Structuring Corporate Loans

for

Small and Middle Market Companies

Chris Droussiotis

2013

Table of Contents

1. Corporate Loans – an overview (Small and Middle Market transactions in the U.S.)

2. Market Overview in the U.S.

3. Loan Terms and Conditions (Money and Non-Money terms)

4. Credit and RAROC Loan Analysis

5. Marketing and Structuring a primary syndicate/club deal with other banks

6. Structuring a Loan: Debt Capacity, Leverage, Coverage and Collateral analysis

7. Case Studies for Debt Capacity using Cash Flow and Asset Coverage

8. Lecturer’s Biography

1

U.S. Corporate Loans – An Overview

Two Markets Served

2

Investment Grade Loan Market

• Rated BBB- and Higher (Corporate)

• Arrangers hold Higher Exposure ($200 million +)

• The majority of the Syndicate are traditional banks

Leveraged Loan Market

• Rated BB+ and Lower (Corporate)

• Arrangers hold Lower Exposure – thus the need to syndicate

• Leverage Ratios (Debt/EBITDA>3.0x)

Large Cap Market (Rated)

EBITDA > $100mm

Middle Market (Rated/NonRated)

$5mm > EBITDA < $100 mm

Small Business (Non-Rated)

$200,000 > EBITDA < $5 mm

U.S. Middle Market Loan Overview

3

$26.7

$38.7

$41.3

$34.5

$11.9

$17.2

$12.5

$26.0

$34.8 $34.2

$28.7

$8.0

$5.3

$11.4

$14.3

$9.9

$2.8

$0

$10

$20

$30

$40

$50

In B

illio

ns

Institutional Pro Rata

Total New-Issue Volume ($2.75B)

18.7%

14.2%

13.7%

7.4%

7.3%

7.1%

6.7%

6.7%

6.5%

5.6%

3.1%

1.5%

0.7%

0.7%

0% 5% 10% 15% 20% 25% 30% 35% 40%

Computers & Electronics

Gaming & Hotel

Services & Leasing

Chemicals

Oil & Gas

Insurance

Food & Beverage

Retail

Home Furnishings

Healthcare

Metals & Mining

Manufacturing & Machinery

Restaurants

Transportation

Total Year 2012

Total New-Issue Volume ($9.88B)

LBO32%

Refinancing25%

Other6%

Recap/Equity Infusion

2%

Corp Purpose5%

Recap/Dividend7%

Recap/General Recap

4%

Acquisition18%

EBITDA of $50 million or Less

L+0

L+100

L+200

L+300

L+400

L+500

L+600

L+700

Pro Rata Institutional

U.S Small Business Loan Market Overview

4

Typical Leveraged Deal Term Sheet / Credit Agreement

1. Parties to the Credit Agreement:

Borrower

Holding Company

Guarantor / Parent and Subsidiaries’ Guarantee

Agent Banks (for middle market deals)

Administrative Agent

Collateral Agent

Syndication Agent

Documentation Agent

Law Firms representing the Borrower and Agent Banks

2. Description of the Transaction / Purpose of the Loan (s) – Use of Proceeds

5

3. Money Terms:

Amount / Tranches

Revolving Credit / Line of Credit

Term Loans

Equipment Loans

Real Estate Loans

Pricing

Interest Rate / Margin over LIBOR/Prime

Commitment Fees on unfunded portion

Maturities (months/years)

Amortization Schedule (set principal payments) / monthly mortgage like payments (P+I) for Small Loans and Quarterly for Middle Market Loans

Collateral

In a middle market, the company needs 100% Vote from the syndicate banks to amend these terms

Typical Leveraged Deal Term Sheet / Credit Agreement (Continued)

6

4. Non-Money Terms:

Financial Covenants

Negative Covenants

Affirmative Covenants / Management Covenants

Need Majority Vote (typical 51%) from the syndicate banks to amend these terms

Typical Leveraged Deal Term Sheet / Credit Agreement (Continued)

7

Typical Financial Covenants

Typical Negative Covenants

Maximum Leverage Ratio (Total Debt / EBITDA)

Maximum Senior Leverage Ratio (Bank Debt / EBITDA

Minimum Coverage Ratio (EBITDA / Interest

Minimum Fixed Charge Ratio (EBITDA – Capex – Taxes ) / Interest + Principal Payments)

Maximum Capital Expenditures

Minimum Tangible Net Worth

Maximum Total Liabilities to Tangible Net Worth (Small Business Loans)

Limitations on Additional Debt

Limitations on Asset Sales / Mergers & Acquisitions / Sale/leaseback transactions

Limitations of Dividends / Investments

Limitation on Liens / Negative Pledges

Excess Cash Sweep

Limitations of Change of Ownership

Typical Leveraged Deal Term Sheet / Credit Agreement (Continued)

New Terminology in 2006 and 2007:

Covenant Lite Structures (“Covy lite”)

Incurrence Tests Vs Maintenance Tests

8

Typical Leveraged Deal Term Sheet / Credit Agreement (Continued)

5. Other Terms & Conditions:

Security / Liens / Guarantees

Borrowing Base

Mandatory Prepayments

Optional Prepayments / Call Protection

Financial Reporting / Maintaining Corporate Existence (“Affirmative Covenants”)

Representation and Warranties

Conditions Precedent at Closing

Events of Default

Assignments and Participations / Secondary Sales

Waivers and Amendments

Indemnification

Cross Default

Material Adverse Clause (MAC)

9

Other Terminology to the Credit Agreement

LIBOR Floor

Original Issuer Discount (OID)

Margin Spread

A typical calculation of Loan Yields in the secondary market for loans:

LIBOR or LIBOR Floor + Margin Spread + (100-OID)/4* years = Loan Yield

*market convention is to use 4 years as it represents the average life

Example:

LIBOR Floor = 1.00%

Margin Spread = 400 basis points (or 4.00%)

OID = 98

Then the Loan Yield is calculated to:

1.0% + 4.0% + [(100 – 98)/100]/4 = 5.0% + (2.0% / 4) = 5.0% + 0.5% = 5.5% Yield

Typical Leveraged Deal Term Sheet / Credit Agreement (Continued)

10

Underwritten deal

Best-efforts syndication

Club deal

Types of Loan Syndication Formats for Middle Market Deals

11

Underwritten deal

Arrangers guarantee the entire commitment, then syndicate the loan to reduce their exposure.

If the arrangers cannot fully subscribe the loan, they are forced to absorb the difference.

Reasons for Arrangers to underwrite:

• Offering an underwritten loan can be a competitive tool to win mandates.

• Underwritten loans usually require higher fees New Terms:

• “Flex Language” • Memorandum of Understanding (MOU)

•Balancing between holding and syndicating exposure •For preferred customers, the banks tend to hold higher exposure justifying it by additional products offered going forward (an important variable in the banks’ profitability calculations (RAROC), though given the size of the facility, the banks’ are phased with the dilemma of successfully syndicating and holding their exposure.

Types of Loan Syndication Formats for Middle Market Deals (Continued)

12

Best-efforts syndication

The Arranger commits to underwrite less than the entire amount of the loan.

If the loan is undersubscribed, the deal may not close unless the terms/pricing/structure are changed.

Best-efforts syndications were used for risky borrowers or for complex transactions.

As in the case of underwriting, for preferred customers, the banks tend to hold higher exposure justifying it by additional products offered going forward (an important variable in the banks’ profitability calculations (RAROC).

Types of Loan Syndication Formats for Middle Market Deals (Continued)

13

Club deal

Pre-marketed to a group of issuer’s or equity sponsor’s relationship lenders.

Typically a smaller loan (usually $25 million to $200 million but as high as $500 million)

The arranger is generally a first among equals, and each lender gets a full cut of the fees.

For preferred customers, the banks tend to hold higher exposure justifying it by additional products offered going forward (an important variable in the banks’ profitability calculations (RAROC).

Types of Loan Syndication Formats for Middle Market Deals (Continued)

14

Typical Internal Analysis Process by each bank

Internal Application sent to their respected investment/credit committees. This application includes the following:

Requested amount that is within the rating parameters for each bank Recommended amounts by Tranche (Revolving Credit / Term Loans) Term and Conditions of the Loans (includes pricing, structure and covenants) Profitability (RORA and RAROC) Syndication strategy Transaction discussion including Source and Uses and Capital Structure Company discussion including historical performance and outlook Corporate Structure Management Biographies / Equity Sponsor Profile Collateral Analysis Industry Analysis Financial Analysis (Projections’ Model) Internal Rating Analysis

Internal Legal Review

KYC (know-your-customer) and Compliance Review

Internal Application for Approval Process

15

This process will be discussed following this page

Typical Internal Rating Analysis by each bank

Most banks’ internal ratings are in line with the Agencies’ external ratings, though the analysis is done independently. This analysis is based on two approaches:

Quantitative Analysis Qualitative Analysis

Risk Assessment Analysis

16

The Quantitative Analysis for establishing the Internal rating which measures the probability of default is based on the following parameters (each component is weighted at a specific level of importance):

Leverage Ratio - the relationship between debt and earnings (i.e. DEBT / EBITDA)

Capitalization Ratio – the relationship between the bank debt and the rest of the capital (Capital Leases, Bonds, Equity)

Coverage Ratio - Issuer’s Cash Flow covering it’s debt obligations (interest and principal payments)

Variance of Projections – based on the projections, the model typically assumes a certain haircut (10-30%) to the management’s projections and it tests it’s ability to pay its debt obligations.

The Quantitative approach adjusts up or down based on industry characteristics (Recession resistance, cyclical, or event driven).

The Qualitative Analysis is subjective based on each bank’s internal policy. The Analysis would include strength of management, support from the equity sponsor, recovery analysis (asset collateral) and outlook.

The Typical Scale is 1-10, 1 being with very limited risk to default and 10 the issuer being in bankruptcy with no chance of recovery

Structuring a Loan – Small Business

Debt Capacity, Leverage, Coverage and Collateral analysis

17

Terms & Conditions:

1. Loan Amounts: SBA 7a – Up To $2,000,000.002. Loan Amounts: SBA 504 – Up To $5,000,000.003. Interest Rate: Prime Rate + Spread Which Is Adjusted Quarterly4. Term: Maximum 25 Years Amortization5. LTV (Loan To Value): Up To 90%6. Debt Coverage: 1.20x7. Assumption: Yes8. Recourse: Yes9. Minimum 30 day closing but probably longer10. Down Payment: 10%-20% on acquisitions11. Borrower must occupy at least 51% of the property12. Minimum FICO Score Of 65013. Minimum Loan Amount: $500,000.00

Structuring a Loan – Small Business

Three Factors determining Eligibility for SBA loan

18

1. Loan to Value Different SBA lenders and different SBA loans have different equity requirements. Many loans require the borrower to retain 10 to 20 percent of the equity in the business.

2. Personal Guarantees Many SBA loans call for personal guarantees. Some of the guarantees bind the borrower's personal credit to the loan; others call for the borrower to pledge personal assets to the loan. In some cases, SBA loans even require the collateral assignment of life insurance death benefits so that if the borrower passes away, the loan will be repaid.

3. Creditworthiness Contrary to popular belief, SBA loans are not for borrowers with poor credit or no business plan. The borrower must posses a valid business plan, good credit and committed capital in the business.

Structuring a Loan – Middle Market (Case Study)

Debt Capacity, Leverage, Coverage and Collateral analysis

19

LBO OpportunityAres Venture Management Group (“Ares”) decided to purchase ABC hotel property and its land in Austin Texas for $10,000,000. In addition, Areas will spend $2,000,000 for Renovations including new furniture and equipment.

Capital Raising

Bank Debt: Amount of Loan: 3.0x ABC’s First Year’s EBITDA Interest Rate: LIBOR + 4.5%Term: 7 yearsSchedule Principal Payments:

Mezzanine: Amount of Loan: Up to 4.0x of ABC’s First Year EBITDA (Equity - not be less than 35% of total Capital)Interest Rate: 9.00%Term: 10 yearsSchedule Principal Payments: Years 1-9: $0 ; Year 10: The Balance

Equity: Ares’ equity contribution to the purchase will be 35% or up to total leverage of 4.0x dictated by the Mezzanine Loan requirements.

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 300,000 500,000 500,000 600,000 700,000 900,000 Balance

Structuring a Loan – Middle Market (Case Study)

Debt Capacity, Leverage, Coverage and Collateral analysis

20

COST OF DEBT CALCULATIONS

3M-LIBOR Assumptions

Loan Spread Initial All -In

0.50% 4.00% 4.50%

9.00%COST OF MEZZANINE NOTE CALCULATION

COST OF BANK DEBT CALCULATION(Floaring Rate)

COST OF EQUITY CALCULATIONS

6-year Treasury Note [ rf ] 1.95%Beta for Publicly Traded Hotel [ β ] 1.633xEquity Premium [ Pe ] 11.05%Firm Specific Risk Premium [e] 0.0%Cost of Equity 20.00%

E (re) = rf + β . Pe + e

ABC CompanyLBO Equity Analysis using CAPM

3 TRANSACTION SOURCES & USES

4

Sources:

Debt Capacity

(EBITDA x)Amount % Capital

Expected Return

Expected Return

(After Tax)

WACC (After Tax)

EBITDA Multiple

5Bank Loan 3.0x 6,000,000 48.5% 5.607% 3.589% 1.74% 3.0x

6 Mezzanine Note 2,000,000 16.2% 9.000% 5.760% 0.93% 1.0x7 Total Debt 4.0x 8,000,000 64.7% 2.67% 4.0x8 Equity 4,360,000 35.3% 20.00% 20.00% 7.05% 2.2x9 Total Sources 12,360,000 100.0% 9.73% 6.2x10

11 Uses:

1st Year'sEBITDAMultiple

Amount

% of Total Uses

WACD = 4.132%

12 Puchase of Property 10,000,000 13 Renovation 2,000,000 First Year's EBITDA = 2,000,000 14 6.0x 12,000,000 97.1% Tax Rate= 36.0%15 Transaction Fees & Expenses 3.0% 360,000 2.9%16 Total Uses 12,360,000 100.0%

Structuring a Loan – Middle Market (Case Study) - (Continued)

Debt Capacity, Leverage, Coverage and Collateral analysis

21

18 DEBT ASSUMPTIONS & RETURN ANALYSIS

19 Bank Loan Information Debt IRR Terms 1 2 3 4 5 6 720 Amount Outstanding (End of Year) 6,000,000 5,700,000 5,200,000 4,700,000 4,100,000 3,400,000 2,500,000 - 21 Schedule Principal Payments 7 years 300,000 500,000 500,000 600,000 700,000 900,000 2,500,000 22 Interest Payment (Calc based on last Year's Outs) 5.61% 270,000 285,000 286,000 305,500 266,500 221,000 162,500 23 Total Financing Payment 5.607% (6,000,000) 570,000 785,000 786,000 905,500 966,500 1,121,000 2,662,500 24 Interest Rate 4.50% 5.00% 5.50% 6.50% 6.50% 6.50% 6.50%25 LIBOR RATE 0.50% 0.50% 1.00% 1.50% 2.50% 2.50% 2.50% 2.50%26 LIBOR Rate Increase Assumptions 0.00% 0.50% 0.50% 1.00% 0.00% 0.00% 0.00%2728 Corporate Bond Information29 Amount Outstanding 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 30 Schedule Principal Payments 10 Years - - - - - - - 31 Interest Payment (Calc based on last Year's Outs) 9.00% 180,000 180,000 180,000 180,000 180,000 180,000 180,000 32 Total Financing Payment 9.000% (2,000,000) 180,000 180,000 180,000 180,000 180,000 180,000 180,000 3334 Total Financing 750,000 965,000 966,000 1,085,500 1,146,500 1,301,000 2,842,500 35 Total Debt Outstanding 7,700,000 7,200,000 6,700,000 6,100,000 5,400,000 4,500,000 2,000,000

Structuring a Loan – Middle Market (Case Study)

Debt Capacity, Leverage, Coverage and Collateral analysis

22

CASH FLOW & EQUITY RETURN ANALYSIS

Company Projections Operating Entry Year Year 1 Year 2 Year 3 Year 4 Year 5 Exit YearAssump. 0 1 2 3 4 5 6 7

Revenues 5.00% growth 4,000,000 4,200,000 4,410,000 4,630,500 4,862,025 5,105,126 5,360,383 Cost of Revenues 35.0% % of Revenue (1,400,000) (1,470,000) (1,543,500) (1,620,675) (1,701,709) (1,786,794) (1,876,134) Operating Costs 15.0% % of Revenue (600,000) (630,000) (661,500) (694,575) (729,304) (765,769) (804,057) EBITDA 50.0% 2,000,000 2,100,000 2,205,000 2,315,250 2,431,013 2,552,563 2,680,191 Less Depreciation 3.00% % of Revenue (120,000) (126,000) (132,300) (138,915) (145,861) (153,154) (160,811) Less Amortization of Fees 7 years (51,429) (51,429) (51,429) (51,429) (51,429) (51,429) EBIT 1,828,571 1,922,571 2,021,271 2,124,906 2,233,723 2,347,981 2,519,380 Less Interest (Unlevered for DCF Analysis) - - - - - - - EBT 1,828,571 1,922,571 2,021,271 2,124,906 2,233,723 2,347,981 2,519,380 Less Taxes (adj out Interest Exp) 36.0% % of EBT (658,286) (692,126) (727,658) (764,966) (804,140) (845,273) (906,977) Plus Depreciation & Amortization 171,429 177,429 183,729 190,344 197,289 204,582 160,811 Less Working Capital 1.00% % of Revenue (40,000) (42,000) (44,100) (46,305) (48,620) (51,051) (53,604) Less Capex 3.00% % of Revenue (120,000) (126,000) (132,300) (138,915) (145,861) (153,154) (160,811) Cash Flow Before Financing (CFBF) 1,181,714 1,239,874 1,300,942 1,365,064 1,432,391 1,503,085 1,558,799

Less Financing ( P + I ) (750,000) (965,000) (966,000) (1,085,500) (1,146,500) (1,301,000) (2,842,500) Equity Cash Flows 431,714 274,874 334,942 279,564 285,891 202,085 (1,283,701)

Terminal Value EBITDA Multiple Method (initial purchase multiple)Growth 6.0x 15,315,379

Perpetuity Method (using WACC + growth) 3.50% 9.73% 25,025,580

Average Terminal Value 20,170,479

Debt Outstanding 4,500,000 Equity Value (TV - Debt) 15,670,479

Equity Cash Flows (4,360,000) 431,714 274,874 334,942 279,564 285,891 15,872,564

x x x x x x$ 1 PV Table (Expected Equity Rate) 20.00% 0.8333398 0.6944552 0.5787172 0.4822680 0.4018931 0.3349135

PV Table (Expected Equity Rate) 6,310,149 359,765 190,888 193,837 134,825 114,898 5,315,937

Initial Investment (4,360,000) NPV= 1,950,149

IRR= 28.6%

Structuring a Loan – Middle Market (Case Study)

Debt Capacity, Leverage, Coverage and Collateral analysis

23

Collateral Analysis

Advance Rates (ABL

Facility)

BV of Assets($ mm)

Debt Capacity based on Colateral

4 Cash 100% 50.00 50.00

5 A/R 85% 200.00 170.00

6 Inventory 50% 150.00 75.00

7 Fixed Assets 50% 300.00 150.00

8 Investments 50% 100.00 50.00

9 Total 800.00 495.00 Debt Capacity

101112 Cash Flow Analysis (Debt Capacity)1314 0 1 2 3 4 5

15 Assumptions16 Revenue 5.00% 100.0 105.0 110.3 115.8 121.6 127.6 17 CoGS 65.00% (68.3) (71.7) (75.2) (79.0) (83.0) 18 Oper. Exp. 10.00% (10.5) (11.0) (11.6) (12.2) (12.8) 19 EBITDA 26.3 27.6 28.9 30.4 31.9 20 Less Capex 5.00% (5.3) (5.5) (5.8) (6.1) (6.4) 21 Less Cash Taxes (% of EBIT) 40.00% (12.6) (13.2) (13.9) (14.6) (15.3) 22 Less WC 2.00% (2.1) (2.2) (2.3) (2.4) (2.6) 23 CFADS 6.3 6.6 6.9 7.3 7.7

2425 Terminal Value (based on EBITDA) 6.0x 191.4 2627 PV 157.9 6.3 6.6 6.9 7.3 199.1

28 Inerest Rate (Cost of Funds) 8.00%2930 Cushion 20.00%31 Debt Capacity 126.31 32 Leverage 4.8x3334 * Adj for Depr = same as Capex

24

Chris Droussiotis, MBA, C.H.E.

Chris Droussiotis has twenty five plus years of banking experience working in the investment banking divisions of major New York money center banks, such as Bank of America, CIBC Oppenheimer, Sumitomo Mitsui Banking Corp., Mitsui Nevitt Merchant Bank, Mizuho Financial Group and Bank of Tokyo-Mitsubishi, specializing in the financing and structuring of merger & acquisition, leveraged buyout and recapitalization transactions.

Chris is currently an Executive Director and the Head of the Leveraged and Sponsor Finance Group at Sumitomo Mitsui Banking Corporation managing a $1.4 billion investment portfolio of leveraged loan investments.

Duties include portfolio analysis, valuation, financial projections, credit assessment, as well as interaction with issuers, broker-dealers, investment banks, Private Equity firms and bank management.

Prior to his banking career, Chris taught mathematics and business statistics at FDU’s Sullivan Business School in Rutherford, NJ. He holds a B.Sc. in business, an MBA from FDU’s Sullivan School of Business, was credit trained at Bank of America, and completed advanced professional development courses in corporate taxation at New York University.

Chris is also an Adjunct Professor of certain finance courses for undergraduate and graduate programs at Baruch College and FDU including Investment Analysis, Quantitative Analysis in Business, Managerial Accounting, Business Statistics, Derivatives, Debt & Fixed Income Markets and Advanced New Venture Management.

Chris has given various lectures on various subjects including Leveraged Buyouts, Credit Markets, Capital Markets for Baruch College, as well as companies such as Cendant Corporation, Wyndham Worldwide, Travelocity and the Industrial Bank of Japan.

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BIOGRAPHY OF THE LECTURER