A highly leveraged transaction (HLT) refers to a bank loan extended to a company that already has substantial debt. These transactions gained prominence in the 1980s for financing buyouts, acquisitions, and recapitalizations.
Key Takeaways
- Highly leveraged transactions involve lending to companies with significant existing debt.
- They are undertaken for purposes such as recapitalizing, buying out a company, or acquiring another company.
- These transactions offer high-interest rates, compensating financiers for the added risks posed by the company’s substantial debt load.
Understanding Highly Leveraged Transactions (HLTs)
Highly leveraged transactions come with elevated risks due to their potential to increase a company’s debt burden and negatively impact its debt-to-equity ratio. However, the interest income garnered from these transactions is significant, making them appealing to investors and financial institutions.
HLTs share similarities with junk bonds and often involve the issuance of such bonds as part of the deal structure. Both HLTs and junk bonds carry significant default risks but HLTs feature stronger debt covenants due to their secure structuring. A leveraged buyout (LBO) serves as a pertinent example of an HLT.
Often, HLTs encompass some form of debt restructuring due to the high existing debt levels of the company receiving the loan. Such restructuring results in an intricate debt structure, typically involving several types of subordinated debt. Ultimately, the lenders behind the HLT frequently obtain an equity stake in the restructured entity.
Guidance for Highly Leveraged Transactions
Guidance for executing HLTs is provided by various U.S. regulatory bodies including the Office of the Comptroller of Currency (OCC), the Federal Reserve Board, and the Federal Deposit Insurance Corporation. The OCC broadly defines an HLT as a situation where the post-financing leverage, evaluated through metrics such as debt-to-assets, debt-to-equity, and cash flow-to-total debt ratios, significantly surpass industry norms.
For a loan to be classified as an HLT, it typically needs to satisfy a combination of the following conditions:
- Usage of proceeds for buyouts, acquisitions, or recapitalizations.
- A notable increase in the borrower’s leverage ratio, potentially including benchmarks such as a doubling of liabilities resulting in a balance sheet leverage ratio exceeding 50%, or a rise above 75%. Alternatively, an increase in operating leverage ratios like debt-to-EBITDA can be used.
- Designation as an HLT by the syndication agent.
- Borrower classification as a non-investment-grade entity with a high debt-to-equity ratio.
- Loan pricing indicating a non-investment-grade borrower, regularly featuring spreads over the London Interbank Offered Rate (LIBOR) fluctuating with market conditions.
While these guidelines serve as a framework, they are not rigid regulations. The financial threshold, such as the implied high-water mark of 6 times debt-to-EBITDA, is occasionally surpassed. Ultimately, the feasibility of HLTs relies on market acceptability.
Related Terms: leveraged buyout, junk bonds, debt restructuring, debt-to-equity ratio.
