Unitranche Loans

shutterstock_761319851A unitranche loan, as the name implies, is one tranche of debt that can replace the traditional two tiered (i.e. first-lien/second-lien, senior/subordinated or secured/unsecured) debt structure for highly leveraged companies. For those unfamiliar with this increasingly popular structure, here is our summary.

What they are

Structure: One tranche of debt that is split into “first-out” and “last-out” pieces. First-out debt typically includes a revolver and part of the term loan; last-out debt is everything else. To replicate the differentiated seniority of traditional deals, unitranche deals define trigger events during which first-out debt is paid before any payments are made to last-out debt. Typical trigger events include a missed payment, bankruptcy or financial covenant default, or acceleration or other actions by first-out lenders to exercise their rights.

Documentation: One credit agreement and one security agreement. In addition, if multiple investors will provide the debt, there is an additional agreement, the Agreement Among Lenders (“AAL”), which allocates interest and principal payments across the tranches and addresses other intercreditor issues. The borrower is not a party to the AAL.

Pricing: One blended interest rate. The AAL replicates the different yields and repayment terms of the traditional two-tiered deal by skimming borrower payments and allocating them from the first-out lenders to the last-out lenders.

Lenders: May be provided by a single lender (typically to companies with revenues between $10 and $50 million) or by multiple lenders. Participants in this market include finance companies, business development companies, and hedge funds.  Some banks also provide unitranche structures.

Voting and exercise of remedies: Highly negotiated and vary significantly deal to deal. They are specified in the AAL. Last-out lenders are often allowed to exercise secured lenders’ remedies if the first-out lenders fail to exercise them within a certain period.

Buyout rights: Last-out lenders often have the right to buy the first-out debt under certain circumstances. These may include any event of default or may be more limited, such as those that trigger the override of normal pari passu payments to direct more cash to first-out debt.

Advantages to the borrower

The main benefit to borrowers is simplicity. There is one (blended) interest rate, fewer documents, fewer parties with which to negotiate upfront pricing and terms, a single administrative and collateral agent, and one set of reporting requirements.

Other benefits may include lower legal expenses, quicker closing, less syndication risk, lower all-in cost, a more attractive amortization schedule, or less restrictive covenants.

Disadvantages to the borrower

Not all unitranche lenders are set up to provide revolvers. The revolver may be provided as part of the unitranche structure by a party unknown to the borrower or with whom the borrower has little contact. Alternatively, the borrower can arrange its own revolver, but this requires an intercreditor agreement between the revolver lender and the unitranche lender, complicating the unitranche agreement.

The unitranche structure creates a very different set of negotiating conditions for borrowers wanting to amend their financing, whether it’s to grow or because they’ve encountered problems. Unitranche lenders may be less likely to grant waivers and more likely to charge fees, exercise rights, and accelerate debt than traditional bankers.  The potential for these different approaches arises from two sources: the lenders’ business model and the lenders’ priority in the capital structure.

  • Relationship banks traditionally have a long-term view, a local presence, and a goal to obtain fee income from the client beyond the loan (e.g. from cash management, trade finance, etc.). This type of relationship has made banks more receptive to modifying loan agreements as the borrower’s situation changes.
  • Unitranche providers may be more interested in maximizing the value of a particular loan (i.e. with waiver fees, etc.) than in developing a multi-faceted relationship. In the case of multi-lender unitranche loans, the borrower may not know its lenders or have had any influence in selecting them.

In a traditional two-tiered structure, the bank is senior and secured and independent from junior lenders. The terms of the junior debt might create breathing space before these lenders can take action. In contrast, the unitranche lender might have provided or purchased the last-out debt itself. In addition, the voting or buyout provisions in the unitranche structures may give more negotiating leverage to last-out lenders than would be given to traditional unsecured, subordinated or second-lien lenders. Finally, because there is less legal precedent to guide interpretations of AALs, the unitranche lender may be less confident of how issues will be interpreted in the event of a bankruptcy, and that uncertainty might lead to less flexibility.

Should I choose a unitranche?

These are some questions borrowers should consider when comparing a unitranche proposal to a traditional structure:

Can all financing needs be met with a unitranche? If a borrower needs (now or in the future) a revolver or other additional financing, how will that be accommodated? How many lenders will be involved in the unitranche and how does the borrower feel about depending on unknown lenders?

What type of relationship does the borrower want with its lenders? Is it seeking a relationship through which it wants advice and/or the ability to grow with a lender, or is it just seeking capital?

How much future flexibility will the borrower need? What could go wrong over the course of the deal, and might the motivations of the different lender types and their different priority positions make a difference in the outcome of negotiations?

Which financing has the more attractive structure? How does the breakdown of first-out vs. last-out, the amortization schedule, prepayment terms and/or covenant package compare to available traditional financing proposals?

Which structure has lower all-in costs? Depending on the size and price of the different tranches, the blended cost of unitranche loans may be more or less than traditional structures.

By Elisa Holquist, Instructor, Financial Training Partners

2 Comments

  1. However, in a unitranche loan that does include call protection, because the loan is a single facility, the borrower cannot avoid paying a prepayment premium if it wishes to reduce its overall

    Reply
  2. In a unitranche facility, the borrower is not involved in and is typically not aware of the intercreditor arrangements governing the respective components of its loan. Because unitranche loans are typically provided by a single lender and are not generally traded, the intercreditor terms may be largely academic because the originating lender generally keeps the entire loan until maturity

    Reply

Submit a Comment

Your email address will not be published. Required fields are marked *