Stretched Senior Debt and Equity Loans

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Stretched senior debt tends to be provided by a single lender as part of a loan arrangement, designed to leverage more debt with numerous ‘layers.’ These types of loan are similar in their nature to mezzanine finance in that they are a hybrid of two forms of debt. In this case, it is a mixture of an asset based loan and a cashflow based loan. This means is that the loan is borrowed against two aspects of a business in a way that other loans such as bridging finance do not.

These loans are best suited to businesses and developers who have large asset bases (such as properties or other material, high value assets) and stable or predictable cashflows. They are also suited to the opposite; businesses with large cashflow but limited asset bases.

These stretch senior loans work by taking the very nature of a business into account and allowing them to secure the loan against the aspects of the business that allow for the greatest loan leverage in a way not necessarily available via other borrowing channels and forms of property finance. ‘Pure’ equity loans work by the borrower taking out a loan which is secured against a percentage of their assets. This may be in the form of a property, a portfolio of properties or in the case of mezzanine finance, their business [shares].

How Stretched Senior Debt Works

This debt is one of the most flexible types of loans available to borrowers. For example, a business that needs funding through the loan may be very well-established in their industry and may therefore over the years have built up a great deal of assets as part of a portfolio.

They may only have a limited cashflow for all nature of reasons; perhaps because the money is tied up in another part of the business. Therefore, they may be able to use proof of a positive flow of capital [cash] into the business as part of the security for the loan. However, this alone is not enough as the risks are very high for the lender.

Whilst there are very strict criteria for the borrower to meet, proving future positive cashflow into their business and showing very clear profit margins to cover the debt, if there is not enough positive capital and they default on the loan, the lender can be hundreds of thousands of pounds out of pocket.

To reduce this risk to an acceptable level and only if the borrower has a sufficient asset base, the lender may include a clause in the agreement that uses part of their asset base as collateral for the loan, along with expected cashflow.

Businesses with Limited Assets

For businesses where cashflow is significant and stable but where they are light on assets, these stretch senior loans can also be taken out. In these cases, the company will not have the assets required to cover the full security needed for the loan. Therefore, they must make a solid case to the lender stating a strong projected cashflow which is enough for them to repay the loan.

Through regular payments to the lender, the borrower can quite quickly pay back the cashflow based portion of the loan and this is usually done over the course of a year or two. This is done to minimise the risks to the lender of the cashflow-based portion not being repaid. Once the initial portion secured against future projected cashflow is repaid, the loan simply uses the agreed asset(s) as security for the remainder of the loan.

Why Companies Use Stretched Senior Debt

Although this type of debt comes with higher risks than traditional property finance or development finance it has good reason to be used. These loans are ideal for businesses that need a large injection of capital, for example to purchase a development as part of their expansion but where they do not have a large enough asset base to finance a loan and secure it against as part of the arrangement with the lender.

Traditionally, these types of borrowers would not be able to get a loan with their limited available collateral. The major benefit of these stretched senior loans is that they provide a substantially higher amount of capital up front than asset only or cashflow only loans. Loans where there is a degree of asset security provide a greater degree of flexibility that those secured purely on cashflow alone and therefore, these loans are usually preferable to cashflow only loans which may also be available.

Stretch Senior Loans – Why Are They Important?

These loans are used for both commercial and residential development projects and may sometimes provide as much as 70% of the Gross Development Value (GDV). However, the criteria are very strict and it is crucial that the borrower shows an acceptable level of risk to qualify for the loan in the first place.

When a business is in a strong position but at a point that they need an injection of capital, used to grow and expand further, these loans can provide the all-important answer and solution. There are fees involved with this type of debt such as legal fees, arrangement fees and sometimes exit fees and these should all be accounted for when applying for these loans.

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