The last 18 months have witnessed an unprecedented level of new product innovation in the Australasian leveraged loan market – the space traditionally dominated by bank-led leveraged loans has been shaken up by competing products in the form of the Unitranche and the Aussie Term Loan B or TLB.

This article will focus on the Aussie TLB, but will also briefly cover the features of the Unitranche.

What are they?

Aussie TLB

Australian companies have historically been able to access the US TLB market but until a few years ago, solely in USD under US-law documents (with the obvious drawback being the cost of doing a USD/AUD cross-currency swap unless the Borrower itself generated USD earnings to service USD denominated debt). The Aussie TLB is an Australian dollar denominated version of the US TLB – typically provided by institutional lenders (but also some banks), and always underwritten or arranged on a best efforts basis, by investment banks or similar debt capital markets arranging institutions. The TLB supports higher leverage than bank loans, especially if combined into a first lien/second lien issue, has minimal amortisation and is usually covenant-lite (more later). First Lien TLBs benefit from first-ranking security, while Second Lien TLBs benefit from second-ranking security. While Second Lien TLBs feature cash-pay interest and are not subject to payment subordination in the same manner that Australian Opco Mezzanine financings are, they earn a higher margin and receive greater prepayment protections (discussed below) to reflect their riskier second ranking nature.

The first Aussie TLBs were documented under US-law documents and were raised as part of a USD/AUD debt raising. However, last year we saw the first standalone AUD-only Australian law governed TLBs.

Unitranche

The Australian version of the “Unitranche” is a single covenant, bullet term loan (i.e. no amortisation) typically provided by institutional lenders such as debt funds. As it can support higher leverage (usually > 5x), it comes with higher pricing compared to bank loans. The Australian variation does not have an ‘agreement among lenders’ behind the scenes. If the borrower requires revolving working capital facilities, these are usually provided by a commercial or investment bank on a super-senior basis.

Why TLBs and Unitranches?

The popularity of the 2 new products can be distilled into 2 main factors :

  • higher leverage; and
  • greater flexibility for Borrowers.

The flexibility feature comprises a few key points – no/minimal amortisation, no/minimal financial covenants and fewer restrictions generally.

In contrast, the traditional Australasian bank leveraged loan includes several features that Borrowers may find unduly restrictive. These include:

  1. amortising tranche A – usually set between 15-30% of overall acquisition debt;
  2. maintenance financial covenants – “maintenance” as they have to be tested and complied with on a quarterly basis. In a traditional bank deal, there are usually 4 covenants
      1. a Leverage Ratio (Net Debt to EBITDA)
      2. an Interest Cover Ratio (EBITDA to Net Interest Expense)
      3. a Debt Service Cover Ratio (Cash Available for Debt Service to Principal amortisation + Net Interest Expense) and
      4. an annual capital expenditure limit;
  3. more restrictive accordion/incremental facilities and ability to incur further debt; and
  4. tighter restrictions on acquisitions, distributions and other negative undertakings.

While a Borrower requirement for higher leverage can potentially be solved with a combination of a traditional senior bank loan and a holdco PIK mezzanine loan (Senior + Holdco Mezz) , the blended cost of the Senior + Holdco Mezz loans is usually higher than for a Aussie TLB or unitranche, and the overall terms will follow bank-style restrictions. A table setting out the differences between the key features of a bank leveraged loan vs the Unitranche vs the TLB is included at the end of this article.

Financial covenants

Covenant ‘lite’ status is one of the main drawcards of the TLB product. Most TLBs are structured so that only the revolving capital facility (RCF) lenders have the benefit of a leverage ratio set at a 30%-35% cushion to the sponsor model without stepdowns.

The covenant is only tested (or ‘springs’) when RCF usage (which may be both loans and LCs or just loans or somewhere in between) exceeds a threshold (highly negotiated but usually within 25%-40% of RCF commitments) on a quarterly covenant testing date.

Term lenders only get the benefit of a covenant indirectly if the RCF lenders choose to accelerate the revolving loans as a result of a breach of the covenant.

Unlike a post-GFC traditional bank loan where equity cures must be applied to prepay debt, equity cures in TLBs are treated as a deemed increase to EBITDA.

It is possible for a TLB to be “voluntarily covenanted” – this means there will be a maintenance financial covenant (leverage ratio). A sponsor may elect to have this feature for the purposes of reducing pricing and/or to attract certain classes of debt investors who may not otherwise invest in a ‘covenant lite’ product. However, the loan still benefits from the other ‘flexibility’ features described in this article.

More flexible accordion/incremental facilities

Typical bank loans permit material additional secured indebtedness only by way of an accordion/incremental facility which must be incurred as an increase to the existing term loans and used only for Permitted Acquisitions or Growth Capital Expenditure. Accordions are also normally capped at a fixed $ limit and/or a half turn (or thereabouts) below opening leverage.

In contrast, TLBs, among other things:

  • permit incremental facilities – with the ability to lever, on a pari secured basis, up to a half/full turn above Closing Leverage (by way of a ‘freebie’ basket)
  • do not restrict the use of proceeds of the incremental facility – so long as not restricted by the facility agreement (so the borrower can use it for dividend re-caps); and
  • permit the incurrence of incremental facilities as term loans, revolving loans or notes/bonds on a pari secured, junior secured or unsecured basis.

Conditions to incurrence are quite permissive and there is usually no right of first refusal for existing lenders. However, a most favoured nation (MFN) pricing test is often required to protect existing lenders but even this has a number of exceptions and may only apply for a very short period of post-Financial Close.

Permitted acquisitions

TLBs contain significantly fewer restrictions on acquisitions than a traditional facility – this can be particularly advantageous for sponsors pursuing a roll-up/bolt-on/tuck-in strategy. Under a TLB, an acquisition will be permitted so long as:

  • no Event of Default is subsisting at the time the definitive documents for the acquisition are signed
  • the acquisition is consistent with the line of business covenant
  • the target is not located in a country or area subject to sanctions; and
  • the guarantor coverage test will be satisfied post-acquisition (after taking into account any relevant grace period).

There are no aggregate caps on acquisitions, limitations on funding sources, or requirements to provide diligence, acquisition documents or updated models.

Other permitteds

The restrictions on distributions (also called Restricted Payments / RPs), guarantees, loans and other like negative undertaking categories are much more flexible in a TLB when compared to a bank leveraged loan. The RP permissions are usually the most heavily negotiated – where, on top of the customary distributions to sponsors that can be made after a certain leverage ratio test is satisfied, there are also “freebie $ bucket” permissions that can be utilised over the life of the loan which do not require any testing.

Call protections

Unlike investors in bank leveraged loans, TLB investors require greater yield protections.

The First Lien call protection (typically a fixed % premium on the principal amount repaid) is only payable within a relatively short period after financial close and solely for repricing events (ie. a refinancing the primary purpose of which is to reduce the yield payable on term loans).

In contrast the Second Lien call protection applies to all voluntary prepayments, repricing events and certain other mandatory prepayments and can include both non-call periods and/or fixed prepayment premiums.

With increased flexibility comes increased ‘flex’

While an underwritten bank deal may have limited pricing flex, an underwriter of a TLB deal will require a more comprehensive flex package that can be exercised if required to assist the underwriter to achieve successful syndication. Common flex items in addition to pricing, include caps on certain EBITDA addbacks, adjustments to the MFN/prepayment premium regime and tightening more aggressive aspects of restricted payments / incremental debt regimes

Future of the Aussie TLB

The arrival of the standalone Aussie TLB into the Australasian leveraged finance market has been welcomed by sponsors and debt investors alike by expanding the menu of financing options / investment products available to those parties. With its many attractive and unique features, we expect to see an increasing take-up as corporates and sponsors learn more about the TLB. Interestingly, we are also seeing traditional banks respond to the challenge by offering increasingly flexible terms in their leveraged loans (including reducing or eliminating amortisation and imposing fewer financial covenants). It all makes for a very interesting leveraged finance market!

The table below sets out the differences between the key features of a bank leveraged loan, a Unitranche and the Australian TLB.

Traditional Senior Bank Financing

Unitranche

Australian TLB

Players

Senior - traditional banks, investment banks, debt funds

Debt funds and investment banks

Debt funds, investment banks, offshore banks

Tranches

  • Amortising term loan (~15-30% of term debt)
  • Bullet term loan
  • Revolving working capital facility
  • Capital expenditure/acquisitions facility

Bullet term loan Super senior revolving credit facility – typically provided by a traditional bank provider

First Lien

  • Term loan – nominal amortisation (1% per annum)
  • Pari passu revolving credit facility

Second Lien

  • Bullet term loan

Financial Covenants

  • Leverage
  • Interest Cover Ratio
  • Debt Service Cover Ratio
  • Annual capital expenditure limits

Leverage covenant only

  • Pure ‘springing’ leverage covenant only for the benefit of revolving lenders
  • Can be voluntarily covenanted

Prepayment protection

Senior – none Mezz – Non-call/prepayment premium

Non-call/prepayment premium

First Lien – ‘soft call’ short period after close Second Lien – ‘hard call’ non-call/prepayment premium

Key restrictions

Additional indebtedness

  • Accordion: term loans only capped at lower of: (i) opening leverage or a threshold inside opening leverage and (ii) often a hard dollar cap
  • Right of first refusal (“ROFR”) and occasionally a most favoured nation (“MFN”)
  • Often limited to acquisitions and growth capital expenditure

Essentially consistent with traditional bank financing product with slightly more flexibility

  • Incremental can be by way of secured, junior secured or unsecured term loans, revolving loans or notes
  • No restriction on purpose
  • No ROFR
  • Pricing MFN for short period
  • Can exceed Closing Leverage Ratio with freebie baskets

Further acquisitions

  • Sometimes aggregate dollar cap (per acquisition / annual / life)
  • Sometimes Lender sign off required on due diligence reports (“DDRs”) if funded by facilities
  • Acquisition is EBITDA/cashflow positive

Essentially consistent with traditional bank financing product with slightly more flexibility

  • Line of business restriction only
  • No aggregate cap
  • No requirement for lender consent
  • No provision of DDRs/acquisition agreements

Distributions

  • Sponsor monitor fees permitted up to a per annum cap
  • Unlimited once a ‘corporate’ leverage ratio level is reached

Essentially consistent with traditional bank financing product

  • General freebie dollar basket
  • Cumulative credit comprising a dollar amount and a builder linked to consolidated net income
  • Unlimited once delivered to a certain threshold inside opening leverage
  • Ratio basket