Cash Sweep: a Worked Example

A fixed schedule forces a choice on a business whose earnings swing. Size the instalments for an average year and a poor year breaks them; size them for a poor year and the loan runs long, while the cash of the strong years goes somewhere else. Commodity processors, farms, miners and contractors all have this shape.

A sweep is the lender's way of getting both. The base instalments stay low enough to survive the trough. When the cycle turns up, a share of the surplus comes to the lender before it can be spent on a dividend, an acquisition or a new venture. The borrower gets a loan it can service in a weak year, and accepts that it does not keep all of a strong one. Sweeps are found in leveraged and project lending, and on term loans to businesses like these.

No accounting standard defines excess cash flow; it exists only in the loan agreement. The list above is one common form; each deal writes its own, and each line is negotiable. Several other terms decide the result. The percentage may step down as leverage falls, so the sweep eases once the loan is less stretched. A first slice of cash may be retained by the borrower before the percentage applies. Voluntary prepayments during the year are often credited against the amount due. The test usually runs annually, off the audited accounts, with payment due shortly after they are delivered, so cash from one year's trading leaves in the next.

The application clause then decides what the prepayment does. Applied in inverse order of maturity, it removes the last instalments and shortens the loan, but gives no relief next year. Applied pro rata, it trims each remaining instalment. Applied in order of maturity, it cancels the next ones. On a floating-rate loan the payment is usually timed to an interest date so that break costs do not arise.

A scrap-metal recycler, constructed for this page like every figure in it, has a US$30m term loan with scheduled principal of US$3m a year. The agreement sweeps 50% of excess cash flow after the borrower keeps the first US$1m. The percentage and the amount retained belong to the example and are not offered as a market norm. Three years, in US$m, with interest as charged:

The weak year paid nothing above its schedule, which is the design working. Each sweep is shown in the year that earned it; the cash would leave some months later. Over three years the sweep took US$3.95m, nearly a third more than a further year of instalments. The definition matters as much as the percentage. Here is year one under looser and tighter wording:

The cash actually left after everything in year one was US$3.70m. Under the fourth line the sweep takes US$2.85m of it, more than three-quarters. The business has less to fund the next rise in metal prices, and the working capital that grew in year one will still be there to finance. That is why the argument over what to deduct is usually where the value lies.

Amortisation is a fixed sum due whatever the year was like; a sweep depends on the year. A mandatory prepayment on an asset sale or insurance receipt is triggered by an event and takes those proceeds, and the excess cash flow sweep is often one line in the same clause. A distribution lock-up stops cash being paid out while a ratio is weak but leaves it in the business; a sweep takes it away.

The word also has an unrelated use. A cash-management sweep moves balances between a group's accounts each day, as in zero-balancing, and repays nothing. Project finance adds its own version, often triggered by a ratio or a target debt balance and set out in the agreement's waterfall, so a reader should check which is meant.

DEFINED IN ONE PARAGRAPH → · MANDATORY PREPAYMENT → · THE TERM LOAN FILE →

A sweep can be why a loan gets approved. A lender uncomfortable with the tenor can accept it if the strong years will shorten the debt in practice, and can show a committee the base case on the schedule and the upside as faster repayment. It can also be a way of agreeing, in advance, how a business in a hard season will pay back extra room, which is how a farm's support after a price fall may be repaid.

A credit reader should check that the model and the document say the same thing. A forecast that assumes a sweep on one definition will be wrong under another. The lender should also resist counting on the sweep to make a weak loan acceptable, since a sweep pays only when there is surplus. The borrower, for its part, should test the clause in the strong year it hopes for: if the sweep takes the cash needed for the next capital project or a rise in working capital, it may come back asking for what it has just repaid, and term debt once swept usually cannot be redrawn.