North American lenders find themselves in a Borrowers’ market where there is fierce competition for every quality middle market financing out there. Historically, lenders have tried to differentiate themselves from their competition by offering aggressive pricing, reduced banking fees and flexible covenant packages. Now, US and European lenders have gone one step further and are marketing a new loan structure called the “unitranche loan”.
A unitranche loan is a lending facility where a single lender offers the borrower a senior and a subordinated tranche of debt and blends them into a single loan. Accordingly, rather than one lender providing a senior debt tranche and a second lender providing a separate subordinated debt tranche, one lender provides the borrower with one single tranche of debt comprised of both senior and subordinated debt. The pricing of a unitranche loan reflects the unification of the senior/subordinate structure, and is priced somewhere along the continuum between senior debt and subordinated debt.
Single credit agreement and security package
Because a typical financing involves two separate tranches of debt (senior and subordinated), the borrower’s assets are typically subject to a first ranking charge in favour of the senior lender and a second ranking charge in favour of the subordinated lender. Each tranche of debt would require (i) a separate credit agreement; (ii) separate pricing and fees; (iii) a separate security package; (iv) a unique covenant package, and each lender’s rights would be governed by a heavily negotiated “inter-creditor agreement”. Comparatively, a unitranche loan requires only one credit agreement, one set of security documents and negotiation with one lender. The reduced complexity of a unitranche loan often results in reduced legal fees, quicker closing times and increased certainty of closing; all features which are extremely important to today’s borrower.
Syndicating unitranche loans
A unitranche loan can be advanced by a single lender or if the hold is too large for one particular lender, the lender has the option to split the unitranche loan into “first-out” and “last-out” tranches to one or more lenders. A lender participating in a unitranche loan will have different rights relative to other lenders participating in the same loan, depending on what tranche that lender participates in. By way of example, let’s assume the following scenario involving only two lenders:
- Lender A issues a $50 million unitranche loan to ABC Co. and the interest charged to ABC Co. is 10 percent, such price a reflection of the amalgamation of senior and subordinate debt.
- After closing the financing with ABC Co., Lender A decides to allow Lender B to participate in the $50 million unitranche loan.
- Lender A and Lender B could split the unitranche loan amongst themselves on a pari passu, basis such that their rights vis-à-vis each other are the same. Alternatively, the Lenders could agree that one Lender would be subordinate to the other, in exchange for the subordinate lender receiving a greater portion of the 10 percent interest stream payable by ABC Co. under the original unitranche loan.
- The subordinate lender would be deemed to have participated in the “Last-Out” tranche, meaning that if ABC Co. became insolvent, the senior lender would have a first claim and the subordinated lender would have a second (in this example, “last”) claim against the assets of ABC Co.
The foregoing steps would only involve the lenders, and not ABC Co., such that irrespective of how the lenders split up the unitranche loan, the blended interest rate payable by ABC Co. to Lender A would remain the same. The following chart shows a comparison of factors between a senior/subordinate loan and a unitranche loan.
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Syndication of unitranche loans
One important characteristic that distinguishes a unitranche loan from a traditional loan is the fact that if a unitranche lender wishes to syndicate a portion of the unitranche loan, it would do so after the financing with the borrower has closed, whereas a traditional loan is syndicated prior to closing the financing with the borrower. By deferring the syndication of a unitranche loan until after closing, the borrower is able to eliminate the uncertainty, delay and cost often a consequence of the syndication process. Furthermore, if a unitranche loan is syndicated, the other lenders do not present their separate interests to the borrower in the negotiation process and instead the borrower would view the original lender as the only lender under the unitranche facility.
Agreement among lenders
The relationship between the different lenders participating in a unitranche loan is governed by a document called an “Agreement Among Lenders” (“AAL”). Similar to an inter-creditor agreement the AAL will determine the relative priority of the lenders, their payment structures, their voting and consent rights with respect to amendments or waivers, the rights of lenders to purchase debt of other lenders after certain triggering events, how the exercise of remedies will be controlled and how collateral proceeds will be distributed.
Common attributes of unitranche loans
As discussed above, the main attribute of a unitranche loan is the streamlining of the process and components into a single package for the borrower to deal with. However, while it has the appearance of a single loan, a unitranche loan permits leveraging ratios similar to that of a two-tranche loan.
Typically, unitranche loans will be structured as term loans; however in some cases the borrower will also require a revolver. In such an instance the revolving facility will usually rank pari passu with the unitranche term loan so that it may be documented in the same credit agreement.
Unitranche loans and LBOs
Private equity companies and other borrowers looking to complete a leveraged buy-out are often competing against other purchasers and must complete an acquisition quickly and cheaply. Borrowers find unitranche loans attractive for (i) providing access to senior and subordinate debt from one lender under a single facility (ii) allowing for a quick closing due to the removal of the syndication process and the reduction and streamlining of legal documentation; and, (iii) providing greater certainty of closing. In this context borrowers are willing to accept a higher interest rate in exchange for a quicker and more certain closing.
Unitranche loans in Canada
A unitranche loan offers a unique and attractive financing structure to borrowers requiring senior and subordinated debt. These loans are frequently used by US lenders in the US, particularly in the LBO space, are starting to be used by US Lenders active in the Canadian financial marketplace. It is likely that US borrowers familiar with the unitranche structure and looking to get financing to complete a Canadian acquisition will want access to unitranche loans. Accordingly, Canadian lenders looking to gain and/maintain market share relative to their competitors, would be wise to better understand unitranche loans and consider making them part of their loan portfolio.