The Many Faces of Unitranche

Once upon a time, it was so simple.

A single institution decided to lend a borrower all the capital they needed. And even though some of the debt was provided in the form of a revolver that could be accessed periodically, and the remainder in the form of a term loan, the lender instructed his lawyer to document the loan in a single agreement to keep matters simple.

Thus, the unitranche was born. But fast forward to today and this simple concept of a unitranche loan has evolved into a variety of structures, all continuing to call themselves “unitranche”. For starters, most unitranche loans now find themselves behind a revolver and are often referred to as split collateral financings. These structures, which were designed to decrease the overall cost of capital, often use an asset based lender to provide the borrower with a revolver secured by the company’s accounts receivable and inventory, with the term loan (or unitranche loan) getting a first lien on all the remaining assets and a second lien on the accounts receivable and inventory.

Because this term loan encompasses both what a senior lender and junior lender would lend, it results in more capital than either type of provider would lend individually and is considered a unitranche loan. But not everything is always rosy when it comes to putting a unitranche facility into place. The intercreditor agreement in a split collateral financing is normally more difficult to negotiate than a traditional senior cash flow/mezzanine intercreditor agreement because, not only does the unitranche lender require no payment blockage and a very limited, if any, remedy standstill, but disputes over many other issues including the right to liquidate collateral, the ability to provide DIP financing, and buy out provisions, are often hotly debated. And, sometimes things can get even more complicated.

Increasingly, either because borrowers lobby for a lower interest rate, or because the unitranche lender decides that the stated interest rate on his loan isn’t high enough, the unitranche lender enlists the asset based lender to help him out by suggesting that, in addition to providing the revolver, the ABL lender also provide a first-out tranche to the unitranche/term loan. This ability to “tranche the unitranche loan” not only results in a lower interest rate to the borrower (compared to what the unitranche lender would otherwise have to charge to meet its desired returns) and a higher rate to the last-out provider (compared to the stated interest rate of the unitranche loan), but it also results in complex legal documentation and, potentially, a different outcome down the road for a borrower. Interestingly, all three forms of unitranche loans are in vogue today.

Because of the continuing difficulties of forming traditional senior cash flow loan syndicates, the variety of unitranche alternatives is a welcome addition for middle market financings. In fact, the higher hold size of most unitranche providers compared to their senior lending brethren, and the flexibility on key terms (such as prepayment penalties, amortization, and even covenants), make the unitranche loan a very attractive alternative to traditional financings. And, with the continuing decrease in active CLOs making it more difficult for many middle market companies to obtain senior cash flow debt, and the increase in the number of active unitranche providers, such as BDCs and credit opportunity funds, unitranche loans should continue to represent a significant and growing percentage of all outstanding loans.

But next time someone tells you they are going to provide you with a unitranche loan, you just may want to ask them, “Which kind?”

Ron Kahn is a managing director at Lincoln International.