Bridge loans are a key option to finance massive acquisitions, however their phrases are very specialised. In “The Fundamentals of Bridge Loans”, the White & Case workforce explains the important thing phrases of bridge loans and discusses some challenges confronted within the present market.

Bridge loans function an important approach {that a} potential acquirer demonstrates its capability to fund an acquisition. Certainty of funds is required each for regulatory causes for financing the acquisition of listed firms in Europe (i.e., underneath the UK takeover code money consideration needs to be accessible to proceed with a bid), in addition to sensible issues, similar to offering assurance that each non-public fairness patrons and company patrons can elevate the required funds to help their bids throughout an public sale course of.

Conventional bridge loans are momentary loans with an preliminary maturity of 1 yr or much less, put in place to bridge a possible hole between the announcement of an acquisition till an organization can safe everlasting financing. Nonetheless, bridge loans carry vital danger. The borrower would like to keep away from sure costly charges and pricing the everlasting financing on the rate of interest cap (mentioned beneath) and lenders would like to be engaged because the preliminary purchasers on the everlasting financing (often excessive yield bond) quite than assume such a big stability sheet legal responsibility. The intent amongst all events on the dedication stage is due to this fact to not fund a bridge mortgage, however to attract down the bridge mortgage solely to take away funding danger from the M&A transaction. To this finish, the price and rate of interest construction of the bridge dedication is ready as much as incentivize the borrower to launch a excessive yield bond providing or different everlasting financing transaction forward of the acquisition closing quite than funding the bridge, or if funding is critical, to refinance the bridge as shortly as doable following the closing of the acquisition.

Lately and through instances of robust market situations, it has been comparatively easy for debtors to then finalize the everlasting financing transaction both earlier than drawing the bridge or instantly after and shortly refinance bridge loans. Nonetheless, latest adjustments and ongoing volatility in credit score markets have delayed the everlasting financing and put a damper on the flexibility to refinance the bridge services through the preliminary one yr time period. In such market situations, banks want to think about whether or not to attend and keep within the bridge mortgage, or doubtlessly worth the excessive yield bond above the Cap (mentioned beneath) and/or worth with vital authentic concern low cost, which might imply the banks may finally lose anticipated charges or extra from the transaction.

Primary Options of a Bridge Mortgage

Events

The important thing events to a typical bridge mortgage are the acquirer (sometimes a newly established firm) in an M&A transaction (the borrower), the banks appearing as arrangers and the executive agent.

Period / Maturity

In a typical transaction, the bridge mortgage’s maturity of 1 yr will robotically be prolonged into long-term financing ought to the borrower fail to refinance the bridge mortgage on the finish of its preliminary time period. The bridge mortgage will convert right into a tradeable mortgage instrument, sometimes with a hard and fast rate of interest set on the “Cap” price (see beneath).

As additional mentioned beneath, as soon as a bridge mortgage “phrases out” into an prolonged time period mortgage, lenders have the suitable to change such loans for “change notes”. Bridge mortgage documentation is drafted on the premise that on the time of conversion, lenders will wish to change their prolonged time period loans into “change notes”. Such change notes are cleared via clearing methods and are freely tradeable, versus prolonged time period loans, that are much less liquid and topic to sure switch restrictions.

Documentation

Sometimes, bridge mortgage commitments are documented by a dedication letter, bridge time period sheet, bridge price letter and excessive yield bond engagement letter.

• Dedication letter – The dedication letter is the important thing operative doc the place the banks decide to make the bridge mortgage accessible to the acquirer to fund an acquisition. This accommodates the general quantum of the financing, roles/titles of banks, in addition to sure different key dedication phrases, together with any conditionality (sometimes restricted to objects throughout the management of the borrower) to the provision of the funds. The dedication may additionally embody extra components of the senior a part of the capital construction (for example, time period loans of a number of varieties) and presumably a revolving credit score facility dedication. Connected to the dedication letter are time period sheets detailing the phrases of the mortgage services that can be made accessible, together with the bridge time period sheet.
• Bridge time period sheet – The bridge time period sheet is often hooked up as a schedule to the dedication letter and offers a abstract of fabric phrases of the bridge facility settlement. This time period sheet additionally consists of displays detailing the change notes and covenant baskets that might govern the change notes and are additionally used as the premise of the anticipated excessive yield bond to refinance the bridge mortgage (or change notes).
• Bridge price letter – The bridge price letter describes the charges and commissions that can be paid to every of the banks in change for his or her bridge dedication, funding the bridge and rolling the bridge right into a long-term debt obligation. The charges are sometimes set as a share of the gross proceeds or principal quantity. The price letter additionally lays out the Cap and the securities demand (all as mentioned intimately beneath). The price letter can even embody charges of any extra components of the senior capital construction, similar to revolving credit score facility charges.
• Excessive yield engagement letter – The excessive yield engagement letter is a letter from the acquirer to the lending banks the place it engages the banks to behave as preliminary purchasers in any future bond providing to take out the bridge mortgage. This letter offers the important thing engagement phrases for the excessive yield bond providing to refinance to bridge mortgage, together with the charges to be paid to the preliminary purchasers. In change for offering the bridge and signing the bridge dedication letter, the banks count on to be engaged on the bridge takeout financing by the use of signing the engagement letter.

Charges, rates of interest and rebates

Charges, rates of interest and varied rebates are sometimes structured to incentivize the borrower to refinance the bridge on the earliest doable alternative. The charges in a typical bridge mortgage could embody the next, all of that are payable provided that the acquisition closes – often called “no deal, no price”:

• Dedication price – A price for the bridge lenders’ dedication, payable no matter whether or not the bridge mortgage is funded (supplied the acquisition closes);
• Funding price – Payable provided that the bridge mortgage is funded. Sometimes, the bridge price letter offers for a “rebate” of the funding price, starting from 25% to 100% of the preliminary price paid, relying on how lengthy the bridge mortgage is refinanced earlier than its preliminary maturity. The much less time between the funding and the refinancing of the bridge mortgage, the better the low cost;
• Deal-away price – Within the occasion one other supply of funding is utilized on the acquisition deadline, the lenders are both absolutely or partially (relying if the bridge was funded) compensated as if they’d led the everlasting financing. This price is often set out within the excessive yield engagement letter and ensures that the banks offering the dedication will act because the mandated lead arrangers and/or preliminary purchasers within the everlasting financing transaction, or in any other case are compensated accordingly;
• Different transaction price – That is payable if the borrower terminates the excessive yield engagement letter and completes the M&A transaction inside an agreed interval thereafter (often inside 6-12 months), with comparable financing supplied by different banks. The unique banks can be compensated a share of the charges they might have acquired, had they dedicated to the bridge mortgage;
• Conversion or Rollover price – If the bridge mortgage just isn’t refinanced at its preliminary maturity date and is transformed into long-term financing, a conversion price is imposed on the borrower. The banks will obtain a price, which ought to cowl the charges the banks would have acquired had the bridge mortgage been refinanced by a excessive yield bond led by the banks committing to the bridge mortgage financing. This may increasingly, in some transactions, be topic to a rebate mechanism just like the rebate of the funding price, reducing with how lengthy after the conversion date the prolonged time period loans are refinanced;
• Bond underwriting or mortgage association price – The banks obtain a price for underwriting the bond providing or arranging a syndicated mortgage to refinance the bridge mortgage;
• Administrative agent price – If syndicated banks are dedicated to the bridge mortgage, the agent will obtain a price as soon as the bridge mortgage is funded and yearly thereafter if the bridge mortgage stays excellent; and
• Rate of interest – the important thing rate of interest can be set out within the dedication paperwork, with an rate of interest that sometimes “steps up” on a quarterly foundation over the course of the bridge mortgage.

Securities Demand

The securities demand provisions within the bridge price letter give the banks the suitable to demand that the borrower concern a excessive yield bond to refinance the unpaid bridge mortgage. As soon as the borrower and the banks fulfill the situations of such demand, the banks in principle acquire full management of the timing and construction of the long-term financing.

The securities demand provision is often exercisable by the banks upon the expiry of a vacation interval following the closing of the acquisition (or doubtlessly previous to the deadline). As soon as accessible to train this provision, the banks can “power” the borrower to go to market with everlasting excessive yield bonds on the Cap rate of interest and on the phrases set out within the bridge price letter. If the borrower doesn’t adjust to the securities demand, then a “securities demand failure” may have occurred underneath the bridge mortgage, which leads to the mortgage instantly “terming out” into an prolonged time period mortgage (which can carry an rate of interest on the Cap price) which might be exchanged into change notes and the conversion price can be due. A securities demand failure will nonetheless not represent an occasion of default underneath the bridge facility settlement.

Key securities demand negotiating issues from the lenders’ perspective embody:

• Most significantly, the “Cap” rate of interest. It is a key time period included within the bridge price letter that determines the best rate of interest the borrower can pay within the everlasting financing and offers a sensible limitation to the banks’ train of the securities demand. If the Cap is just too low for the present market situations, then exercising the securities demand might end result within the banks needing to successfully cowl the hole between the Cap and the market price ensuing from poor market situations in the event that they wish to place securities above the Cap;
• Negotiate a ground to any potential authentic concern low cost (OID). Such low cost is often set at a 98% ground such that the problem worth is not going to be decrease than 98% from the par quantity of the bonds;
• Set up an affordable advertising interval for the excessive yield bond to encourage the borrower and banks to launch a excessive yield bond on an environment friendly timeline; and
• Present the banks with the suitable to reject the debtors’ request for a vacation interval earlier than the securities demand is initiated, or negotiate to shorten the vacation interval as a lot as doable.

One possibility that the banks can negotiate on the outset within the context of a securities demand is for sure “flex” within the bridge price letter, which permits banks to “flex”, or amend, sure phrases of the securities provided underneath a securities demand to facilitate the issuance of everlasting financing. Flex provisions might embody, however are usually not restricted to, forcing rate of interest will increase, restructuring low-cost senior secured loans to increased priced mezzanine loans or bonds, shortening or extending maturities of the mortgage tranches or tightening covenants. Nonetheless, any such flexibility is much less generally seen not too long ago within the European leveraged finance market.

Prolonged Time period Loans and Alternate Notes

As famous above, if the preliminary bridge mortgage phrases out both by reaching its one yr maturity or upon a failed securities demand, the bridge mortgage robotically (topic to very restricted exceptions similar to non cost of charges) is refinanced into prolonged time period loans, which have a maturity date equal to that proposed for the everlasting financing (i.e., the tenor of the excessive yield bond take out financing). At sure common intervals and topic to minimal issuance quantities, the lenders underneath the prolonged time period loans can change their prolonged time period loans for an equal quantity of change notes, that are privately held securities which have typical options of long run financing, similar to name safety and free transferability, and accrue curiosity on the Cap. The lenders additionally obtain the conversion or rollover price to compensate for the longer publicity to the credit score.

Advertising and marketing

Within the European leveraged finance market, bridge loans are sometimes not syndicated to different establishments and there’s a strict limitation on transferability of such bridge loans, that are relaxed for prolonged time period loans and fall away for change notes. Subsequently, the funding banks funding the loans will maintain the commitments till the excessive yield bond providing is completed (both previous to the closing of the M&A transaction, wherein case the bond is issued into escrow, or after the closing of the M&A transaction, wherein case the underwriting banks may have funded the bridge mortgage and can be repaid with the proceeds of the bond).

Preparation for the excessive yield providing will due to this fact kick off as quickly as doable following the signing of the sale and buy settlement for the M&A transaction, to allow the bond providing to launch as quickly as doable. excessive yield bonds are issued pursuant to Rule 144A / Regulation S underneath the US Securities Act, so three years of audited financials, relevant interim financials, professional forma monetary data (if relevant), a fulsome providing memorandum and diligence of the goal firm can be essential to launch the excessive yield bond providing. Pre-commitment, the underwriting banks may have thought of the timing to market and availability of financials and may have factored extra timing constraints into their choice to underwrite by contemplating the issuer’s readiness to market.

What Occurs if the Bridge is Nonetheless in Place?

Bridge loans can, and are, funded. Nonetheless, the intention is that they’re excellent for as brief a time as doable.

If, resulting from market situations, it isn’t doable to keep away from drawing down on the bridge mortgage or, if the bridge mortgage is funded, a fast refinancing, underwriters might want to weigh whether or not to attend and keep within the mortgage, or doubtlessly worth the bond above the Cap, which might imply the banks could finally lose anticipated charges (or extra) from the transaction. If the banks are unable to position the excessive yield bonds at a suitable worth, a hung bridge mortgage happens. At this stage, the bridge mortgage has rolled over into an prolonged time period mortgage and/or change notes with an rate of interest set on the Cap. Within the present market situations, both of those choices are prospects.