What Is a Highly Leveraged Transaction (HLT)?
A highly leveraged transaction (HLT) is a bank loan to a company that has a large amount of debt. They were popularized in the 1980s as a way to finance buyouts, acquisitions, or recapitalizations.
- Highly leveraged transactions are financing arrangements extended to companies that are already deeply in debt.
- Highly leveraged transactions are undertaken for the purpose of recapitalizing, buying out a company, or even acquiring another company.
- Highly leveraged transactions pay the financiers much higher rates of interest to compensate them for the additional risks posed by the large debt load.
Understanding Highly Leveraged Transactions (HLTs)
Highly leveraged transactions are risky in that they add to a company's debt load and often result in an unattractive debt-to-equity ratio, but the interest income generated from these transactions is significant enough to make them attractive to investors and financial institutions.
Highly leveraged transactions are thought of as being similar to junk bonds—and junk bonds may well be issued as part of the deal structure. Both junk bonds and highly leveraged transactions face significant default risk, but HLTs are more secure because they have stronger debt covenants due to their structure. Leveraged buyouts (LBOs) are an example of a highly leveraged transaction.
Highly leveraged transactions often include some type of debt restructuring regardless of what the intention is for the financing. This is simply because the existing debt levels of the company must be dealt with for any chance of future success. The end result is usually a complicated debt structure with several types of subordinated debt. In the restructured entity, the lenders behind the highly leveraged transaction often end up with an equity stake in the new enterprise.
Guidance for Highly Leveraged Transactions
Guidance for highly leveraged transactions is set out by the U.S. Office of the Comptroller of Currency (OCC), the Federal Reserve Board, and the Federal Deposit Insurance Corporation. The OCC broadly considers a highly leveraged transaction as one where the borrower’s post-financing leverage, when measured by debt-to-assets, debt-to-equity, and cash flow-to-total debt significantly exceeds industry norms for leverage. Depending on the particulars of the industry in question, customized industry metrics can be substituted for these broader measures.
For a loan to be defined as an HLT, it generally has to fit some combination of the following conditions:
- Proceeds used for buyouts, acquisition, and recapitalization.
- The transaction results in a substantial increase in the borrower’s leverage ratio. Industry benchmarks include a twofold increase in the borrower’s liabilities, resulting in a balance sheet leverage ratio (total liabilities/total assets) higher than 50%, or an increase in the balance sheet leverage ratio of more than 75%. Other benchmarks include increasing the borrower’s operating leverage ratios (debt-to-EBITDA or senior debt/EBITDA) above defined levels.
- Transactions are designated as an HLT by the syndication agent.
- The borrower is rated as a non-investment-grade company with a high debt to equity ratio.
- Loan pricing indicates a non-investment-grade company. This generally consists of some spread over the London Interbank Offered Rate (LIBOR) that fluctuates as a function of market conditions.
The guidance on highly leveraged transactions isn't a legal regulation. There is an implied high-water mark of 6 times debt-to-EBITDA for the restructured entity, but this amount has been exceeded many times. With highly leveraged transactions, as with almost everything, the limit is what the market will buy.