Highly confident letter

What Is a Highly Confident Letter?

A highly confident letter is a non-binding document issued by an investment banking firm or other financial institutions to indicate that it is highly confident it can arrange the necessary debt financing for a transaction. This letter is typically provided in the context of corporate finance deals, such as mergers and acquisitions (M&A) or leveraged buyout (LBO) offers³⁵, ³⁶. While it expresses a strong belief in the ability to secure funding, a highly confident letter does not constitute a legal commitment or guarantee that the financing will be provided³³, ³⁴.

History and Origin

The concept of the highly confident letter gained prominence in the 1980s, primarily popularized by Drexel Burnham Lambert (DBL) and its influential financier, Michael Milken³². During this era, DBL developed a reputation for its ability to raise substantial amounts of capital quickly, particularly through the issuance of high-yield debt, commonly known as junk bonds³¹.

The highly confident letter was first notably used in 1983 during Carl Icahn's attempt to acquire Phillips 66²⁹, ³⁰. Drexel's lead investment banker on the deal, Leon Black, suggested that Drexel issue a letter stating its high confidence in raising the necessary debt. This approach allowed corporate raiders to proceed with significant takeover bids without having all the financing fully committed upfront, leveraging Drexel's market-making capabilities in junk bonds. The effectiveness of the highly confident letter, despite its lack of legal enforceability, was rooted in Drexel's formidable reputation for arranging large-scale financings²⁸.

Key Takeaways

• A highly confident letter indicates an investment bank's strong belief in its ability to arrange transaction financing.
• It is a non-binding statement and does not guarantee the provision of funds.
• The letter became prominent in the 1980s, particularly associated with Drexel Burnham Lambert and Michael Milken.
• It is often used in large corporate transactions like mergers, acquisitions, and leveraged buyouts.
• This document serves to reassure target companies or sellers that an acquirer can likely secure the necessary funding.

Interpreting the Highly Confident Letter

A highly confident letter should be interpreted as a strong indication of an investment bank's intent and capacity to raise funds, rather than a definitive promise. It signals that, based on current market conditions and the bank's assessment, securing the required financing is probable²⁷. Companies considering an offer supported by a highly confident letter will typically evaluate the reputation and track record of the issuing financial institution. While it offers a degree of assurance, it necessitates further due diligence into the financing structure and market receptiveness²⁶. The letter provides psychological leverage in negotiations, particularly in competitive bidding scenarios, by suggesting the financial viability of a proposed transaction²⁵. It is often requested by the board of directors of a target firm when evaluating a proposed takeover²⁴.

Hypothetical Example

Imagine "Alpha Corp," a publicly traded company, wants to acquire "Beta Innovations." Alpha Corp approaches "Global Financial Partners" (GFP), a renowned investment bank, to help arrange the substantial securities and loan financing needed for the acquisition. Due to the rapid pace of negotiations and the need to present a credible offer quickly, GFP issues a highly confident letter to Alpha Corp.

In this letter, GFP states that based on its analysis of Beta Innovations' financials and the current credit market, it is "highly confident" it can structure and syndicate a $1.5 billion financing package, consisting of a credit facility and the issuance of high-yield bonds. This letter allows Alpha Corp to formally submit its acquisition proposal to Beta Innovations' board, demonstrating its serious intent and perceived ability to fund the deal, even before all lenders and investors are fully committed.

Practical Applications

Highly confident letters are primarily used in contexts where significant [capital] is required for large-scale transactions, and speed or strategic positioning is crucial. Their practical applications include:

• Mergers and Acquisitions: In competitive M&A scenarios, particularly hostile takeover attempts, an acquirer can present a highly confident letter to demonstrate its ability to finance a bid without having all financing fully committed²³. This can provide an edge in a bidding war.
• Leveraged Buyouts (LBOs): Private equity firms seeking to acquire companies using a significant amount of borrowed money may use a highly confident letter from an investment bank to show potential sellers that they can secure the substantial debt required for the LBO²².
• Tender Offers: A bidder initiating a tender offer for a target company's shares may include a highly confident letter to assure shareholders and the target's board that the necessary funds for the purchase will be available²¹.
• Market Signaling: The letter can serve as a market signal, influencing the perception of a deal's likelihood of closing. While non-binding, the backing of a reputable financial institution can instill confidence among investors and stakeholders¹⁹, ²⁰.
• Interim Financing Steps: When there isn't enough time to secure a full, legally binding commitment letter from lenders, a highly confident letter can be used as an interim step to move forward with an acquisition agreement¹⁸.

Limitations and Criticisms

Despite their utility in facilitating complex transactions, highly confident letters carry significant limitations and have faced criticism:

• Non-Binding Nature: The most critical limitation is that a highly confident letter is not a legally binding commitment to provide financing¹⁶, ¹⁷. The investment bank is not obligated to provide the funds, and if market conditions change or issues arise during final syndication, the financing may not materialize. This introduces a substantial risk management concern for the recipient.
• Reputational Reliance: The effectiveness of a highly confident letter largely depends on the reputation of the issuing bank¹⁵. If the bank's standing or ability to raise funds is questioned, the letter's value diminishes.
• "Putting a Company into Play": A key criticism is that the relatively low cost and incentive for an investment banker to issue such a letter might enable insincere bidders to "put a company into play"¹⁴. This means a bidder could initiate a takeover attempt, potentially manipulating the target company's stock price, without a firm commitment to complete the acquisition, creating market uncertainty and disruption for the target company and its shareholders¹³.
• Lack of Specificity: While it expresses confidence, the letter typically lacks the detailed terms and conditions found in a formal commitment letter, which can lead to ambiguities or unexpected hurdles during the actual financing process. An academic paper on financial contracting highlights that such discretionary contracts, while fostering reputation, impose no legal obligation on the promisor¹².
• Market Shifts: Changes in economic conditions or investor sentiment between the issuance of the highly confident letter and the attempt to secure firm financing can significantly impact the ability to raise the promised funds¹¹.

Highly Confident Letter vs. Commitment Letter

The primary difference between a highly confident letter and a commitment letter lies in their legal enforceability and the stage of the financing process at which they are issued.

A highly confident letter is a preliminary, non-binding statement from an investment bank expressing confidence in its ability to arrange financing. It is typically issued early in a transaction process when a bidder needs to demonstrate financial credibility but firm commitments have not yet been secured⁹, ¹⁰. It is not a promise to lend and carries no legal obligation for the issuer to provide the funds.

In contrast, a commitment letter is a legally binding agreement in which a lender formally commits to providing a specific amount of financing under defined terms and conditions⁷, ⁸. It is typically issued later in the process, after extensive due diligence and internal credit approvals, and closer to the closing of the transaction⁶. A commitment letter obligates the lender to provide the financing, subject to the satisfaction of outlined conditions.

FAQs

Is a highly confident letter a guarantee of financing?

No, a highly confident letter is not a guarantee of financing. It is a non-binding statement of belief from an investment bank that it can arrange the necessary funds, but it does not create a legal obligation to provide those funds⁴, ⁵.

Why would a company accept a highly confident letter instead of a commitment letter?

Companies might accept a highly confident letter when speed is essential, particularly in competitive M&A situations or hostile takeover bids. It allows an acquirer to present a credible offer without waiting for the more time-consuming process of securing a legally binding commitment letter³. The reputation of the issuing financial institution plays a significant role in its acceptance.

Who issues a highly confident letter?

A highly confident letter is typically issued by an investment banking firm or another financial institution that specializes in arranging large-scale debt financing for corporate transactions¹, ².