The use of unitranche financing creates opportunities for lenders and value for borrowers. There are some risks that lenders must understand in these structures.
With the volume and competition of middle market financings growing, many loan officers and lenders are asking, “What can we do better in order to get more business?”
In an acquisition financing scenario, unitranche may be a good path for you and your borrower. You may able to offer your borrower good terms, close quickly and keep admin and legal costs down.
Recently, middle market lenders have been enjoying higher yields than large cap lenders and have been able to control, even in club deals or smaller syndicates, documentation, underwriting and decision making. Middle market lenders can access a variety of financing structures and provide borrowers with custom terms and conditions with less adherence to what is “market.”
In an acquisition scenario many lenders commonly face the following structures of senior and subordinate debt.
First and Second lien financing. In a First and Second lien financing, there are two separate groups of lenders who are separately granted liens on the same collateral. Pursuant to an intercreditor agreement, the two lender groups agree that the first lien lenders have a senior priority lien and therefore recover first on the value of the collateral following the exercise of remedies by the lenders against the borrower.
Recently, middle market lenders have been enjoying higher yields than large cap lenders and have been able to control, even in club deals or smaller syndicates, documentation, underwriting and decision making.
While other arrangements do exist, this is common and many acquisition deals will also involve some form of seller financing. This is true for the smaller deals where the borrower may have limited capital, other than sweat equity, to invest.
In First and Second lien scenarios there are two sets of loan documents, perhaps with different covenants, and two lenders to administer the loan terms. You and the other lender will be represented by separate counsel to document the loan and those attorneys will also negotiate an intercreditor or subordination agreement.
In any structure involving subordinated debt, the lenders need to understand both the return on investment and the default risks. Senior lenders live by a tried and true rule — the liquidation value of the borrower’s assets must be sufficient to cover the senior debt. The senior lender is taking on less risk than and sub debt lender or second lien lender. Therefore, the rates are usually lower than the sub debt lender rates. The sub debt lender is taking on more risk and therefore the reward, and rates, are usually higher.
In a untrianche scenario, there is a single layer of senior secured debt. The borrower needs only one set of loan documents. All lenders and the borrower are party to the agreements. Same covenants, same default scenarios, same remedy provisions. This benefits the borrower, the senior lender and the sub debt lender. The borrower may be getting a better “blended” rate. The senior lender may be getting a higher rate of return and the sub debt lender has less risk exposure.
The lenders will enter into an agreement between themselves – an Agreement Among Lenders. The sophisticated lenders can negotiate to create certain scenarios of first out and last out “tranches.” These terms and conditions are typically negotiated on a case by case basis and will be dictated by the interest and involvement of each lender in the deal.
Unitranche deals can incorporate all of the typical facilities that lenders typically offer borrowers. In an acquisition scenario there can be multiple term loans, equipment loans and revolvers. Lenders can structure these with first out tranche facilities and last out tranche facilities. Similarly, separate pricing can be used for different facilities. The structure, pricing and arrangements among the lenders would be dealt with in the AAL.
In the middle market sectors, the benefits of unitranche lending are reduced closing, legal and admin costs; quicker closing since there are one set of documents for the borrower’s team to review and negotiate; less risk since the risk and pricing is spread between the lenders; some borrowers may be able to leverage more senior debt; decreased debt service for borrowers; streamlined compliance and admin.
As a senior secured lender you could make your borrower happy by providing more credit, quicker and cheaper. While at the same time, as a senior secured lender you debt would be fully collateralized, your pricing could increase and you can still manage and administer the loan. Obtaining higher ROI without more risk exposure, since the liquidation value of the collateral is sufficient to cover the debt, will make you a hero with your credit department. Being able to develop a reputation as a lender who gets the borrower more money, faster and cheaper could go a long way for your reputation and should help get you more business.