In brief
As regulatory and political pressure increases on the major banks in Australia, alternative credit providers are entering the market with a variety of products to attract borrowers. The unitranche loan is an example of one such product. Partner Warwick Newell, Senior Overseas Practitioner Alex Tonkin and Associate Hamish McCormack examine what makes unitranche loans unique – and what role they could play in the increasingly competitive Australian acquisition financing market.
How does it affect you?
- Unitranche loans provide borrowers with a degree of flexibility on terms, longer tenor debt, and access to leverage, that has not been seen recently in structured loans in the Australian marketplace.
- Already a dominant form of alternative financing in Europe, unitranche loans are beginning to appear in Australia and may soon be commonplace, particularly in acquisition financing.
- While unitranche loans are structured in a manner that makes it difficult for traditional commercial banks to participate in the term debt, opportunities remain for commercial banks to provide the revolving and ancillary facilities (should they be required) on a 'super senior' basis.
Background
As the political and regulatory pressure on major banks to deleverage their balance sheets grows, it is no surprise that alternative credit providers have stepped into the market armed with a variety of new and novel products with which to tempt borrowers and compete with traditional lenders. Perhaps the most popular of these products (particularly in the acquisition finance space) is the 'unitranche loan' – a loan which combines senior and mezzanine debt risk into a single debt instrument.
Australia has recently seen its first wave of unitranche structures used across the leveraged acquisition financing market in the past six to nine months. Allens has advised on the majority of these deals, including the first unitranche structure to be signed in the Australian market.
Given (i) the increased prevalence of alternative debt providers in the Australian market, and (ii) the administrative and cost advantages that can arise in simplifying a tiered debt package into a single funding document, unitranche structures are likely to continue their rise in popularity in Australia over the coming years.
What are unitranche structures?
Unitranche loans first appeared in the United States in 2005 in the 'middle market' as an alternative to the first and second lien structure common in syndicated lending.
In contrast to a traditional senior/mezzanine debt structure, a unitranche facility is structured as a single secured term loan that blends both senior and mezzanine risk in a single interest rate.
On occasion, rather than all lenders under the unitranche loan sharing pro rata in the blended interest rate, the lenders may agree (through a separate 'agreement among lenders' (AAL)), to receive lower or higher pricing between themselves in lieu of agreeing an adjusted waterfall on repayment as between lenders. The borrower is not party to these agreements, which are discussed in greater detail below.
Unitranche facilities are usually provided on a term loan basis with a single bullet repayment and occasionally a very small amortisation schedule. By structuring the unitranche facilities in this manner, debt fund investors are able to put their capital to work for a relatively certain investment period, while borrowers are able to retain cash to fund business requirements rather than having to amortise the loan. Where a form of undrawn committed funding line is also required (such as for working capital purposes), the loan agreement may also contain a revolving credit facility which is provided on a 'super senior' basis. The 'super senior' facility is usually provided by a traditional bank lender, as the vast majority of funds that provide the unitranche term debt are unable to provide revolving or ancillary facilities.
This 'super senior' unitranche structure is particularly prevalent in acquisition financing, where revolving credit may be required by the business for working capital purposes. Typically, the 'super senior' debt represents a small percentage of the overall commitment compared to the unitranche term debt.
Although syndication has not been a significant feature of unitranche financing in Australia to date, transactions typically do involve some level of syndication.
How do they work?
Documentation
The unitranche facilities seen so far in Australia have, for the most part, been documented in a single facility agreement secured by a single set of security documents (through a traditional security trust). To the extent a super senior lender group is involved, the facility agreement is accompanied by an intercreditor agreement regulating the relationship between the lenders.
The documentation contains a single set of representations and warranties, undertakings and defaults, with the super senior lenders effectively dragged on all decisions other than those that relate to particularly material issues peculiar to the super senior (payment default for instance).
Pricing
Unitranche lenders charge a higher rate of interest in comparison to the weighted average cost of debt seen in traditional senior/mezzanine loan structures. This disparity is largely due to the leverage, tenor and terms on which the unitranche term debt is provided.
Unitranche margins may be structured as cash pay, however may also include an element of payment-in-kind (PIK) or PIK toggle depending on the transaction and the cash needs of the business following the financing. Documentation generally does not include a margin ratchet.
Priority and intercreditor relationship
As you would expect, the super senior working capital facilities and hedging are repaid first out of the proceeds of any enforcement recoveries. With the exception of this requirement, there is otherwise no 'standard' approach to intercreditor relationships in the context of unitranche financing, and documentation can differ markedly between deals.
Depending on the market and debt structure, intercreditor relationships in unitranche financing are either governed by a traditional intercreditor agreement to which the borrower is party, or an AAL, which operates like a traditional intercreditor agreement but to which the borrower is not a party. AALs are more common in unitranche financing in the United States, whereas a traditional intercreditor agreement is seen more often in European transactions. Although the Australian market is still in its formative stages, to date we have seen a preference for traditional intercreditor agreements over the AAL methodology.
If a super senior facility is provided, a traditional intercreditor agreement will generally be required and, as noted above, the super senior will take priority in respect of enforcement proceeds. However, as the super senior facility will normally represent only a small percentage of the secured debt on issue, in the interests of protecting their position, unitranche lenders seek to exclusively retain the ability to trigger enforcement, with the super senior lenders only granted limited enforcement rights following the conclusion of a standstill period. These standstill periods are generally shorter where the enforcement has been triggered by a super senior payment default or insolvency.
Key terms
Unitranche structures tend to be tailored to the individual transaction, and do not necessarily conform to a market 'standard'. That said, there are a number of common characteristics shared across the recent deals we have seen.
Call protection
As discussed above, as unitranche lenders prefer to lock in returns over a specified period, unitranche loans usually include some form of call protection.
The call protection can take the form of 'hard' call protection (where the borrower is not permitted to prepay for a specific period) or 'soft' call protection. The soft call protections used can include provisions whereby the borrower must pay a premium or 'make-whole' if it wishes to reduce overall leverage during the initial loan term (generally defined to be somewhere in the range of the first 9-24 months).
Covenants
Unlike the extensive covenant lists usually seen in senior/mezzanine facility agreements, unitranche covenant packages usually only contain a leverage covenant.
Transfer and assignment
Unitranche documentation contains the usual restrictions on lenders transferring and assigning their debt.
Concluding thoughts – the advantages of unitranche loans
Unitranche facilities can offer some compelling advantages for borrowers:
- Generally large underwrites/holds provided by lenders increases the certainty of funding and minimises engagement required with lenders.
- Simpler to document – one ‘set’ of documents can mean less negotiation, with future consents and amendments easier to manage.
- Given the smaller group of debt providers, can be quicker to execute and finalise documents.
- Typically only a single leverage covenant.
- Flexible (and often more relaxed) terms can be used to tailor transactions to individual borrowers – and can be very helpful in acquisition financing and when dealing with sub-investment grade borrowers.
- Longer term debt with limited amortisation presents opportunities for fixed returns for lenders and capital certainty for borrowers.
These attractive characteristics, combined with the increased pool of private debt funds in the Australian market, make unitranche structures worthy of consideration for prospective borrowers. However, it is important to note that notwithstanding these advantages, these structures aren't for everyone – higher pricing, call protection and, where relevant, AAL uncertainty for borrowers, are all issues that would require consideration on a deal-by-deal basis. That said, as the number of transactions funded by alternative debt providers increases in the Australian market, we expect the popularity of unitranche financing to grow.