Highly Leveraged Transaction (HLT)

What is an HLT?

A highly leveraged transaction (HLT) is financing provided to a company that already carries a large amount of debt. HLTs are commonly used to fund buyouts, acquisitions, or recapitalizations. They increase a borrower’s overall leverage and compensate lenders with higher interest rates because of the elevated risk.

Key takeaways

• HLTs are loans or financing arrangements to companies with substantial existing debt.
• Typical uses include leveraged buyouts (LBOs), acquisitions, and recapitalizations.
• Lenders demand higher interest and stronger covenants to offset increased default risk.
• HLTs often involve debt restructuring and may result in lenders obtaining equity stakes.

How HLTs work

HLTs usually involve adding new debt to an already-leveraged balance sheet. Common features:
* Purpose: proceeds are used for buyouts, acquisitions, or recapitalizations.
* Structure: the transaction often restructures existing liabilities and creates a layered debt capital structure (senior and subordinated debt).
* Investor return: higher interest spreads and tighter covenants help compensate lenders.
* Outcome: in many deals lenders end up with an equity stake or other recovery mechanisms if the borrower struggles.

HLTs are similar in risk profile to junk bonds and sometimes include high-yield debt issuance as part of the financing. Compared with pure high-yield bond transactions, HLTs often have stronger debt covenants because of the negotiated loan structure.

Risks

• Increased default risk and financial distress for the borrower.
• Unfavorable debt-to-equity and debt-to-assets ratios.
• Complexity in debt servicing and covenant compliance.
• Potential loss of control or dilution if lenders convert claims to equity during restructuring.

Regulatory guidance and benchmarks

U.S. banking regulators (Office of the Comptroller of the Currency, Federal Reserve Board, and FDIC) provide supervisory guidance to help banks identify and manage HLT exposure. A loan is typically considered an HLT when it meets a combination of conditions such as:

• Proceeds are used for buyouts, acquisitions, or recapitalizations.
• The transaction substantially increases post-financing leverage, measured by metrics like:
• Balance sheet leverage (total liabilities/total assets) rising above roughly 50% or increasing by more than 75% in some benchmarks.
• Operating leverage measures (e.g., debt-to-EBITDA or senior debt/EBITDA) moving above defined industry thresholds.
• A roughly twofold increase in liabilities is often used as a practical benchmark.
• The borrower is non-investment-grade with a high debt-to-equity ratio.
• Loan pricing reflects non-investment-grade risk (a notable spread over a reference rate such as LIBOR or other market benchmarks).
• Transactions can be designated as HLTs by the syndication agent.

The guidance is supervisory, not a binding regulation. An often-cited “high-water mark” is around 6× debt-to-EBITDA for the restructured entity, but this threshold has been exceeded in practice; ultimately the market determines what debt levels can be financed.

Considerations for lenders and borrowers

For lenders:
* Perform rigorous due diligence on cash flows and recovery prospects.
* Negotiate strong covenants and priority structures.
* Price the loan to reflect default and recovery risk.

For borrowers:
* Assess sustainability of increased leverage and contingency plans.
* Understand covenant restrictions and potential dilution or loss of control.
* Factor in higher borrowing costs and refinancing risk.

Conclusion

Highly leveraged transactions enable corporate transactions that might otherwise be unaffordable but concentrate risk on both borrowers and lenders. Proper structuring, disciplined underwriting, and clear contingency planning are essential to manage the elevated default and restructuring risks inherent in HLTs.