A negotiated term loan option where borrowers are able to request additional funds after the draw period of the loan's already closed
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A delayed draw term loan (DDTL) is a negotiated term loan option where borrowers are able to request additional funds after the draw period of the loan’s already closed. Draw term loans are structured with a maximum loan amount that can be accessed throughout a certain time frame, called a draw period.
The delayed draw period is an extended draw period, usually offered to borrowers with good credit ratings. Such loans differ from other loan types where the full amount is given all at once to the borrower.
Draw term loans allow borrowers to access funds throughout a draw period. A delayed draw term is negotiated between the borrower and the lender.
DDTLs are important financing tools for companies making acquisitions, purchasing capital expenditures, and refinancing debt.
DDTL loans are now common in the syndicated leveraged loan market, which has changed its structure by increasing its scope of uses and commitment length.
How are Delayed Draw Term Loans Structured
Delayed draw term loans include a “ticking fee” – a fee paid from the borrower to the lender. The fee amount accumulates on the portion of the undrawn loan until the loan is either fully used, terminated by the borrower, or the commitment period expires.
DDTLs also include an upfront fee, which is usually payable to the lender on the closing date of the loan. An upfront fee is a percentage of the loan amount, and the borrower ultimately will owe the full amount of the term loan to the lender at maturity.
Some DDTL upfront fees are paid on the occurrence of each DDTL funding date rather than a lump sum on the closing date. In such situations, the fee will be based on the portion of the loan already funded prior to the next funding date.
Benefits of Delayed Draw Term Loans
1. Lower interest payments
Delayed draw term loans benefit the borrower by enabling them to pay less interest. The draw period itself allows borrowers to request money only when needed; hence, they avoid paying interest on a lump sum of cash they may not use for many months.
2. More time to request additional funds
By extending the draw period, borrowers enjoy more time to request additional funds without the pressure of withdrawing a lump sum before their period deadline. The extended period allows for more flexibility around the loan use that accommodates the borrower’s changing needs.
Historically, delayed draw term loans existed mainly in the middle market, where lenders were comfortable holding longer-term commitments. They were arranged for borrowers who wished to secure a large loan capacity – often to finance an acquisition – but did not want to incur immediate debt or additional interest until they needed the funds.
Recently, with DDTLs migrating “upmarket,” they are being seen in the larger, syndicated leveraged loan market. The deals are now larger in size and offer longer commitment periods, helping ex[and the uses of delayed draw term loans.
DDTLs are now commonly used by large companies to complete numerous transactions in which they purchase capital assets, refinance debt, or to make multiple acquisitions.
Before the use of DDTLs expanded to include multiple purposes, they would typically be used to finance a single acquisition made known to the lender prior to the closing date of the loan. Hence, the commitment length of the delayed draw period would be set to match the closing of the acquisition in consideration. It would typically be three months, where the company was limited to one drawing of funds to consummate the acquisition.
With the recent widespread uses of DDTLs in multiple acquisitions, capital expenditures, refinancing loans, and other evolving purposes, commitment periods are significantly increasing. The average delayed draw period is now nine months, going up to as long as 18 months.
Lenders are also becoming more flexible by allowing for multiple draws of funds during the delayed period. The draws are permitted with a “good faith expectation” that the funds would be used for the agreed-upon reason.
Expanding uses of DDTL are also contributing to more negotiations over other traditional customs surrounding the loan. Now that loan proceeds are used for purposes other than acquisitions, lenders want to ensure the accurate representation of each loan use and the absence of payment default.
Also, with delayed periods coming with longer commitment lengths, lenders are pushing to remove any related maximum leverage ratio conditions. The presence of a maximum leverage ratio tends to limit the amount of debt a bank can hold in relation to its equity or capital. Due to increased flexibility surrounding DDTLs, the ability to comply with the ratio is made uncertain, and its importance is being reconsidered.
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:
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