A senior credit facility is a secured loan that takes precedence over unsecured “junior loans” provided by a lender. A senior secured loan is backed by collateral proffered by the borrower, which can be sold in the event that the borrower defaults on a loan payment or is unable to repay the full amount. The seniority of these facilities also dictates that should it go bankrupt, the borrowing company in question must repay this loan before any debt it has assumed.
Liens and Securities
The legal terms of a senior credit facility are typically negotiated through a credit facility contract, or what is termed a statutory lien. These liens simply verify a lender’s right to temporarily hold a borrower’s property as a type of security deposit. In the case of traditional term loans, this lien may take the form of real estate holdings or mortgages. However, in a corporate senior loan these liens typically take the form of a security or bond exchange. This is often referred to as a Non-Purchase Money Security Interest, since the lender holds interest in capital already owned by the borrower.
Generally, a senior credit loan will only be approved if a company can put up collateral that is not already bound by any other liens. In some stricter cases, senior secured loans will only be provided to a company who has no other existing liens on any assets whatsoever. These regulations are set to guarantee repayment on a loan and to reduce risk for lenders: lending institutions want to be sure they will not be competing with any other creditors over secured assets, in the event that the borrower should be unable to repay the loan as originally planned.
Senior credit facilities typically operate under a floating rate. This means that the borrower agrees to a loan rate that “floats” or adjusts across a base rates fixed by the bank, which will cause the loan rate to reset periodically to meet changing market values. These floating rate loans are more attractive to investors because their rate flexibility actually makes their value more consistent; that is, because they change with the market, they are less apt to be greatly affected by significant fluctuations in the economy.
Additional Provisions and Benefits
The strict collateral and security interest provisions dictated by the terms of a senior credit facility agreement sometimes stipulate not only that a senior loan must be repaid before all others, but also that cash profits and accrued capital must be used to repay loan principal before any other transaction. Despite these regulations, senior loan provisions can also be beneficial for the borrower. For instance, because these loans are privately negotiated, a certain amount of enhanced flexibility in terms of duration, loan caps, and interest rates is permitted.
Senior credit facilities benefit both lender and borrower, though their increasing popularity is largely due to their attractiveness as an investment for lending institutions. As “secured debt,” they pose a diminished financial risk to the creditor, who will be compensated by assuming ownership of the collateral in the event of loam default. In turn, the borrowers may receive better loan terms or higher loan amounts than would be granted in an unsecured credit facility.