July 1, 2015
In 2014, total leveraged lending in the United States filled out to approximately $940 billion. A large portion of this market, roughly $340 billion in 2014, consisted of "Term Loan B" loans, driven by investors in non-traditional lending markets, particularly hedge funds, institutional investors and collateralized loan obligations (CLOs). As the market has matured, Term Loan B loans, once almost exclusively a US market phenomenon, have gradually established themselves in the European market and made inroads into new markets, particularly the Asian/Pacific markets.
For example, in 2014, Goodpack, Ltd., a Singaporean enterprise, became one of the first Asian/Pacific companies outside of Australia to access the US Term Loan B market to finance a $1.1 billion leveraged buy-out with $845 million in Term Loan B. While Australia has developed its own Australian Dollar Term Loan B markets, which have funded deals such as the Apollo-Leighton backed LS Newco, historically, Asian/Pacific leveraged lending markets have been dominated by bank lending. In Europe, over 30% of leveraged loans (by volume) were raised by European borrowers in the US markets during 2014. While credits have been growing in the US Term Loan B market for a few years now, as the European high yield bond market became stronger through 2014, the flexibility afforded by the US Term Loan B moved ahead as a credible alternative, regardless of whether the underlying credit had significant revenues or presence in the United States.
A Term Loan B product is a term loan made under a syndicated credit agreement or loan agreement which has minimal amortization, usually 1% per annum in quarterly payments, and a large bullet payment of the remaining principal balance at maturity. Generally bearing interest at a floating rate, a Term Loan B loans have a longer maturity of 6-8 years. When paired with a revolver with an earlier maturity or commitment termination date, a Term Loan B has a quality of simple structural subordination, i.e., the revolver is more likely to be repaid before the Term Loan B despite pari passu ranking. Pricing for Term Loan B tends to be higher than that for more traditional bank product term loans, with a portion of that pricing structured as original issue discount (OID).
The origin of Term Loan B’s name itself distinguishes it from these traditional bank products, the Term Loan A. Term Loan A refers to a term loan product with significant amortization, which requires the borrower to either de-lever or refinance in a few years, and a shorter final maturity of 4-6 years. Term Loan A usually has traditional bank covenant protection, including maintenance financial covenants.
Term Loan B loans almost invariably include call protection. A Term Loan B may have soft-call protection, with a prepayment premium paid with repayment, on a declining scale, typically a six to twelve month soft call at 101% for a first lien product. A second lien product may have 103% in year 1, 102% in year 2, etc., or a no-call and make-whole protection in the early years, and soft-call protection in later years. Increasingly in second lien Term Loan B investors require that such call protection applies to mandatory prepayments and payments of the Term Loan B after acceleration.
The Term Loan B product arose in the United States’ as the financial markets for high yield bonds and the financial market for term loans converged. A Term Loan B has some characteristics similar to a bond, i.e., a longer final maturity, and is conducive to remaining outstanding for a longer period of time. Like a high yield bond, a Term B loan does not place as much structural pressure on the borrower to de-lever or refinance. Non-traditional lenders which typically hold Term Loan B loans, such as CLOs and hedge funds, receive a financial stream of payments and yield suitable for their investment models.
As the market for Term Loan B has matured, Term Loan B terms and high yield terms have tended to further convergence. In 2014, covenant-lite accounted for $240 billion of Term Loan B issuances. Covenant-lite loans have no maintenance financial covenants which require the periodic testing of negotiated financial tests versus financial tests that only need be satisfied upon the incurrence of debt or the making of a restricted payment or investment. This structure brings the financial behavior of the Term Loan B even closer to that of a high yield bond, which customarily only includes incurrence tested financial covenants, and other covenant flexibility appropriate for an instrument with a long life to maturity.
The Term Loan B covenant-lite structure provides more flexibility with restricted payments and investments, more flexibility with the incurrence of additional debt and more flexibility with acquisitions. Other Term B Loan covenant-lite concepts often include "unrestricted subsidiaries" which are excluded from covenants and EBITDA and other financial calculations, and asset sale covenants which generally permit sales so long as the sale is made at market value, a portion (usually 75%) of the consideration is paid in cash, the cash proceeds are applied to repay the Term B Loan or other secured financing, and the ability to reclassify debt incurrences under incurrence tested and basket permitted debt.
Each of these features means little need for direct discussion or negotiation with the lender syndicate over time as circumstances change for the borrower. This of course includes circumstances where performance is deteriorating. In the absence of maintenance covenants, insufficient liquidity to make required interest and principal payments and failure to deliver required financial statements may be the only events that will necessarily trigger a default.
While the same covenant-lite loan document may include a revolver that has the benefit of a maintenance financial covenant (which may be "springing" — i.e., only apply if a significant portion of the revolver commitment is used) and a Term Loan B, this maintenance covenant will be structured to protect only the revolver. When the maintenance covenant is tripped, the default is only a default in respect of the revolver; the Term Loan B is often only tripped by "cross-acceleration" if the revolver is declared due and payable.
Where the Term Loan B market finally heads in 2015, with half the year elapsed already, is hard to say. In Europe, for example, as US pricing has increased and European documentation has begun to catch-up with US terms, we anticipate 2015 may see a move back towards more traditional European loans. That said, given the liquidity in the lender market and new issuer markets circling the product, in the US at least the Term Loan B is certain to continue as a bedrock of the non-investment grade leveraged loan markets.
 Source: Thomspon Reuters LPC.
 See IFR Asia, Singapore loan house, May 28, 2015, http://www.ifrasia.com/singapore-loan-house/21177512.article. Asia leveraged loans liquid despite US sell-off, September 2, 2014, http://www.financeasia.com/News/389661,asia-leveraged-loans-liquid-despite-us-sell-off.aspx.
 See Financial Review, Welcome to the $A TLB Market, May 6, 2015, http://www.afr.com/street-talk/welcome-to-the-a-tlb-market-20150505-ggu7op.
Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Global Finance practice group, or the authors:
Stephen Gillespie – London (+44 (0)20 7071 4230, firstname.lastname@example.org)
J. Eric Wise – New York (+1 212-351-2620, email@example.com)
Amy Kennedy – London (+44 (0)20 7071 4283, firstname.lastname@example.org)
Please also feel free to contact the following leaders and members of the Global Finance group:
Thomas M. Budd (+44 (0)20 7071 4234, email@example.com)
Gregory A. Campbell (+44 (0)20 7071 4236, firstname.lastname@example.org)
Aaron F. Adams (+1 212-351-2494, email@example.com)
Bruce D. Bolander (+1 212-351-2362, firstname.lastname@example.org)
Joerg H. Esdorn (+1 212-351-3851, email@example.com)
Darius Mehraban (+1 212-351-2428, firstname.lastname@example.org)
Janet Vance (+1 212-351-3854, email@example.com)
Andrew W. Cheng (+1 213-229-7684, firstname.lastname@example.org)
Linda L. Curtis (+1 213-229-7582, email@example.com)
Cromwell Montgomery (+1 310-551-8744, firstname.lastname@example.org)
Richard Ernest (+971 (0)4 318 4639, email@example.com)
Patricia Tan Openshaw (+852 2214 3868, firstname.lastname@example.org)
Lisa A. Alfaro (+55 (11) 3521-7160, email@example.com)
Saptak Santra (+65 6507 3691, firstname.lastname@example.org)
Jamie Thomas (+65 6507 3609, email@example.com)
© 2015 Gibson, Dunn & Crutcher LLP