The New Loans for Middle Markets: Unitranche
Here’s a word you may have never heard before: unitranche.
While it may sound like something you could contract in a jungle environment, it’s actually the name for a newly popular hybrid loan, mostly aimed at middle market companies and private equity buyout shops.
Unitranche loans simplify the use of subordinated debt, cut through the paperwork for borrowers, and may offer many companies a lower cost of capital. But they also provide borrowers with less transparency about the rights and identities of their lenders.
The traditional structure for middle market term lending involved two sets of lenders and two sets of documents and legal filings. Lenders with first liens on collateral and lenders with second liens on the collateral were included in the credit facility but were documented under separate credit agreements and collateral documents. The two sets of lien holders and the borrower would sign onto a single “intercreditor agreement” that sets forth their rights to payments by the borrower and control of collateral in the event of a default.
Unitranche loans simplify the documentation. There’s just one credit agreement and a single set of collateral documents. Instead of an intercreditor agreement, the lenders sign onto an “Agreement Among Lenders” that sets which lenders get paid in which order. Basically, the AAL slices the single loan up into tranches for the other investors.
Because the documentation is so much simpler, unitranche loans can be put together quickly. This saves time for borrowers, who would usually rather be running their companies than negotiating complex loan arrangements. And it saves everyone money on lawyers.
There is a reason for caution, however. The borrower isn’t a party to the AAL. The exact rights and identities of some lenders may be opaque to some borrowers. And that could make it more difficult for a borrower to renegotiate provisions of the agreement or have some covenants waived.
Another drawback: Some provisions of the unitranche deals have yet to be tested in the courts. Three of my old colleagues recently wrote about this problem:
“The enforceability of key provisions of the AAL has not yet been tested in bankruptcy. Just as intercreditor agreements raised questions about the rights of the first-lien lenders and the second-lien lenders in the event of a borrower’s bankruptcy, AALs are likely to raise a number of unique issues in bankruptcy courts,” Michael Friedman, Nicholas A. Whitney and Keith N. Sambur of the law firm Richards, Kibbe & Orbe recently wrote.
Critics of financial innovation will no doubt be wary of these loans. But increasingly, borrowers and lenders seem comfortable taking and making unitranche loans.