Volatile credit markets and guarded banks have made securing term loan C (TLC) debt attractive for borrowers who heavily rely on letters of credit to trade but either have low credit ratings or otherwise have difficulty accessing large enough revolving facilities to support the high amount of letters of credit needed.
A uniquely positioned product, TLC proceeds are used to fund cash collateral accounts that support letters of credit—a letter from a bank guaranteeing that a seller of goods or services will receive payment in full and on time, even if the buyer defaults. Letters of credit are particularly important for facilitating international trade, giving buyers and sellers in different countries with differing legal frameworks the confidence to transact.
Although TLC debt is an established product, it has grown especially important for companies now, given the challenging macroeconomic backdrop. As liquidity has tightened and more companies have seen credit ratings downgraded, TLC debt has become a viable option for banks to provide highly levered companies with letters of credit when required.
Structure, terms and pricing
TLC facilities are similar to term loan B (TLB) debt and are broadly syndicated to institutional investors through the same channels as TLBs. TLC loans also have similar pricing, maturity and covenants, and most of the investors and banks holding a company’s TLB debt will usually hold a portion of its TLC debt too.
Amortization schedules and the use of proceeds are where the two products differ. TLB proceeds can be used in various ways, including for refinancing, acquisitions and general corporate use. TLC debt, however, may only be used to provide collateral for letters of credit. Since TLCs are specifically raised to provide cash collateral, which must be available in an account to support letters of credit, they also do not amortize whereas TLBs will amortize at around 1% per annum.
In the event of mandatory prepayments (provisions in loan agreements obliging borrowers to prepay a portion of a debt when certain events occur, such as excess cash flow, asset disposals, new debt incurrence, or equity issuance), prepayments would be applied to the TLB tranche first—prepayments of the TLC tranche will not be made until the TLB tranche is paid off.
Companies emerging from distress
In addition to helping companies with lower credit ratings secure letters of credit, TLC loans are also a crucial part of the capital structures of companies coming out of restructuring, bankruptcy and other distressed situations.
Even when companies can restructure and stabilize, they may still find it difficult to secure letters of credit from hesitant banks when emerging from a period of distress. But if there is cash sitting in an account, serving as collateral, it becomes easier for banks from a risk and credit quality perspective to issue letters of credit to these borrowers.
As a higher volume of companies encounter distress—according to S&P Global figures quoted by Forbes, there were more than 230 corporate bankruptcy filings in the US in H1 2023, more than double the number of filings during the same period in 2022 and the highest number of bankruptcies for any comparable period since 2011—TLC debt will become an attractive option for businesses that are able to restructure and recover. For example, earlier this year, Talen Energy Supply successfully secured exit financing that included a TLC, as noted in its Chapter 11 plan of reorganization.
A US-based power generation and infrastructure company, Talen owns and operates approximately 12.4 GW of high-quality power infrastructure in the US. In addition, it is developing a hyperscale data center campus adjacent to its Susquehanna nuclear plant.
The company’s exit financing included a US$700 million senior secured revolving credit facility, a US$580 million senior secured TLB credit facility and a US$470 million senior secured TLC credit facility.
With markets braced for a sustained period of elevated interest rates and liquidity constraints, TLC financing is likely to continue to play an important role for companies exiting bankruptcy, and for stable but highly levered borrowers in sectors where international trade and letters of credit are key for sustaining earnings.
