As the market for term loan B (TLB) financing becomes choppier in the face of macroeconomic and geopolitical uncertainty, the term loan A (TLA) segment of the market is having its moment in the sun.
Unlike the TLB market—where loans are sold down to institutional investors, including mutual funds, insurance companies and CLOs—TLA or “pro rata” debt is typically held by banks and other financial institutions. This form of financing usually consists of a revolving credit facility alongside an amortizing term loan, with each lender holding a pro rata share of both facilities (hence the name “pro rata” facilities).
The institutional TLB market has expanded significantly in the past ten years, as investors have grown more comfortable with flexible debt terms (including “covenant lite” structures) that appeal to borrowers and financial sponsors. This flexibility has seen institutional loans gain market share and crowd out traditional TLA structures in the buoyant markets of recent years.
In 2022, however, the institutional loan market has experienced volatility in the face of rising interest rates and climbing inflation. As a result, it has become more difficult for arrangers to fully syndicate TLB debt tranches. In the US, institutional loan issuance for H1 2022 fell 60% year-on-year. Institutional loan issuance has also fallen in Western and Southern Europe, dropping by 72% year-on-year during the same period.
Calm in the storm
This drop in institutional loan issuance has seen TLA/pro rata structures rise to prominence.
Rather than testing institutional appetite, which has been affected by market volatility, some borrowers in the US and Europe are now looking to raise pro rata facilities instead.
In H1 2022, pro rata tranches accounted for 67% of overall leveraged loan issuance in the US, up from a 35% share in 2021. In Western and Southern Europe, pro rata structures accounted for half of all issuance in H1 2022, up from 43% in all of 2021.
The TLA debt market typically includes international and regional banks and other financial institutions. Many of these TLA players participate in the TLB space only as arrangers and underwriters (rather than investors) and represent a distinct pool of capital for borrowers to tap.
While this cohort of lenders can be affected by macroeconomic headwinds and regulatory pressures, the TLA market is generally more resilient than the institutional loan space.
TLA lenders buy debt with a view to holding it through to maturity, as opposed to CLOs and other institutional investors, which are more likely to trade in and out of positions. TLA lenders will typically focus on lower leveraged credits, in many cases with higher credit ratings.
This credit profile, coupled with the long-term strategy of the lenders, means the TLA market tends to be less exposed to the vagaries of market cycles, and provides a credible option for borrowers in periods of dislocation. TLA financing also tends to be cheaper than TLB debt, although as a floating-rate instrument these facilities are still exposed to increases in benchmark rates.
Tightened terms
The tradeoff for borrowers is that, while the pro rata market is more stable, TLA structures tend to offer less flexibility. In particular, pro rata facilities will typically include a financial maintenance covenant, and there will often be more limited scope for borrowers to incur additional debt and make restricted payments, among other things.
Amortization schedules and loan maturities are also more lender-friendly with TLA. TLA loans typically require meaningful amortization payments, whereas TLB debt usually amortizes at just 1% a year. TLA maturities are also shorter, at five years rather than the seven years typical for institutional loans, leaving borrowers with a shorter timeframe to pay back or refinance debt.
Against the current market backdrop, borrowers approaching debt maturities or requiring acquisition capital are having to consider forgoing the flexibility of TLB structures for the certainty and stability of TLA.
Tighter documentation may not suit all borrowers, but it does offer a credible option for securing financing in an unpredictable market.
Borrowers also have the option of anchoring a debt package with a TLA facility and then bringing in additional high yield or TLB debt.
White & Case advised on a debt financing that combined TLA, TLB and high yield facilities for Univision Communications, a Spanish-language content and media company.
The facility included a five-year, US$500 million senior secured TLA facility and a US$500 million TLB, alongside a US$500 million senior secured high yield bond. The proceeds were used to pay down US$370 million of senior secured notes due in 2025 and partly repay outstanding amounts of debt maturing in 2024.
In a bumpy environment, more borrowers are likely to consider these types of structures. The TLA market—somewhat overlooked in recent years as borrowers took advantage of attractive pricing and flexible terms in the buoyant TLB space—is sparking back to life.
