Pro-Rata Tranche Definition

What is a pro rata slice?

A pro rata tranche is a portion of a syndicated loan that consists of two elements: a revolving credit facility, and a amortizing term loan. Prorated tranches are common in the leveraged loan market or in lending to already heavily leveraged businesses.

Within the pro rata tranche, the revolving line of credit will generally have the same end or due date as a term loan. Prorated tranches have always been much larger than institutional tranches in terms of dollar amount.

Key points to remember

  • A pro rata portion is a portion of a syndicated loan that contains a revolving credit facility and an amortizing term loan.
  • Prorated tranches are common in the leveraged loan market.
  • The pro rata tranche spreads the debt among several banks, which significantly reduces the potential credit risk of each lender.

Understanding a Prorated Slice

Syndicated loans

A syndicated loanalso known as syndicated bank easeis financing offered by a group of lenders, called union— that work together to provide funds to a single borrower. The borrower can be a corporation, a large project or a sovereign government.

The loan may involve a fixed amount of funds, a line of credit, or a combination of both. Syndicated loans arise when a project requires too large a loan for a single lender or when a project needs a specialist lender with expertise in a specific asset class.

The leveraged loan

A leveraged loan is a type of loan granted to companies or individuals who already have considerable amounts debt or a poor credit history. Lenders consider leveraged loans to carry a higher risk of defaultand therefore a leveraged loan is more costly for the borrower.

Default occurs when a borrower cannot make any payments for an extended period. Leveraged loans for highly indebted businesses or individuals tend to have higher interest rates than conventional loans; the increase in interest reflects the higher level of risk associated with issuing the loans.

Most leveraged loans are structured and syndicated to accommodate two main types of lenders: banks (domestic and foreign) and institutional investment firms. Thus, leveraged loans consist of prorated debt (the prorated slice) and institutional debt.

Investors in pro rata loans are mainly banks and other finance companies. Prorated tranche loans allow borrowers to withdraw funds, repay them, and then withdraw again. Investments in institutional loans, which for the most part are term loans-to understand structured financial products, bonds secured by loans (CLO)and mutual funds, among other investment vehicles.

Features of the Pro-Rata Slice

In business and finance, pro rata translated from Latin to mean “in proportion”. In this context, pro-rata refers to a process where whatever is allocated will be distributed in equal shares. Thus, the pro rata tranche distributes the debt among a number of banks proportionately, thereby significantly reducing the potential loss to each lender or credit risk. This is seen as favorable to the syndication of credit institutions.

The pro rata tranche is generally made up of working capital the lenders who hold a proportionate share of the revolving credit facility and the shorter-maturity amortizing term loan. Typically, these investors are actively engaged in lending activity, and the sizes (dollar amount) they hold in a particular loan are relatively large compared to their institutional counterparts.

Risk inherent in the Pro-Rata Tranche

Investing in leveraged loans is more inherent risk than many other investments, including actions. Because of this risk potential, the pro rata tranche is characterized by a hands-on approach, which often subjects the borrower to stricter monitoring and oversight.

An economy experiencing a contraction in its institutional markets would tend to have a little risk averse lender mentality. Thus, investors in this economy, particularly in the middle market— might feel more comfortable with a smaller, more active lending group, as opposed to the heavily syndicated, large institutional investor-led leveraged loan market of the 1990s, for example.