Unitranche Financing Overview – What is Unitranche Debt?

Companies that have challenges securing financing with traditional bank loans often seek other financing alternatives such as unitranche financing to meet their borrowing needs. Unitranche financing has increased in the middle market as hedge funds, credit opportunity funds and business companies pursue high returns from borrowers in a low interest rate environment. The article will present an overview of unitranche financing including the characteristics associated with this type of loan, and the benefits and disadvantages of structuring unitranche loans. The article will also include a discussion on the risks and implications of incorporating unitranche loans in a company’s capital structure.

Overview       

Unitranche financing is a hybrid loan structure that blends subordinated and senior debt to form a single debt instrument. Unitranche loans are mainly used by middle market borrowers with sales under $500million and an annual EBIDTA of $50million or less. [1]

The main function of a unitranche is to serve the same purpose as a traditional first or second lien or mezzanine debt but providing a more effective and streamlined process. Unitranches can be used in the middle market for refinancing, acquisitions such as equity-back acquisitions, and dividend recapitalization. The Agreement Among Lenders (AAL) regulates unitranche transactions, focuses on the allocation of interest and principal, and enforce intercreditor rights and duties.¹

Types of Unitranche Loans

The two types of unitranche loans are the straight and bifurcated unitranches. Both loans are structured as alternative loans to traditional loans. The straight unitranche offers five to six times leverage and is considered an option for first lien or second lien structure or a senior or mezzanine structure.  A common type of a unitranche instrument is the bifurcated unitranche. Although, the bifurcated loan is presented as a single facility, the loan is split into first-out (FO) and last-out (LO) pieces, and is divided among at least two or more lenders investing in the tranche.[2] The FO tranche typically involves a revolver offered under the credit agreement and includes an exclusive portion of the term loan. Additionally, unitranche products are diversified to reflect first-lien/second-lien, senior/mezzanine, hybrids, upside-down intercreditor or split collateral.[3]

Payment Waterfall

In the payment waterfall, the FO and LO debts are generally paid pari passu. However, during the case of a waterfall trigger event, the AAL payment waterfall is enforced for all collateral earnings and payments from the borrower. A trigger event can include a bankruptcy event of default, acceleration or violation of a maximum FO leverage ratio. During a trigger event, FO loan obligations are paid prior to LO obligations. LO lenders have buyout rights to acquire FO obligations during trigger event. The purchase of FO obligations is typically at par and usually includes specific prepayment premiums.[4]

Characteristics

• Blended interest rate that is generally higher or equal to that of traditional loan debt
• Multiple debt tranches are combined into one single financing. The borrower of a unitranche loan will only have one group of creditors.
• The rights of the company and various creditors are established in a single debt instrument.
• Single credit agreement and security agreement authorized by both the lender and borrower. The single credit agreement offers for a single tranche of term loans and enables the borrower to pay a single interest rate to lenders. [5]
• Unitranche loans have maturities of five to six years and interest is paid quarterly.[6]

Benefits

• Unitranche borrowers benefit from this type of financing structure due to the low cost of fees. For example, borrowers only must pay one single blended interest rate, low legal fees, and expenses.¹
• Unitranche loans have one single set of documents with one set of covenants that include reporting and financial covenants. The financial covenant allows the borrower to only pay one single interest and one amortization payment. Borrowers can benefit from the simple amortization requirements during the initial years of the term of the loan. The amortization enables the borrower to have the flexibility to make the payment on the debt or refinance the debt.
  1. Debt amortizes over time compared to first/second lien or senior/mezzanine debt, where the first lien or senior debt amortizes but the junior debt does not amortize.
• The use of one credit facility to blend junior and senior debt results in a greater debt than debt available to a borrower under a first lien or senior credit facility alone. [7]
• Borrowers do not experience delays since loan due diligence does not involve different credit facilities. There are also no delays associated with syndication for unitranche loans.⁴
• Unitranche financing is a one-stop financing that reduces the execution risk and allows the borrower to only negotiate with one lender.

Disadvantages

• Unitranche lenders may not be inspired to structure unitranche loans since a lot of controls should be relinquished in exchange for higher interest rates.
• Borrowers may have challenges amending the loan agreement or waiving covenants as the lender’s rights and identity are hidden.[8]
• Although, unitranche loans provide higher yields than traditional senior debt, they add incremental risk to the portfolio.⁴
• There is no secondary market for unitranche loans making this type of loan relatively illiquid.
• There is uncertainty regarding cases of bankruptcy and whether borrowers may have court rulings in their favor. Unitranche investor borrowers may be uncertain about enforcing AAL to support sales of collateral or authorization of a plan of reorganization.
• There could be ambiguity associated with enforcing subordination provisions.⁵

Risks and Implications

Unitranche financing has been associated with bankruptcy-related risks. One of the implications is that unitranche lender’s counsel need expertise in resolving issues unique to unitranche lending during bankruptcy proceedings.²  Unitranche loans have not been assessed in bankruptcy courts and there are no stated rulings regarding how issues will be addressed during a bankruptcy.⁵ During a bankruptcy proceeding, unitranche loans may have potential issues with the voting provisions of AAL.

Another risk that unitranche borrowers face is the threshold issue related to unitranche loans in bankruptcy. It is uncertain whether a bankruptcy court will carry out the agreements set forth in the AAL. Some bankruptcy courts may not have the jurisdiction to enforce the provisions of the agreement. The implication is that unitranche lenders may have to seek relief in a non-bankruptcy setting. For example, a bankruptcy court may authorize a reorganization that may be opposed by the lending party and will require the issue to be settled out of court.⁵

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Since bifurcated unitranche loans are in their infancy stage in Europe, it is important for European dealmakers to understand bifurcated technology as well as the documentation principles to structure the loans. Europeans need to properly adjust the US product to fit within the legal and market framework of Europe.³

Conclusion

Unitranche financing has gained popularity in the middle-market and has enabled hedge funds and business companies to secure capital and gain high yield returns. Unitranche loans are a blend of subordinated and senior and is typically represented as a bifurcated unitranche with first-out and last-out loan pieces. The low interest rate, low legal fees, the single set of documents, use of a single credit facility as well as the one-stop financing is beneficial to investor borrowers. However, unitranche financing can increase portfolio risk, present challenges with amending the loan agreement and cause uncertainty with bankruptcy proceedings. Unitranche lenders and borrowers need to gain more insight into bankruptcy-related issues and provisions.

Author Bio

Nate Nead is an M&A and real estate investment banker with InvestmentBank.com. Nate assists long standing business owners in creating and structuring transactions for capital formation and mergers and acquisitions across the middle market. He resides in Seattle, WA.

Sources

[1] Marc A. Reich, Unitranche Lending… What You & Your Borrowers Need to Know, (March, 2014), http://www.abfjournal.com/articles/unitranche-lending-what-you-your-borrowers-need-to-know/

[2] NXT Capital, Not all unitranche loans are created equal, (May 2016), https://www.nxtcapital.com/wp-content/uploads/Unitranche_PDI_May_2016.pdf

[3] Proskauer, Unitranche 2.0: A Global Revolution, (Nov, 2015), http://www.proskauer.com/files/uploads/PDI28_Proskauer.pdf

[4] Pitchbook, Unitranche deals: What you need to know about agreements among lenders, (Oct 15, 2015), https://pitchbook.com/news/articles/unitranche-deals-what-you-need-to-know-about-agreements-among-lenders.

[5] Geoffrey R. Peck &Todd M. Goren, Morrison & Foerster LLP, Developments in Unitranche Financing (2016), THOMSON REUTERS, https://media2.mofo.com/documents/160800unitranchefinancing.pdf.

[6] GetFilings.com, CION Investment Corp – FORM 10-K – March 15, 2017, (March 15, 2017),
http://getfilings.com/sec-filings/170316/CION-Investment-Corp_10-K/

[7] Jennifer Hildebrandt & Jennifer Yount, Unitranche Credit Facilities: Advantages, Disadvantages and Recent Developments, (June, 2013)

[8] FCS Commercial Finance Group, Unitranche Loans, (2017), http://www.fcscfg.com/index.php/terminology/unitranche-loans.