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Briefing Prof. Ian Giddy, New York University Leveraged Finance DefinedLeveraged finance is funding a company or business unit with more debt than would be considered normal for that company or industry. More-than-normal debt implies that the funding is riskier, and therefore more costly, than normal borrowing. As a result, levered finance is commonly employed to achieve a specific, often temporary, objective: to make an acquisition, to effect a buy-out, to repurchase shares or fund a one-time dividend, or to invest in a self-sustaining cash-generating asset.Although different banks mean different things when they talk
leveraged finance, it generally includes two main products - leveraged
loans and high-yield bonds. Leveraged loans, which are often
defined as credits priced 125 basis points or more over the London
interbank offered rate, are essentially loans with a high rate of
interest to reflect a higher risk posed by the borrower. High-yield or
junk bonds are those that are rated below "investment grade," i.e. less
than triple-B. A key instrument in much leveraged finance, particularly in leveraged buy-outs, is mezzanine or "in between" debt. Mezzanine debt has long been used by mid-cap companies in Europe and the US as a funding alternative to high yield bonds or bank debt. The product ranks between senior bank debt and equity in a company's capital structure, and mezzanine investors take higher risks than bond buyers but are rewarded with equity-like returns averaging between 15 and 20 per cent. Companies that are too small to tap the bond market have been the traditional users of mezzanine debt, but it is increasingly being used as part of the financing package for larger leveraged acquisition deals. Although mezzanine has been more expensive for companies to use than junk bonds, the low coupons coupled with high returns often makes some sort of mezzanine or hybrid debt an essential buffer between senior lenders and the equity investors.
Leveraged Acquisition FinanceLeveraged Acquisition Finance is the provision of bank loans and the issue of high yield bonds to fund acquisitions of companies or parts of companies by an existing internal management team (a management buy-out), an external management team (a management buy-in) or a third party (an acquisition).The leverage of a
transaction refers
to the ratio of debt capital (bank loans and bonds) to equity capital
(money
invested in the shares of the target company). In a leveraged
financing,
this ratio is unusually high. As a result, the level of debt service
(payment
of interest and repayment of principal) absorbs a very large part of
the
cashflow produced by the business. Consequently, the risk of the
company
not being able to service the debt is higher and thus the position of
the
lenders is riskier than in a conventional acquisition. The interest
rate
on the debt will be high. Leveraged RecapitalizationsA technique whereby a public company takes on significant additional debt with the purpose of either paying an extraordinary dividend or repurchasing shares, leaving the public shareholders with a continuing interest in a more financially-leveraged company. This is often used as a "shark repellant" to ward off a hostile takeover.Leveraged Corporate Credit
Leveraged corporate credit
involves the provision and managment of credit products, including bank
loans, bridge loans and high-yield debt, for below investment grade
companies that rely heavily on debt financing. |