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Corporate Banking 101: Term Loans, Bridge Loans and Letters of Credit

This article is part of a series on Corporate Banking

The corporate bank falls within the investment banking division of financial institutions that have a balance sheet (meaning they make their own loans).

Next we turn to the corporate banks other core product: Term Loans.

In our last article, we talked about the revolving credit facility as an important  loss leader product in the corporate bank.

Term Loans

Term Loans are loans in which the borrower draws the entire facility up front, incurs interest, and repays the full balance at the end of the term.

Borrowers usually take on term loans to fund capital expenditures, refinancing debt, general operating activity, M&A, and recapitalizations.

Unlike the revolver, term loans are a lucrative credit product for corporate banks as the whole commitment amount is drawn and therefore earns strong lending returns.

Once a portion of the term loan is repaid, it cannot be redrawn, so the bank’s capital is no longer at risk.

Pricing is largely the same as the revolver, with term loans receiving a drawn margin on top of a benchmark rate, which may be LIBOR or the Prime Rate.

Other Corporate Banking Products

While term loans and revolvers are the most common products offered by the corporate bank, they also provide clients with letters of credit and bridge financing.

Letters of Credit (Standby and Performance)

When a company promises to pay another company, the recipient may sometimes request a letter of credit to ensure that they will get paid.

A letter of credit is a letter from the bank promising payment will be made, providing backing from the bank, and effectively replacing the credit risk of the creditor / borrower with that of the bank.

Fees

Banks usually charge 50-75 bps for investment grade corporates and upwards of 100-150 bps for riskier companies, but can be reduced if certain actions are taken, such as cash collateralizing the letters of credit amount.

Bridge Financing

Sellers in M&A transactions often require that the buyer’s funding be secured as a condition to close, so buyers turn to banks to indicate they are committed to financing.

Since it often takes time to clear the regulatory hurdles and underwriting process for the bonds and other debt used in a deal, bridge financing is usually for interim funding for M&A transactions before more permanent capital is raised.

As such, bridge financing for M&A is not meant as permanent capital. Corporate banks do not want a “hung bridge”, where the bridge loan stays outstanding after being used to initially complete the purchase.

Bridge Financing Example

A company is looking to fund a $1 billion acquisition by tapping into the capital markets for $500 million of notes and $500 million of new equity, it may take advantage of a bridge loan while the investment bankers go to market to raise capital.

Bridge financing is attractive for corporate banks

Bridge loans are attractive for the corporate bank because there are fees associated with funding and margin when drawn – the bank’s capital is only briefly at risk as it is taken out by the permanent capital provided by ECM and/or DCM.

The fees on bridge loans are as follows:

  1. A commitment fee where the bridge lenders are paid on the size of the facility, whether the bridge is funded or not.
  2. A funding fee upon issuance of the bridge loan, for which the borrower may receive credit or a rebate if they pay down the loan quickly.
  3. Drawn fees for the time the drawn amount is outstanding. Unlike normal corporate banking term loans, bridge financing is meant to be paid down. Drawn fees ratchet up the longer the bridge is drawn, incentivizing the borrower to repay quickly.

Corporate Banking Series

  1. Ultimate Guide to Corporate Banking
  2. Corporate Banking 101: Revolving Credit Facilities
  3. Corporate Banking 101: Term Loans, Bridge Loans and Letters of Credit – You are here
  4. Corporate Banking 101: Corporate Banking 101: Key Lending Ratios
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