Unitranche loans: how are they evolving? Annette Kurdian & Sam Lukaitis 25 February 2015
Outline 1. What are unitranche loans? 2. Unitranche loans compared to other potential financing structures 3. What are the advantages/disadvantages of unitranche loans to borrowers? 4. Intercreditor issues: a) The Intercreditor agreement: RCF/hedging v unitranche b) The Agreement among lenders: first out / senior v last out / junior c) other market approaches: joint venture arrangements and dual tranche unitranche loans 5. The future of unitranche loans
What are unitranche loans? Background History: from the US to Europe Why are they relevant now? A source of liquidity in the mid-market as banks delever/adhere to liquidity and capital requirements imposed by Basel III Traditionally ACPs, but banks re-entering the market to invest alongside the unitranche providers (i.e. not just capex/rcf) 1. Classic unitranche Avoids senior/mezz blended interest rate allows lenders to take individual risk positions and receive different economic rewards Risk/reward position historically not disclosed to borrower (dealt with in AAL ) 2. Strategic unitranche For more difficult credits Traditional lenders not as interested a more expensive senior deal as no real blending of senior/mezz. Often alongside equity co-invest to achieve targeted returns
What are unitranche loans? (cont.) Purpose Multi-purpose financing E.g. acquisition (Anesco, CRH, Big bus tours, Wireless logic)/refinancing (Trainline, KP1)/dividend recap (Amtek global technologies) Size? From small beginnings financing mid-market deals Is there a market standard? A search for common themes Increasingly so, but the terms vary depending on lender/credit/debt advisers/competitive tension and the type of unitranche Use in Europe: need to watch bank monopoly issues (e.g. France & Germany) but deals done using bond or fronting bank structures Key selling point of unitranche is its flexibility positions evolve and bespoke covenant packages can be created
Unitranche: structuring Financial sponsors Shareholders agreement Management Senior tranche Junior tranche Topco Intercreditor group Agreement among lenders Covenant group Parent RCF Vendor Sale and purchase agreement Bidco Hedging Unitranche facility Senior A / Junior B Target Guarantee and security package Target opcos Guarantee and security package
Unitranche and other debt products: deal size Possible funding options Unitranche Syndicated loan Club loan Bilateral loan High Yield Bond Asset-based Lending 0 50 100 150 200 250 300 350 400 450 Source: Michael Dance (Senior Consultant), Grant Thornton
Unitranche: market sentiment Bonds jostle with unitranche financing in cash-strapped European middle market (Financial Times, 8 October 2013) Unitranche loans increase presence in Europe's leveraged market (Reuters, 22 December 2014) Chunky unitranches provide alternative route for slow syndications and unique deals (Debtwire, 5 January 2015)
Unitranche and other debt products: features compared Comparison of Key Features Unitranche Senior/Mezz ssrcf/hyb Size EUR 30 250m EUR 30 800m (Syndicated) EUR 150 800m (ssrcf a small % of capital structure) Leverage 5.0 5.5x 3.0 4.5x 4.0 6.0x Speed 3 4 weeks (fast) 8 weeks (medium) 12 weeks (min.) (slow) Flexible terms Yes: tailored to client Historically, tight covenants but note cov lite/tlb Cash retention Good (bullet repayment often without cash sweep / cash sweep + unitranche right to waive) Historically, more restrictive: cash sweep and amortisation but note cov lite/tlb Incurrence covenants = operational flexibility Very good Call protection Usually but negotiated Mezz only HYB only Pricing More expensive than senior Dearth of mezz opportunities query if overall slightly cheaper than unitranche? Expensive for small issues but can be fixed rate PIK / Equity / Sometimes No for senior only (sometimes for mezz) No, but HY will sometimes have PIK Warrants Distributions More flexible than senior/mezz Historically limited, but growing Most flexible convergence with HY flexibility Fees / Expenses Generally cheaper than senior/mezz Generally more expensive Expensive Documentation Single loan agreement, ICA, AAL Two loan agreements, ICA RCF, HYB, ICA Payment blocks Enforcement Not usually but query if in AAL if US style? Unitranche lead subject to RCF/hedging step-in rights (3/6 months/insolvency?), but note AAL Mezz typical payment blocks 120 days No (unless subordinated HYB 179 days) Senior lead subject to mezz step-in HYB lead subject to RCF/hedging step-in rights (90/120/150 days) rights (3/6 months/insolvency)
Unitranche: what are the advantages and disadvantages to Borrowers? Advantages Disadvantages Speed of execution / deliverability Sourcing working capital requirements / committed (but undrawn) facilities Flexibility (covenant package / structure often more bespoke so suits complex situations) Lower debt service burden (bullet repayment preserves cash for growth via acquisitions and capex) Simplicity of decision making (tighter lender group / relationship lending) Pricing (may be higher in the first couple years, but can apply cash to entire tranche of debt (incl. PIK) rather than just senior and less expensive debt) Transparency Non-call (lock in returns for lost yield but subject to negotiation) Leverage at least a turn / turn and a half higher than senior only (usually 5.0x-5.5x but have seen up to 6.0x) Equity / warrants: board observer rights?
Unitranche: intercreditor issues (RCF/hedging v unitranche) Ranking The approach now generally follows the European ssrcf/hy intercreditor position (i.e. pari but RCF/hedging super senior in relation to distribution of enforcement proceeds) Enforcement The approach now generally follows the European ssrcf/hy intercreditor position (i.e. unitranche control subject to RCF/hedging step-in rights consultation?) Material events of default : non-payment, insolvency, financial covenant breach, information covenant breach, cross-default, negative pledge etc Voting RCF/hedging will have entrenched rights which cannot be amended/waived without their consent: e.g. enforcement regime, RCF acceleration provisions, Material events of default, certain other matters that go to the security package (given RCF/hedging s super senior position) Option to Purchase Unitranche able to take out the super senior liabilities at par following acceleration
Unitranche: Agreements among lenders Background The AAL is the document required to get from the unitranche facility (as set out in the credit agreement) to the underlying agreement that has been struck between the unitranche providers ( Classic unitranche ) Key Principle The First out or Senior unitranche lender receives a lower portion of the blended interest rate paid under the credit agreement in exchange for an enhanced risk/security position Payments The US approach: (i) distribution of interest payments First out take senior portion; (ii) prepayments rateable but post waterfall trigger event all payments to First out Enforcement The opposite to the European ssrcf/hy position: First out control enforcement, therefore more in line with the senior/mezz position
Unitranche: Agreements among lenders (cont.) Voting Default rule: consent of both the majority First out and majority Last out required Transfers Right of first offer What does this mean for a potential investor? More than one AAL? Potential disclosure and confidentiality issues? Buy-out Bilateral buy-out options post-enforcement (both ways) and where Last out fails to approve an amendment (by the First out ) Other potential issues? Transparency, liquidity for incoming/outgoing lenders, insolvency, schemes of arrangement not work out tested!
Unitranche: joint ventures and dual tranches Joint ventures General e.g. Ares/GE joint venture Transaction specific Dual tranche unitranche Two tranches (each provider a lender of record): senior (A) and junior (B) Different pricing within unitranche or same as RCF? Senior tranche often invested by banks providing the RCF/hedging Purpose to achieve overall reduction in unitranche margin (as if blended) Intercreditor issues? Does senior unitranche vote get counted in super senior lender vote on entrenched rights/enforcement etc?
Unitranche: the future Deal sizes growing Future club deals (e.g. Trainline and beyond)? Convergence with HY/TLB terms and/or covenant lite? Partnerships between banks and direct lending institutions are key Market will evolve to get deals done
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Your presenters Annette Kurdian Partner, Banking Tel: +44 20 7456 2431 annette.kurdian@linklaters.com Sam Lukaitis Associate, Banking Tel: +44 20 7456 2296 sam.lukaitis@linklaters.com
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