What Is a Highly Leveraged Transaction (HLT)?
Let me explain what a highly leveraged transaction, or HLT, really is. It's essentially a bank loan given to a company that's already loaded with a lot of debt. These became popular back in the 1980s as a method to finance buyouts, acquisitions, or recapitalizations.
Key Takeaways
- Highly leveraged transactions are financing deals for companies already deep in debt.
- They're used for recapitalizing, buying out, or acquiring companies.
- They come with much higher interest rates to make up for the extra risks from the heavy debt.
Understanding Highly Leveraged Transactions (HLTs)
You need to know that highly leveraged transactions carry risks because they pile on more debt to a company's existing load, often leading to a poor debt-to-equity ratio. But the high interest income makes them appealing to investors and banks anyway.
Think of HLTs as akin to junk bonds—sometimes junk bonds are even part of the package. Both have high default risks, but HLTs are a bit more secure thanks to stronger debt covenants in their setup. A classic example is a leveraged buyout, or LBO.
No matter the goal, HLTs usually involve restructuring the debt. That's because you have to handle the company's current debt for any shot at success. This often ends up with a messy debt structure including various subordinated debts. In the end, the lenders might get an equity stake in the restructured company.
Guidance for Highly Leveraged Transactions
Guidance on these comes from the U.S. Office of the Comptroller of the Currency (OCC), the Federal Reserve Board, and the Federal Deposit Insurance Corporation. The OCC sees an HLT as a deal where the borrower's leverage after financing—measured by debt-to-assets, debt-to-equity, or cash flow-to-total debt—far exceeds industry standards. For specific industries, they might use tailored metrics instead.
This guidance isn't a hard law. There's a sort of benchmark of 6 times debt-to-EBITDA for the restructured company, but it's been surpassed plenty of times. Ultimately, with HLTs, the real limit is whatever the market will accept.
Conditions for Defining a Loan as an HLT
- Proceeds are for buyouts, acquisitions, or recapitalizations.
- The deal causes a big jump in the borrower's leverage ratio, like doubling liabilities to over 50% balance sheet leverage, or more than 75% increase, or pushing debt-to-EBITDA above set levels.
- The syndication agent labels it as an HLT.
- The borrower has a non-investment-grade rating with high debt-to-equity.
- Loan pricing suggests non-investment-grade, often a spread over LIBOR that varies with the market.
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