds is immediate because lenders have already committed to funding once the required pre-conditions have been met. For borrowers, this certainty of funding, compared with negotiating an additional facility, typically justifies the additional fees associated with DDTL.

Latest developments: “Synthetic PIK”

The flexibility offered by DDTL has recently been used in a more innovative way, in what has been described as a “synthetic PIK”. PIK debt, in which interest is paid in kind rather than in cash, can be attractive in an environment where liquidity and cash flow are challenging issues for the company. The borrower can add the amount of their interest payment to the principal amount of the total debt and defer payment until the debt matures. Failure to make interest payments in cash will result in a “default” on the covenants on the financial documents, so the ability to defer a cash payment can be advantageous in times of illiquidity and in high-interest-rate environments.

Private credit lenders are usually able to offer some elements of PIK debt as part of the deal, which gives them a competitive advantage when competing with bank lenders to provide debt to sponsors. Unfortunately, there can be limits to the amount of PIK debt a private credit lender can offer. In these situations, sponsors may be offered a “synthetic PIK,” which is structured through a DDTL, as an alternative. The lender will provide a unitranche loan, typically fully drawn at closing, with a delayed payoff tranche of term debt also provided as part of the debt package. When cash interest becomes payable on the unitranche loan, the borrower has the option of drawing down DDTL to service that debt (“Payment DDTL”), which is effectively synthetic PIK. Interest is paid on the cash advance, but the borrower adds more debt to their balance sheet.

Lenders use this synthetic PIK option to offer PIK terms to the borrower without violating any limit imposed on the amount of permitted PIK debt, since technically the interest on the unitranche debt is paid in cash. These Payment DDTLs are a relatively new concept, and their terms are usually transaction-specific, including how interest is calculated and how it is paid under the Payment DDTL. Some transactions allow for the continued use of the Payment DDTL to pay interest on the DDTL, or the Payment DDTL may be structured without an interest component but with additional fees. These structures are novel, and the exact scope and application of synthetic PIKs is still developing in the marketplace, particularly in the US, where this structure appears to have its roots.

Application

DDTLs remain an attractive option for sponsors due to the easy access to debt on pre-agreed terms, which should ensure their continued popularity. In a competitive market where sponsors are looking to acquire attractive assets quickly, we have seen syndicated lenders attempt to offer these loans to compete directly with the private credit market. In the leveraged loan market, sponsors are seeking increasingly favourable terms. The new innovative use of DDTLs as a synthetic PIK offered by private credit lenders could be a feature that we will see in the coming year in the European leveraged loan market.

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