Demand for unitranche loans isn’t going away any time soon. Ease of use draws private equity firms to the structure, which combines senior and subordinated debt into one instrument and can sometimes be provided by just one lender (depending on hold size). Even though many financings are based on a floating Libor rate, they’re likely to remain popular even if and when interest rates rise.
“A lot of private equity buyout deals are unitranche now,” says Tom Lesch, head of Livingstone Partners debt advisory practice. PE firms can often close deals more quickly when they use the structure, because fewer groups are involved, and the documentation is simpler.
The ever-growing hold sizes offered by several mid-market lenders mean that money for many deals is coming from fewer groups. “We’ve seen some people hold north of $150 million,” Lesch (below) says. “They are raising larger debt funds and really need to put them to work.”
The loan class has another perk: blended amortization that comes out to less than that of a first-lien and second-lien combination, says Golub Capital CEO Lawrence Golub. Golub boasts a $300 million hold size. Working with a single lender can work in the borrower’s favor, assuming borrower and lender are on the same page. “We see many deals where the sponsor knows what the sponsor wants to do, but the first- and second-lien lenders disagree with each other, and that can be bad for everybody,” Golub says.
Investors’ continued interest in middle-market loans, driven by the search for yield, means that some lenders have been able to raise sizeable debt funds, which can contribute to generous hold sizes.
Heightened bank regulations have also built up the unitranche structure’s popularity. Now, banks that previously lent in the space sometimes hesitate. With that cheaper bank financing less available, borrowers have migrated from using a commercial bank loan plus a mezzanine loan, to the unitranche. If and when the U.S. Federal Reserve raises interest rates, which have been at record lows for years, the cost of unitranche loans will also increase, as many are based on the floating Libor rate, Lesch says.
But don’t expect higher rates to erode the popularity of unitranche loans. “They should be able to survive reasonably well in a rising interest-rate environment,” Lesch says.
For more on unitranche loans, see Lenders Line Up Loan Options.