Unitranche loans: how are they evolving?

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Unitranche loans: how are they evolving?

Annette Kurdian & Sam Lukaitis

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Unitranche loans: how are they evolving?│February 2015

Outline

1. What are unitranche loans?

2. Unitranche loans compared to other potential financing structures

3. What are the advantages/disadvantages of unitranche loans to borrowers? 4. Intercreditor issues:

a) The Intercreditor agreement: RCF/hedging v unitranche

b) The Agreement among lenders: “first out”/“senior” v “last out”/“junior”

c) other market approaches: joint venture arrangements and “dual tranche” unitranche loans

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What are unitranche loans?

 Background

• History: from the US to Europe

• Why are they relevant now? A source of liquidity in the mid-market as banks de-lever/adhere to liquidity and capital requirements imposed by Basel III

• Traditionally ACPs, but banks re-entering the market to invest alongside the unitranche providers (i.e. not just capex/RCF)

1. “Classic unitranche”

• Avoids senior/mezz – blended interest rate allows lenders to take individual risk positions and receive different economic rewards

• Risk/reward position – historically not disclosed to borrower (dealt with in “AAL”)

2. “Strategic unitranche”

• For more difficult credits

• Traditional lenders not as interested – a more expensive senior deal as no real

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What are unitranche loans? (cont.)

 Purpose

• Multi-purpose financing

• E.g. acquisition (Anesco, CRH, Big bus tours, Wireless logic)/refinancing (Trainline, KP1)/dividend recap (Amtek global technologies)

 Size? From small beginnings  financing mid-market deals

 Is there a market standard? A search for common themes

• Increasingly so, but the terms vary depending on lender/credit/debt advisers/competitive tension…and the type of unitranche

 Use in Europe: need to watch bank monopoly issues (e.g. France & Germany) but deals done using bond or fronting bank structures

 Key selling point of unitranche is its flexibility – positions evolve and bespoke covenant packages can be created…

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Unitranche: structuring

Unitranche facility Topco Bidco Shareholders’ agreement Covenant group Guarantee and security package Guarantee and security package RCF Hedging Target opcos Vendor

Financial sponsors Management

Target Parent Sale and purchase agreement “Senior” tranche

“Senior A” / “Junior B”

Intercreditor group Agreement among _lenders “Junior”

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Unitranche and other debt products: deal size

Source: Michael Dance (Senior Consultant), Grant Thornton

Possible funding options

Unitranche

Syndicated loan

Club loan

Bilateral loan

High Yield Bond

Asset-based Lending

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Unitranche: market sentiment

“

Bonds jostle with unitranche financing in cash-strapped European

middle market

”

(Financial Times, 8 October 2013)

“

Unitranche loans increase presence in Europe's leveraged market

”

(Reuters, 22 December 2014)

“

Chunky unitranches provide alternative route for slow syndications and

unique deals

”

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Unitranche and other debt products: features compared

Comparison of Key Features

Unitranche Senior/Mezz ssRCF/HYB

Size EUR 30–250m EUR 30–800m (Syndicated) EUR 150–800m (ssRCF a small % of capital

structure)

Leverage 5.0–5.5x 3.0–4.5x 4.0–6.0x

Speed 3–4 weeks (fast) 8 weeks (medium) 12 weeks (min.) (slow)

Flexible terms Yes: tailored to client Historically, tight covenants  but note cov lite/TLB

Incurrence covenants = operational flexibility

Cash retention Good (bullet repayment often without cash sweep / cash sweep + unitranche right to waive)

Historically, more restrictive: cash sweep and amortisation but note cov lite/TLB

Very good

Call protection Usually but negotiated Mezz only HYB only

Pricing More expensive than senior Dearth of mezz opportunities – query if overall slightly cheaper than unitranche?

Expensive for small issues but can be fixed rate

PIK / Equity / Warrants

Sometimes No for senior only (sometimes for mezz) No, but HY will sometimes have PIK

Distributions More flexible than senior/mezz Historically limited, but growing convergence with HY flexibility

Most flexible

Fees / Expenses Generally cheaper than senior/mezz Generally more expensive Expensive

Documentation Single loan agreement, ICA, “AAL” Two loan agreements, ICA RCF, HYB, ICA

Payment blocks Not usually but query if in “AAL” if US style?

Mezz typical payment blocks – 120 days No (unless subordinated HYB – 179 days)

Enforcement Unitranche lead subject to RCF/hedging step-in rights (3/6 months/insolvency?), but note “AAL”

Senior lead subject to mezz step-in rights (90/120/150 days)

HYB lead subject to RCF/hedging step-in rights (3/6 months/insolvency)

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Unitranche: what are the advantages and disadvantages

to Borrowers?

Advantages Disadvantages

 Speed of execution / deliverability  Sourcing working capital requirements / committed (but undrawn) facilities

 Flexibility (covenant package / structure often more bespoke so suits complex situations)

 Pricing (may be higher in the first couple years, but can apply cash to entire tranche of debt (incl. PIK) rather than just senior and less expensive debt)

 Lower debt service burden (bullet

repayment preserves cash for growth via acquisitions and capex)

 Transparency

 Simplicity of decision making (tighter lender group / relationship lending)

 Non-call (lock in returns for lost yield but subject to negotiation)

 Leverage – at least a turn / turn and a half higher than senior only (usually 5.0x-5.5x but have seen up to 6.0x)

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Unitranche: intercreditor issues (RCF/hedging v

unitranche)

 Ranking

• The approach now generally follows the European ssRCF/HY intercreditor position (i.e. pari but RCF/hedging “super senior” in relation to distribution of enforcement proceeds)

 Enforcement

• The approach now generally follows the European ssRCF/HY intercreditor position (i.e. unitranche control subject to RCF/hedging step-in rights – consultation?)

• “Material events of default”: non-payment, insolvency, financial covenant breach, information covenant breach, cross-default, negative pledge etc

 Voting

• RCF/hedging will have entrenched rights which cannot be amended/waived without their consent: e.g. enforcement regime, RCF acceleration provisions, “Material events of default”, certain other matters that go to the security package (given RCF/hedging’s super senior position)

 Option to Purchase

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Unitranche: “Agreements among lenders”

 Background

• The AAL is the document required to get from the unitranche facility (as set out in the credit agreement) to the underlying agreement that has been struck between the unitranche providers (“Classic unitranche”)

 Key Principle

• The “First out” or “Senior” unitranche lender receives a lower portion of the blended interest rate paid under the credit agreement in exchange for an enhanced

risk/security position

 Payments

• The US approach: (i) distribution of interest payments – “First out” take senior portion; (ii) prepayments rateable but post “waterfall trigger event” all payments to “First out”

 Enforcement

• The opposite to the European ssRCF/HY position: “First out” control enforcement, therefore more in line with the senior/mezz position

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Unitranche: “Agreements among lenders” (cont.)

 Voting

• Default rule: consent of both the majority “First out” and majority “Last out” required

 Transfers

• “Right of first offer”

• What does this mean for a potential investor? More than one AAL? • Potential disclosure and confidentiality issues?

 Buy-out

• Bilateral buy-out options post-enforcement (both ways) and where “Last out” fails to approve an amendment (by the “First out”)

 Other potential issues?

• Transparency, liquidity for incoming/outgoing lenders, insolvency, schemes of arrangement…not work out tested!

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Unitranche: joint ventures and “dual tranches”

Joint ventures

• General – e.g. Ares/GE joint venture

• Transaction specific

“Dual tranche” unitranche

• Two tranches (each provider a lender of record): senior (A) and junior (B)

• Different pricing within unitranche or same as RCF? Senior tranche often

invested by banks providing the RCF/hedging

• Purpose to achieve overall reduction in unitranche margin (as if blended)

• Intercreditor issues? Does “senior” unitranche vote get counted in “super

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Unitranche: the future

• Deal sizes

growing

• Future

club deals

(e.g. Trainline and beyond)?

• Convergence with

HY/TLB

terms and/or

covenant lite

?

• Partnerships between

banks and direct lending institutions

are key

• Market will

evolve

to get deals done…

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Your presenters

Annette Kurdian Partner, Banking Tel: +44 20 7456 2431 [email protected] Sam Lukaitis Associate, Banking Tel: +44 20 7456 2296 [email protected]

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