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Unitranche Financing –The Global Market for Unitranche Debt

Structuring unitranche deals have gained traction in both the US and European middle market as investors and sponsors are financing more acquisitions with unitranche loans. Unitranche loans are highly valued by investors who need flexibility and lower cost of capital to execute transactions. The article will present the trends and outlook of unitranche loans as well as the recent transactions in the middle market for unitranche loans.

Trends

The emergence of complex models is a trend in the U.S. middle market for unitranche loans. Unitranche lenders are integrating a payment-in-kind (PIK) relative to cashpay in unitranche to increase returns. As a result, lenders have utilized unitranche loans to enhance returns without adding to the percentage of subordinated debt in portfolios.[1]

Alternative lenders are forming partnerships with funds to offer unitranche financing. Lenders are collaborating with private companies to co-invest in large cap deals.[2]

Innovation and flexibility of private debt funds is one of the emerging trends in the European market that is influencing unitranche transactions is. European private equity investors are engaging in unitranche transactions to reduce the cost of capital. Lenders in Europe are structuring cheaper term loans alongside unitranche loans for investors. The typical transactions are first-out/second-out structures where the bank maintains the subordinated margin, the first level of term debt, while the private debt fund secures the higher priced debt.[3]

Structuring unitranche loans is trending in Australia. In Australia, where unitranche deals are non-existent, institutional investors are engaging in unitranche deals to gain more flexible terms on loans. Unitranche deals are also gradually being introduced in Australia due to global yields and low interest rates. The trend of structuring unitranche loans in Australia is expected to increase as institutional investors become more comfortable with the debt instrument.[4]

Outlook

  • Unitranche deals will continue to develop complex models and be tailored to meet the unique needs of investors.
  • The volume for unitranche deals is expected to increase as investors become more comfortable with the structure and risks of unitranche loans.
  • Besides the UK, cross-border deals will increase in the future as unitranche loans are expected to grow in countries such as Canada and other European countries. Lenders in countries unfamiliar with the risks associated with unitranche loans need awareness of bankruptcy risks.
  • Multi-jurisdiction deals are expected to be executed as dealmakers from different countries collaborate in multiple jurisdiction. It is presumed that dealmakers will gain understanding about insolvency and bankruptcy risks as well as documentation for unitranche loans.
  • Unitranche structures that migrate to large cap markets may experience challenges from lack of standardization of documents and unitranche terms.[5]
  • Unitranche loans are expected to become as common as debt funds since more investors are financing acquisitions with this type of loan.[6]

Transactions

The middle market experienced an increase in first lien and total leverage multiples in 2017. The average first lien multiple in Q3 2017 was 4.6x compared to 4.1x in 2016. The increase in EBITDA multiples was due to a stronger unitranche bid, lower default rates and higher valuations by investors. [7]

Leverage

Source: Duff &Phelps

Leverage multiples in the US reached a historical peak in 2017. Unitranche loans experienced leveraged peaks during the first half of 2017 for first lien debt at almost 3 times EBITDA up from 2 times EBITDA from 2016. The peak in leverage was due to heated market conditions such as competition for market assets. Leverage also remained high due to low to no amortization with unitranche loans as sponsors and investors pushed for competitive margins on deals.[8]

                 Leverage Peaks in First Half 2017 Across Capital Structures

Source: The Lead Left

 

Although, a 2017 survey showed that almost 50% of investors are in favor of first/second lien structures, a third (27%) of the survey respondents reported that they favored unitranche loans. However, in 2016, almost half (50%) of investors favored unitranche deals. The downward shift to favor unitranche loans has been attributed to the covenants and time-consuming call protection.[9]

Sponsor Survey

Source: The Lead Left

 

Unitranche spreads dropped significantly during the first three quarters of 2017. The decline in unitranche spreads was due to the competitive structures for first lien and second lien loans.

Source: The Lead Left

European Transactions

In Europe, the trend to deploy unitranche debt in larger deals is increasing. Unitranche deals in 2017 increased by 12% to 244 deals from 2016. In H12017, unitranche loans represented almost a third (29%) of total deals in the middle market. The United Kingdom was the lead in unitranche deals in H12017 with 28 deals. Germany and Holland are also penetrating the middle market to secure unitranche deals as local market originators recruit them. HSBC continues to lead unitranche leads in the UK, although, companies such as Lloyds, SMBC and AIB have increased their deal counts.[10] The last twelve months (LTM) deal volumes reached 124 and increased by 32% from 2016. The increase in the deal volume was due to more senior focused approaches to raise capital and to compete with traditional bank financing. More investors in Europe also engaged in structuring unitranche loans to increase their deployment capabilities.

Improvement in the Irish economy also increased unitranche deals in Q2 2017. By Q2 2017, both UK and Irish lenders had developed a stronger appetite for unitranche structures. More than half (54%) of UK transactions and 47% of European transactions were unitranche deals.[11]

Source: Deloitte

Unitranche loans in Australia increased in 2017 for mergers and acquisitions (M&A) as investors became attracted to the recession free economy. For example, a $120million six-year unitranche by TPG Capital Asia was structured to purchase Novotech, and a $650 million six-year unitranche facility was structured by the Carlyle Group LP and Pacific Equity Partners to purchase iNova Pharmaceuticals.4

Conclusion

Many investors in both the US and European middle market are structuring unitranche loans to support M&As, private equity acquisitions and recapitalizations. Trends such as the emergence of complex models, lender partnerships and innovation and flexibility of private debt funds are influencing the development of unitranche deals in both the U.S. and Europe. The future of unitranche deals is expected to include more complex models, an increase in cross-border deals, multi-jurisdiction deals and challenges with standardization of documents. The US middle market has experienced an increase in leverage and EBITDA multiples due to aggressive investor bids for unitranche loans. Nonetheless, in the European middle market, the deployment of unitranche deals has increased significantly, and European dealmakers are becoming attracted to the structure of unitranche loans.

Sources

[1] FINAlternatives, Direct Lending: What’s Different Now? , Mar 14, 2017), http://www.finalternatives.com/node/34775

[2] Chambers & Partners, Banking & Finance 2018, (Updated Nov 20, 2017), https://practiceguides.chambersandpartners.com/practice-guides/banking-finance-2018

[3] Ben Davis & Reed Smith, The Evolution of Unitranche, ACQUISITION INTERNATIONAL, (Feb, 2016).

[4] Mariko Ishikawa & Ruth Carson, Australia Becomes New Testing Ground for Riskier New Funding Tool, (Oct 12, 2017), https://www.bloomberg.com/news/articles/2017-10-12/private-equity-giants-target-australia-with-hot-new-funding-tool

[5] Geoffrey R. Peck &Todd M. Goren, Morrison & Foerster LLP, Developments in Unitranche Financing (2016), THOMSON REUTERS, https://media2.mofo.com/documents/160800unitranchefinancing.pdf.

[6] Proskauer, Unitranche 2.0: A Global Revolution, (Nov, 2015), http://www.proskauer.com/files/uploads/PDI28_Proskauer.pdf

[7] Duff & Phelps, https://www.duffandphelps.com/-/media/assets/pdfs/publications/mergers-and-acquisitions/industry-inserts/private-capital-markets/capital-markets-insights-fall-2017.ashx

[8] TheLeadLeft, Leveraged Loan Insight & Analysis – 7/24/2017, (July 26, 2017),
https://www.theleadleft.com/leveraged-loan-insight-analysis-7242017/.

[9] TheLeadLeft, Leveraged Loan Insight & Analysis – 2/27/2017, (Mar 1, 2017), https://www.theleadleft.com/leveraged-loan-insight-analysis-2272017/

[10] PrivateEquityWire, AlixPartners report reveals significant rebound in unitranche deals in the first half of 2017, (Sept 29, 2017), https://www.privateequitywire.co.uk/2017/09/26/256467/alixpartners-report-reveals-significant-rebound-unitranche-deals-first-half-2017.

[11] Deloitte, Deloitte Alternative Lender Deal Tracker Q2 2017, (2017), https://www2.deloitte.com/content/dam/Deloitte/uk/Documents/corporate-finance/deloitte-uk-aldt-q2-2017.pdf

 

Jenn Abban contributed to this report.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
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