Lev fin questions
1. What is the difference between a TLB and a standard unitrache (i.e. not synthetic with a super senior tranche / FOLO)?
2. is a gross leverage test preferable to a net leverage test as any cash reserves won’t disguise any EBITDA underperformance? In what situations would you want a gross or net test? (For the mid market)
3. How are covenant levels set? Is this set with headroom above the bank case (which would be a moderate inflationary case)?
4. is private credit still attractive as an asset class given leveraged structures still have relatively high risk and given the current rate environment where returns on cash are improving? Will margins have to increase dramatically to compete?
Others who are more experienced in the industry pls correct me if I’m wrong somewhere :
1) TLB is a BSL term, not really a DL term. A unitranche is a first lien senior secured term loan that is designed to go deeper than what a "normal" first lien would be. Basically, you replace a 1L/2L or 1L/Mezz structure with a single tranche of debt. Blend the pricing up given higher risk profile. Simpler to document and negotiate, higher yield, everyone wins. Behind the scenes, you could make it into a FOLO (enter into agreement among lenders that diverts the payment) if you wanted, but not required. Does not have to be one lender, plenty of club unis
2) Preferable from whose perspective? A lender would probably all things equal want a gross leverage test, but thats not very common and ultimately it would come down to what the respective levels are. Net leverage is far more common with a negotiated cap on cash that can be netted for covenant purposes.
3) Covenant levels are set through negotiation. Typically it is based on a cushion to the lender case. The levels are calculated by applying a "cushion" % of EBITDA lower than the projected EBITDA / debt levels. Commonly 30-40% cushions, but again negotiated and dependent on the starting leverage, etc.
4) still attractive asset class, plus its floating rate (unlike bond market which is getting torched, floating rate credit is just suffering). from an intrinsic value perspective, first lien, decent covenant packages, improving OID dynamics and solid absolute returns (>10% cash interest) given assumption of SOFR (~4%) + 650-700, lots of equity capital and debt capital still around to help support exit strategies (sale/refi) continue to point to attractive risk adjusted returns for direct lending.
Thanks! Had forgotten about club unitranche deals, saw a MM transaction financed that way. But we still had a single credit agreement (which all participants sign) as far as I remember!
All lenders in the same tranche (or there can be multiple tranches with different lenders) will all be in the same credit agreement. Usually there is a side letter that details each lender's upfront fees.
Thanks all! Appreciate your wisdom
Minor addition, but it is important to distinguish between mid-market transaction and large size syndicated deals. The latter has way looser terms, and you should expect by default no maintenance covenants; e.g. setting a net leverage covenant (gross leverage is not a thing - you will never see it) based on a model case is only something you will see for mid-market deals.
Just as an interesting read if you are into LevFin; take a look at some recent interesting transactions such as Stada. Understanding the concept of exchanges (cash upfront (perhaps in the form of OID), potential par paydown etc.) is going to be highly relevant as I guarantee you will be seeing more of those as issuers will have to tackle their upcoming maturities at some point. At the end of the day, LevFin is not only about LBO's - refi's are a big chunk of the deals.
A TLB is a publicly traded instrument. Banks underwrite them in an acquisition financing scenario but then markets / distributes them mostly to CLOs (up until the world blew up and markets shut and they’re now stuck with unsold paper - ie the « hung bridges »)
Realistically there is no TLB market right now except for the best recurring credits
The unitranche / DL is a completely different market, it’s a private market where banks are not involved and issuers (and their advisors) arrange directly with credit funds
Essentially that market has this year mostly « replaced » the public leveraged finance market (ie TLBs and HYBs) but the depth and size are not there
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