Unitranche facilities have become an increasingly significant financing option in the European leveraged loan market. They originated in the US in 2005 and since 2012, have increased in prevalence in Europe. In 2015, over a hundred unitranche financings were signed, of which 72 per cent were bilaterals.
What is a Unitranche facility?
Typically, a unitranche facility is a single tranche term loan which combines a blend of senior and junior risk with a single interest rate (which is essentially a blended senior/junior rate) It is typically documented in a single loan agreement.
Unitranche facilities are generally provided by non-traditional lending entities, i.e., debt funds and other alternative institutional lenders, and is usually lent in amounts ranging between GBP/EUR 20 - 250 million. Increasingly, larger debt sizes are available, which reflects the significant firepower of debt funds, together with greater appetite from private equity sponsors.
In most cases, unitranche facilities are accompanied by a revolving credit facility (“RCF”) from a commercial bank as borrowers often need to finance the working capital requirements of target entities immediately post-acquisition.
Benefits for a borrower
Unitranche facilities offer borrowers a range of benefits. Its terms are more flexible and can often include a numnber of Term Loan B/covenant lite features such as grower baskets, ratio tests, debt incurrence covenants and more flexibility on permitted transactions.
With bilateral unitranche facilities, lender decision making is generally simpler.
Syndication risk is elimiated as well as the need to negotiate market flex provisions.
In addition, transactions can be executed faster and cheaper as a result of there being fewer parties to negotiate with and the fact that a single facility agreement is entered into.
Unitranche facilities typically have a single bullet repayment with no cash sweep provisions and often a PIK toggle element to the margin which result on overall less onerous debt service requirements for the borrower. As a result, borrowers are able to preserve cash for making acquisition and capital expenditure as well as other forms of reinvestment in the business.
Disadvantages for the Borrower
There are however some disadvantages for the borrower, namely interest margins are usually higher. Moreover, call protection essentially locks borrowers into the financing for a minimum period when they are unable to use excess cash to reduce the debt through making voluntary prepayments.
Key characteristics of unitranche facilities:
- Fewer Documents to negotiate
Unitranche financing is usually contained in a single loan agreement,. This is unlike a traditional leveraged financing where the senior, mezzanine, and junior debt is documented separately and often have different covenant packages, resulting in the borrower having to comply with different obligations in each package. The working capital facility usually provided by a bank in the form of a revolving credit facility is also usually documented within the same facility agreement, however certain unitranche providers prefer to have the RCF documented in a separate loan agreement. The voting position between the RCF lender and the unitranche providers tends to be documented in the facility agreement, however where the RCF is separately documented, this is addressed in the intercreditor agreement.
- Maturity and Bullet repayment
Typically six or seven years and there is usually a one-time lump sum repayment of the entire loan at maturity.
Often ranges from 7-9% which is higher than the margin for a senior facility. Mostly, the margin has cash pay element and a PIK toggle.
- Financial covenants
Unitranche facilities are increasingly being provided on a covenant loose basis with just a leverage financial covenant, often with significant add-backs and an equity cure.
- Security Package
Generally a full security package similar to the packages typically seen on standard European leveraged financings.
- Higher opening leverage
On recent transactions, leverage levels have ranged from 3.5x to 6.5x.
- Call protection
Typically, unitranche lenders will look for non-call / early prepayment protections for at least the first 12 to 24 months of the facility’s life, although the length of the non-call period and the prepayment fees are strongly negotiated and vary across the market. A prepayment fee of 1-2% of the total unitranche facility is not uncommon. However an alternative approach is often to include 'make-whole’ provisions for the first two years of the facility. This would require any interest and fees that would otherwise be payable during the ‘make-whole’ period to be paid along with any prepayment amounts.
The RCF usually ranks super-senior vis-à-vis the unitranche and will take priority in payment upon enforcement. However, it is worth noting that because the unitranche is usually the larger piece of the capital structure, unitranche lenders customarily retain the ability to trigger acceleration and enforcement, thus protecting their position. The RCF lenders will have voting/enforcement rights in only limited circumstances. For example, RCF lenders may have limited consultation, step-in or enforcement rights upon the occurrence of material events of default (which would typically include non-payment of the RCF facilities, insolvency, breach of financial covenants, cross-default, breach of negative pledge (if it affects RCF security) and breach of RCF information covenants or RCF consent provisions). Another protection that RCF creditors would usually negotiate relates to entrenched rights, i.e. terms that cannot be varied or waived without their consent. These may include the definitions of “Majority Lenders” and “Majority RCF Lenders”, “Material Undertakings”, and “Material Events of Default”; provisions relating to utilisations and pricing of RCF loans, incurrence of additional financial indebtedness, breach of RCF consent provisions, change of RCF financial covenant and others.
Given the relatively small proportion of RCF facilities in the overall financing package (usually 10-20% of the aggregate facilities, including hedging) and the priority of RCF repayment upon enforcement, RCF lenders often agree to have standstill periods in certain circumstances. The standstill periods will vary depending on the underlying enforcement event (e.g. 90 days for non-payment, 120 days for financial covenant breach and 150 days for other material events of default). These standstill periods give unitranche lenders time to consider their options on enforcement. Unitranche lenders are also typically able to buy out the super senior facilities at par following acceleration of the facilities, thus removing the RCF lenders from the scope of the enforcement process.
Agreements Among Lenders
Unitranche financings are sometimes provided by a group of lendersinstead of as a bilateral facility. Where there are multiple lenders, they often agree to receive lower/higher pricing betwen themselves to reflect the lower/higher risk they are taking. In thissituation, a separate and bespoke agreement among lenders (“AAL”) is negotiated to regulate the relationship between the unitranche lenders in relation to return, risk and enforcement rights. The AAL differs to an LMA intercreditor agreement in that the borrower is not a party to it and the AAL is generally not disclosed to the borrower.
A key feature of the AAL is that it essentially bifurcates the unitranche by distinguishing between “First Out” (i.e senior) lenders and the “Last Out” (i.e junior) lenders.
First Out lenders usually receive a lower proportion of the blended unitranche margin payable under the facility agreement but will be first to receive interest and (upon satisfaction of certain conditions) principal (re)payments. Cash interest is generally paid to the First Out lenders and PIK interest is allocated to the Last Out Lenders, in each case, pro rata to their participation. “First out” lenders have control of any enforcement process, an arrangement which is similar to how senior lenders are treated in a standard senior/mezzanine structure. Voting decisions are based on the majority of both “first out” and “last out” (junior) unitranche lenders.
Both senior and junior unitranche lenders will typically benefit from “rights of first offer” and each set of lenders has the option to purchase the other’s debt in certain situations such as following insolvency, non-payment acceleration, or failure to consent to specific amendments.
Recently, an alternative approach to AAL structures is being used in the form of dual-tranches in unitranche facilities. This splits the unitranche into a separate senior and junior tranche, each with a different margin and occasionally different enforcement rights.
Furthermore, one of the biggest uncertainties relevant to unitranche financings is how unitranche providers will operate in a restructuing scenario as this product has not been tested extensively in a work-out context. In the next downturn, it will be interesting to see how the AAL and intercreditor agreements hold-up and therefore negotiating these documents is of paramount importance.
Trends for 2016
Unitranche facilities are set to remain popular. Both the size of the debt, complexity of structures together with the number of transactions is increasing. Even traditional banks are getting involved with certain banks announcing that they are open to providing unitranche debt. However, whilst dealflow in early 2016 has started off fairly quietly, mainly due to volatility in the stock market, concerns about China, plus other global geo-political issues coupled with Brexit fears, there are expectations that the M&A market will return in the near future. With more competition from banks and other debt providers, unitranche providers will have to consider whether pricing needs to be reduced in order to compete more effectively amongst the plethora of financing options available to borrowers.