Unitranche facilities are a relatively recent innovation in middle market lending which are now common in the UK and European markets and, occasionally, now also being seen in the US markets. Unitranches were created to simplify debt structures and, as they are principally used for leveraged acquisitions, accelerate the acquisition process. Their popularity can be attributed to their potentially significant benefits for borrowers including higher leverage, greater operational flexibility and speed of documentation and closing – all benefits that are particularly attractive to private equity purchasers and other financial sponsors.
Unitranche facilities are primarily offered by credit funds that provide acquisition financing but they are increasingly being offered by a wider range of financiers, including Ardian (formerly Axa Private Equity), Babson Capital, KKR Credit Advisors, ICG, GE Capital, Bluebay, Hayfin and Macquarie. Unitranche facilities are also growing in size – making them an alternative for financing acquisitions squarely in the middle market. In May 2013 Ardian arranged a €275m multi-currency unitranche facility to finance the €450m buyout of Flexitallic by Bridgepoint.
We have acted on a number of these facilities in Europe, but are yet to see a unitranche facility close in Australia. However, with the likes of Babson Capital, ICG, KKR Credit Advisors, Macquarie and Sankaty all active in the Australian market and with Australia’s sponsor-backed M&A market largely centred in the middle market, it seems like it will only be a matter of time before we see the first unitranche facility used here.
What is a unitranche facility?
A unitranche facility has a single tranche of debt and combines what might historically have been structured as separate first and second lien facilities into a single secured loan facility or a “stretched” B facility.
The distinguishing features of a unitranche facility, as compared to a traditional syndicated facility, result from the unitranche lenders providing all of the financing on the closing date. The facilities are not generally intended to be syndicated and the terms can therefore be structured around the institutional lenders’ requirements rather than bank regulatory requirements.
Unitranche facilities are typically structured as term loan facilities and are often accompanied by revolving facilities for working capital, transactional facilities and hedging. These ancillary facilities are usually provided by a traditional “bank” on a super-senior basis. Providers of these super-senior facilities are most often the clearing banks (eg in the UK the provider have historically been Barclays, Lloyds and RBS).
What are the common terms of a unitranche facility?
There is no standard form of unitranche facility. The terms vary as much as, if not more than, any other type of loan facility. This lack of uniformity results from the fact that the terms of an individual unitranche facility are negotiated between the lender and borrower in the same way as any other loan agreement and also because unitranche facilities remain a relatively new form of financing.
Some common features of a unitranche facility include:
- a single rate of interest (which can in effect be a blended interest rate calculated using the weighted average interest rates of the comparable senior and junior debt facilities);
- a single credit agreement; and
- a single set of security documents.
Unitranche facilities are typically structured with a bullet repayment after a fixed term or with a very small amortisation schedule. This suits the preferences of unitranche lenders and also offers borrowers some of the benefits of high yield bonds such as the ability to retain cash to fund business requirements. Given that unitranche lenders tend to prefer to fix their returns on the loan, many unitranche facilities have call protection for the lenders – usually in the form of a prepayment premium and/or a “make- whole” payment by the Borrower.
The super-senior working capital facilities and hedging are usually paid first out of the proceeds of any enforcement, giving them payment priority. However, the lenders under these facilities generally vote along with the main unitranche facility lenders on most matters and have limited independent voting and enforcement rights.
In addition to the usual suite of documents, one or more lenders may choose to allocate recoveries among themselves using their own version of an intercreditor agreement (known as the “Agreement Among Lenders” (AAL)) to which the borrower is not a party.
The AAL will split the loan into “first out” and “last out” tranches to be allocated among new lenders buying into the facility:
- the “first out” tranche will have a lower effective interest rate than the “last out” tranche to account for the different levels of risk; but
- the blended interest rate paid by the borrower remains the same.
In practice, this splitting does not always occur. It is most commonly seen in the European property loan market.
Advantages of unitranche facilities
Speed and certainty:
- Only one set of credit and collateral documents is required which allows for a more cost efficient, certain and timely closing and also means that the borrower has a streamlined process for ongoing administration and decision-making.
- Given that there will usually only be one initial lender committing to make the unitranche loan, the borrower will be able to avoid the logistical difficulties and cost of completing a syndication process.
- There may not be any need for an intercreditor agreement given that the AAL does not need to be negotiated among various lenders prior to closing (however, an intercreditor agreement is normally required as between the super-senior and unitranche lenders and to subordinate intragroup debt).
Predictability in pricing:
- Since the syndication of a unitranche facility is generally not a condition precedent to closing, the facility will not be subject to provisions that allow the arrangers to increase the pricing and modify the structural terms of the facility in order to complete the syndication process (commonly referred to as “market flex provisions”).
- The absence of market flex provisions means that the cost of the facility agreed in the unitranche term sheet is the cost that will be paid throughout the life of the loan.
Single agent and covenant compliance:
- Loan payments, financial reporting, notices, consents and modifications to the unitranche credit facility only involve a single agent.
- The borrower has only one package of financial covenants to observe. Generally, the financial covenant package will contain standard leverage, interest cover and debt service ratios and limitations on capital expenditure, but these are all typically softer than in a senior-only covenant package. The unitranche and super-senior facilities are typically documented in a single facility agreement and usually reflect a middle ground between the traditionally tighter senior lender approach and the more relaxed one of the unitranche lenders.
Pricing of unitranche facilities
Historically, the blended margin on unitranche facilities has tended to be higher than the margins on traditional senior facilities (but generally no more expensive than combined senior/mezzanine facilities in European transactions).
The pricing of unitranche facilities needs to be assessed against the:
- ability to achieve higher leverage (compared to a traditional senior-only deal);
- costs saved upfront in the documentation of the loan;
- decrease in warrants (which are often required by mezzanine financiers); and
- long-term interest savings generated by an amortisation of the entire facility (as opposed to just the senior debt).
Typical features of an AAL
AALs are bespoke to the lenders involved, but will address a number of issues including:
- notionally splitting the loan into tranches and addressing the priority of the component parts;
- the “first out” lenders will pay over a portion of their interest to the “last out” lenders in recognition of their accepting to be paid last;
- if the proceeds of an enforcement are received by the lenders, the “last out” lenders will pay over those proceeds to the “first out” lenders until their interest and principal are paid in full;
- mandatory and optional principal payments:
- principal payments are usually paid rateably to the “first out” and “last out” lenders unless a “waterfall trigger event” occurs;
- waterfall trigger events usually include:
- a payment default under the credit agreement;
- failure of the borrower to comply with all or certain financial covenants, usually within a percentage range;
- bankruptcy and insolvency events; and
- failure of the borrower to conduct all or a material portion of its business, usually following a disposal.
- the payment “waterfall” typically only applies with respect to payments and proceeds received by the agent from the collateral following an enforcement of the security, meaning that any other proceeds received by the agent – even following a waterfall trigger event - would be distributed rateably to the lenders, irrespective of whether they are a “first out” or “last out” lender;
- control of the exercise of remedies:
- most AAL’s include “standstill periods” designed to restrict, for a period of time, lenders from exercising remedies against the collateral;
- as a general rule, “first out” lenders that wish to exercise secured creditor remedies are required to standstill for 30 days, which gives the “last out” lenders time to determine whether to exercise any right they have to buy out the “first out” lenders (see further below);
- usually “last out” lenders that wish to exercise secured creditor remedies must standstill for 90-180 days to allow the “first out” lenders to determine whether to exercise remedies;
- if the “first out” lenders do not exercise their rights against all or a material portion of the collateral following the standstill period, the agent will follow the “last out lenders’” instructions;
- voting and consent rights with respect to waivers and amendments. Typically, the “first out” and “last out” lenders agree that any amendments requiring the consent of all lenders under the credit agreement will also require the sign-off of both the “first out” and “last out” lenders under the AAL; and
- rights of lenders to purchase debt of other lenders:
- typically, “last out” lenders have a right to acquire the loans of “first out” lenders at par after certain trigger events;
- in addition, it is common for an AAL to provide a right of first offer (requiring a selling lender to first offer the loan to be assigned to the other lenders); and
- lenders are generally comfortable with these provisions even though they impact the liquidity of their loans.