Basic, lesson 1 of 3
Anatomy of a credit agreement
A two page term sheet becomes a two hundred page credit agreement. Most of it follows the same order, and knowing the order tells you where to look.
9 min, 3 checks
1From term sheet to agreement
A deal starts as a term sheet: amount, tranches, pricing, maturity, amortization, the financial covenant, and a handful of key terms. Once the credit committee approves, lawyers turn it into a credit agreement, plus a security agreement that grants the liens and a guarantee from the subsidiaries. A lender who signed the term sheet still has to read the agreement, because definitions written later can quietly change what the term sheet meant.
| Article | What it does | What a lender reads for |
|---|---|---|
| Definitions | Defines every capitalized term | EBITDA, Indebtedness, Excess Cash Flow, Material Adverse Effect |
| The credits | Amounts, interest, fees, amortization, prepayments | Mandatory prepayments, call protection |
| Conditions | What must be true to fund at close and for each later draw | Whether a revolver draw can be blocked |
| Representations | Facts the borrower states as true | Solvency, no litigation, accurate financials |
| Affirmative covenants | Things the borrower must do | Reporting, insurance, adding new subsidiaries as guarantors |
| Negative covenants | Things the borrower may not do, with exceptions called baskets | Debt, liens, dividends, investments, asset sales |
| Financial covenants | Ratio tests | Level, step-downs, cure rights |
| Events of default | What lets lenders accelerate | Grace periods, cross default thresholds |
| Agency and amendments | The agent's role and voting rules | Required lenders, sacred rights |
Check 1
Where would you look to find out whether the borrower may pay its sponsor a dividend?
2Representations, conditions, and the agent
Representations are statements of fact at signing, usually repeated each time the borrower draws. If one turns out to be false in a material way, that is an event of default. Conditions are the gate: a revolver draw normally requires that the representations are still true and no default exists. That is how lenders can stop funding a company that is already in trouble.
The administrative agent is a lender, or a firm hired for the job, that sends notices, collects payments, and passes them to lenders pro rata. The collateral agent holds the liens on behalf of all secured lenders. Neither decides anything on its own; they act on lender votes.
Check 2
A borrower asks to draw its revolver while a covenant breach is uncured. What usually lets the revolver lenders refuse?
Check 3
Why do lenders read the definitions article before the covenants?
Terms in this lesson: Amortization, Covenant, EBITDA, Revolving credit facility, Sponsor.
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