A highly leveraged transaction (HLT) refers to a bank loan granted to a company already carrying an exceptionally large amount of debt. In the United States, the Office of the Comptroller of the Currency defines highly leveraged transactions very simply as bank loans to a company with a debt to equity ratio that significantly exceeds industry norms.
A highly leveraged transaction (HLT) refers to a bank loan granted to a company already carrying an exceptionally large amount of debt.
Highly leveraged transactions are commonly used for mergers and acquisitions, recapitalization, business expansions, and debt restructuring.
HLTs may also occur in relation to loans made to individuals – most commonly, mortgage loans.
Understanding Highly Leveraged Transactions
Highly leveraged transactions are commonly used for mergers and acquisitions or for recapitalization or debt restructuring. They are also sometimes used by companies needing to make substantial capital expenditures to expand their business, either by introducing new product lines or by moving their business into new markets (such as establishing operations in a foreign country).
HLTs became immensely popular during the 1980s when there was a surge in M&A deals. Many companies used highly leveraged transactions to acquire other companies, with lenders assuming that the additional revenues resulting from the acquisition would enable the acquirer to pay back its debt successfully.
Highly leveraged transactions are attractive to lenders because the loans made carry high interest rates according to the increased risk that the lender is taking on. Interest rates for highly leveraged transactions are typically floating rates specified as a premium over a major benchmark interest rate, such as the prime rate in the United States or the London Interbank Rate (LIBOR) in the United Kingdom.
As of 2019, the Colgate-Palmolive Company (NYSE: CL) was one of the most highly leveraged companies in the world – owing approximately $70 for each $1 that it held. Nonetheless, because the company is considered overall very financially sound and unlikely to fail altogether, lenders were willing to extend more than $1 billion in further capital to Colgate-Palmolive to acquire the European skincare company, Laboratoires Filorga Cosmetiques.
How Lenders Handle Highly Leveraged Transactions
Lenders do not commonly make loans to companies already burdened with a large debt load without recognizing the risk involved and, therefore, structuring the loan in such a way as to reduce the risk.
First, lenders typically require that the company applying for the loan do a total debt restructuring that includes the new capital to be loaned. Second, the lender usually requires certain covenants to be applied to the loan, such as the company maintaining certain levels of financial ratios such as its debt-to-equity ratio or cash flow-to-debt ratio.
Also, the lender often receives a substantial equity stake in the company to which it is extending the loan. The equity stake may be in the form of shares, stock warrants, or other stock options. All of the requirements are usually included with a requirement of significant collateral for the loan.
Personal Highly Leveraged Transactions
Highly leveraged transactions also exist in the area of personal loans, usually in the form of second mortgages or home equity loans made to individual homeowners who already own a sizable home mortgage. In such cases, the key metric is the homeowner’s income-to-debt ratio or their assets-to-debt ratio.
Even if the homeowner’s income to debt or assets to debt ratio is already high compared to norms or will become high with the additional loan, a lender may be willing to extend the additional loan if, for example, they believe the homeowner will be able to sell their home for more than an adequate amount to repay all of their outstanding debt.