3  Banking the Deal

Rob Sherr

 

I'm not doing this for love!
Unnamed banker during negotiations with producer for a loan

 

 

Introduction

It is very important to recognize the bank's role in the deal. In many respects the role is simple, although accommodating a bank into the financing structure can be complex. The reason lies with the bank's chosen position as provider of senior debt finance. In simple terms, this means that the bank is prepared to lend strictly on the basis that it expects to be fully repaid, without facing any unreasonable risk and, in doing so, to receive a small return on its cost of capital.

This approach influences the bank's attitude towards distribution agreements, its reliance upon the completion guarantee, its attitude towards co-financiers and its cautious approach to calculating its interest reserve. Practically, this also often results in the bank being the last to put in its funding and the first to be repaid.

Getting the bank to the stage where it is prepared to lend can be somewhat tortuous, but I hope that this chapter will provide some clues to help the process along.

Getting to the Term Sheet

Putting together the finance of a film can be likened to completing a jigsaw puzzle. However, most often there is no picture on the front of the box to illustrate how the final puzzle should look. For all the parties, it is therefore important to obtain the terms of the deal on offer. This, at least, will give an outline of the picture and will help identify areas of conflict that will need to be resolved.

As far as the bank is concerned, at the term sheet stage you are not seeking a commitment but an understanding of what will be required. Accordingly, the amount of information required by the bank is not vast but will include the following:

  • background of the producer;
  • budget;
  • finance plan;
  • synopsis;
  • details of director, key cast, production crew;
  • details of completion guarantor;
  • details of co-producers;
  • deal memos on pre-sales;
  • details of sales agent;
  • sales estimates.

This information should allow the bank to issue a term sheet. The term sheet will not offer a commitment to provide the finance, but it will indicate a willingness to consider providing a facility and will set out the terms upon which the bank is prepared to take the deal forward. The detail provided within the term sheet will vary from bank to bank but should include the details below as a minimum.

  • Amount — this will also confirm the currency in which the facility is to be made available. The amount will incorporate the allowance made by the bank for its financing costs (see below).
  • Purpose — financing the production costs of the film.
  • Arrangement fee — this may vary depending on the security offered to the bank.
  • Interest rate — this will be a margin above cost of funds. The cost of funds is typically expressed as LIBOR (the London Interbank Offer Rate) and is the rate at which banks lend to each other.
  • Security — this will include an assignment and charge over the film, an assignment of current and future distribution agreements, a completion guarantee and an assignment of the usual comprehensive insurance policies (including errors and omissions insurance). Other security may be required depending on the structure of the finance.
  • Other conditions — this will include the likely conditions precedent, the basis upon which the bank will calculate its interest reserve and the basis upon which distribution agreements will be discounted for security purposes. These are expanded upon below.

From Term Sheet to Cash Flow Forecast

The term sheet should provide sufficient information to enable the financing structure to proceed. Within the financing plan, an assumption will have been made as to the amount of bank debt required and the term sheet will indicate whether sufficient funds can be raised from the bank, given the security (collateral) that is to be made available. The key determinates of this will be as follows.

The acceptability of the distribution agreements

Banks will tend to split distribution agreements into three categories:

  1. Primary collateral — these will be with counterparties of undoubted standing and will include all the US Major Studios. It may be that a lesser counterparty is prepared to support its payment obligation with a letter of credit. A letter of credit transfers the obligation to pay to a bank and in most cases this will be considered primary collateral. Other conditions will apply, such as the completion guarantor adopting the contract, the contract being properly assigned and payment being due without any set off. Banks will lend up to 100 per cent of the face value of this collateral.
  2. Secondary collateral — these will be with acceptable counterparties of lesser standing. In addition to the conditions mentioned within primary collateral, contracts will only be deemed to be acceptable provided a signature payment of 20 per cent has been paid. Banks will lend up to 50 per cent of the remaining value of this collateral.
  3. Tertiary collateral — these will be contracts that are not considered acceptable. Banks tend not to apply any value to these contracts although they will form part of the bank's security.

Other acceptable security

At the time of writing (March 2004) there is an active market in providing advance funding on the net producer benefit arising outof a UK sale and leaseback agreement. Some banks are prepared to look at these agreements in the same way as they look at distribution agreements and it may be possible to obtain up to 100 per cent of the estimated net producer benefit. The principal conditions applying will be: the issuance of preliminary approval of co-production status by the Department for Culture, Media and Sport (if applicable) and appropriate wording within the completion bond to mitigate the British Qualifying risk. The legislation relating to films with a budget under £15,000,000 is due to expire in July 2005.

The calculation of the interest reserve

An interest reserve is the reserve set aside by the bank to meet the financing costs of the facility it is making available. The size of this reserve is critical as this money will not be available for any other production cost. It is an expense not covered by the completion guarantee (save where the completion guarantor has requested an accelerated draw down of the facility) and the bank will therefore adopt a cautious approach when calculating the figure. The following factors will be taken into account.

A. Timing of the draw down

The Bank may be required to draw all the money down on day one and place these funds into a production escrow account. In this instance, interest will accrue on the borrowing throughout the term of the production and until it is repaid. Most often, however, the loan is drawn down during the production period. The dates upon which the loan is to be drawn down will be pre-agreed and approved by the completion guarantor.

In view of the fact that the completion guarantee does not become effective until all the money has been advanced to the production (that is, the strike price has been met), the bank will usually insist that its money goes in last. This is advantageous to the producer as the interest will be lower as a result.

B. Cost of funds

This is the cost to the bank of making the finance available and is typically expressed as LIBOR, the London Interbank Offered Rate. LIBOR is available in all major currencies and the rate is fixed everyday in London at 11.00 h. Each draw down under the loan will be fixed for a period (usually 1 or 3 months) at the LIBOR rate that applies on the day. The LIBOR rate can be fixed in advance through financial hedging instruments but this has a cost, as a non-returnable premium is payable. Most often, therefore, the rate is not hedged but, to protect itself from increases in the LIBOR rate, the bank will build an anticipated increase into the interest reserve calculation, typically of 2 per cent.

C. Interest margin

The interest margin is the rate that is applied above LIBOR and represents the bank's return on its loan. The rate will vary depending upon the perceived risk of the transaction to the bank. In the event that the contract being discounted is a major studio agreement, the studio may insist that the interest margin does not exceed a maximum figure.

D. Repayment date

The bank will look at the very worst-case scenario in estimating the final repayment date. Accordingly, an assumption will be made that the full force majeure and arbitration periods allowed for in the completion guarantee will be required. A further period will then be added to recognize any likely delays in the distributor meeting its payment obligation. Roughly speaking, 180 days may be added to the delivery date as part of the interest reserve calculation.

E. Foreign exchange

It may be that whilst you have a distribution agreement in one currency, you may need to spend the funds in a different currency. In such circumstance, there will be an exchange risk. The example below illustrates this.

Pre-sales totalling US$5,000,000 have been made.

The exchange rate between US dollars and sterling is 1.65.

The production is being shot in the UK with the budgeted cost, including interest, of £3,000,000, which the bank is prepared to lend.

18 months later the film is delivered.

Bank borrowing stands at £2,950,000, representing an underspend of £50,000.

The bank receives US$5,000,000 from the pre-sales.

The rate between US dollars and sterling that day is 1.8.

The bank converts the dollars to sterling and receives £2,777,777, suffering a shortfall of £172,223.

To prevent this situation from arising, the bank will insist that the foreign exchange risk is covered. The example above is a simple one with three possible ways of hedging the exchange risk available.

1. The loan could be converted into dollars on day one. This has two potential disadvantages:

  • interest will be paid on the full advance from day one;
  • the LIBOR rate for US dollars may be higher than the LIBOR rate for sterling.

2. A forward foreign exchange agreement can be entered into to convert the sterling loan to dollars at an agreed date in the future. The disadvantages of this are:

  • the rate may be such that the amount available to spend in sterling is lower than the budget;
  • there is no certainty as to the date of repayment. This is not necessarily a major problem as a foreign exchange contract can be arranged so that it is exercisable between dates.

3. A series of forward foreign exchange agreements can be taken out to coincide with the dates upon which the loan is to be drawn down. This method is more complex than the other two but certainly represents the best solution when more than two currencies are involved.

The bank will be able to assist you with your decision.

F. Legal cost contingency

The bank will hold an additional amount back in case it needs to make use of legal advice. The amount will tend to be influenced by the size and complexity of the transaction. This sum is in addition to any legal costs that will have been incurred in putting the facility in place.

From Cash Flow Forecast to Commitment

The cash flow will be recalculated many times and will not be finalized until the day of draw down.

In the meantime, the bank will have undertaken its due diligence upon all the parties to the transaction and, provided it is satisfied, an approach will be made to its credit committee to obtain commitment. Solicitors will be instructed and a loan agreement will be produced setting out in greater detail the terms that had previously been set out in the term sheet.

Conditions precedent

The loan agreement will incorporate a list of all the conditions that will need to be fulfilled before the loan can be drawn down. The length of the list will vary from transaction to transaction but typically will contain between 15 and 40 conditions. Below are some general headings into which these conditions fall and a brief explanation of some individual matters that will need attention.

  1. Account opening documents.The bank's account opening requirements must be fulfilled. These will include the completion of the application to open the account together with the mandate to operate the account, certain incorporation documents (e.g., Certificate of Incorporation and Memorandum and Articles of Association or partnership deed) and documents to identify the principals (shareholders or partners), executive officers (directors) and the authorized signatories.

    A word of warning: this sounds straightforward but banks are very particular about this documentation. Leave plenty of time to fulfil this condition, especially as this includes satisfaction of the individual bank's anti-money laundering procedures.

  2. Corporate governance documents.These will include incorporation documents (see above) and various resolutions.
  3. Security documents.These will include charges and assignments over the film and any distribution agreements, an interparty agreement, a collection agreement, a laboratory pledge holders agreement and a completion guarantee.
  4. Insurances.The bank will need to see evidence that it is a named loss payee under all the film insurances, including the production insurance, errors and omissions insurance and any third party liability insurance.
  5. Opinions.This will include an opinion letter on chain of title. It may also be necessary to obtain opinion on documents entered into by parties in other legal jurisdictions.
  6. Other.This will include such matters as receiving a final certified copy of the budget and cash flow, satisfaction of repayment of any pre-production facilities and may also include matters relating to specific types of lending such as advance financing of sale and leaseback.

All these conditions precedent have been met. There are some things that you can do that will help move matters along. Here are some simple tips.

  • Give yourself as much time as possible. A period less than eight weeks is definitely too short.
  • Ensure that the film rights are properly vested in the rights holding company.
  • Identify any potential conflicts early on and get them resolved.
  • Give early warning on any potential difficulties in meeting any of the conditions.
  • Ensure that you fully understand the requirements of the bank -don't be afraid to ask.
  • Encourage the solicitors acting to identify early on who is responsible for producing which document.
  • Encourage the creation of a conditions precedent schedule showing the status of each document and then its regular circulation.
  • Make sure your solicitor is driving the transaction forward and that all parties are communicating.

Closing Time

Once the bank's solicitor is satisfied that all conditions have been met, the loan can be drawn down. The bank will insist that certain payments are made out of the first draw down. These may include:

  • the completion guarantor's fees;
  • any payments to discharge finance provided for pre-production;
  • the bank's arrangement fee;
  • the bank's legal fees;
  • insurance fees.

After draw down, contact with the bank will lessen, although the bank will have certain monitoring requirements to ensure that theproduction of the film is on track. Not least of these is the provision of regular cost reports, with the bank's requirements usually matching those of the completion guarantor. The bank may raise certain questions but, generally speaking, as long as the cost reports are received in a timely manner they will let you get on with things, sit back, wait for repayment and look forward to the next deal.

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