Bifurcated unitranche vs 1L/2L

From my understanding, unitranche loans will be more convenient for the issuer. 

For the banks and bond investors who are making the loans, is the 1L/2L vs. unitranche structure that different for them? As in 1L/2L and first-out/last-out sounds fairly similar for the lenders. Is that the right way to think about it?

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Comments (7)

  • Prospect in AM - Equities
Nov 30, 2020 - 10:50am

Because both FO and LO are technically invested in the same piece of debt, they are counted as pari passu in payment order but only different in waterfall. Hence, compared to a traditional 1L/2L where the payments are made separate, one payment is made for the unitranche facility altogether. Theoretically, if there aren't cross-default covenants, then in the case of a traditional 1L/2L the borrower could default on the coupon of the 2L without affecting the 1L, whereas you can't do that with the unitranche. What this also means is that the FO and LO will always mature at the same time, whereas with 1L/2L you can have different maturities.

  • Intern in PE - LBOs
Nov 30, 2020 - 11:46am

Thanks for the response. Would direct lenders prefer that the issuer can't default on the loan without defaulting on the bank loan?

Just thinking from the lender's perspective. They're still getting paid (about) the same amount whether it's 2L or LO so it doesn't make too much of a difference to them?

Most Helpful
Nov 30, 2020 - 2:04pm

Unitranche (FO/LO) vs. 1L/2L TLB - Will answer in more detail, but additional considerations to hit on:

Considerations -

  • Leverage @ FO/LO, partner w/ banks (who can also provide the Revolver), Intercreditor vs. AAL, No Syndication risk, financial covenants, tenor, prepayment premium, non-sponsor vs. sponsor, non-rated vs. rating, tighter docs (EBITDA add-backs capped), etc.

Also - 2L more often seen in Sponsor deals (LBO), less-often in non-sponsored.  Unitranche - seen in both, but an additional solution in non-sponsored (HPS, Ares, Comvest, Owl Rock).

Tenor -  Direct Lending/Unitranche - 5yr / vs. 1L 6-7yr and 2L 7-8yr

Financial Covenants (Unitranche - 2+ vs. 1L/2L - cov-lite or middle market 1-2) . Unitranche will have at least 2 covenants , often 3+ depending on how storied the credit (1) Leverage (w/ heavy step-downs - For Exmaple - Manitex - Total Lev: 5.00x at closing, step-downs to 2.85x, for total step-downs of 2.35x turns of lev), (2) FCCR, and often more (3) Secured Lev, Liquidity, etc.) vs. 1L/2L - cov-lite or middle-market will also have covenants, but more often a Total Lev and Interest Cov. ratio, vs. Unitranche less so does Interest Coverage Ratio.

Prepayment penalties - heavier, altho sometimes less-so (but often at least 102, 101 or NC1, 102, 101 to give certainty of ecomomics).

Amort - Unitranche is heavier vs. 1L - !% (more for middle market) , 2L - none

Unitranche (FO/LO) - leverage @  attach point -(2.0 / 4.0x) - where banks can get approved + direct lenders can boost returns meet their hurdle rate

Unitranche - bank such as PNC, Wells, CapOne, often partner w/  Institutional Lender - often they've done deals w/ them in the past and will see eye to eye on the docs, structure

Intercreditor Agreement vs. Agreeement Among Lenders

Intercreditor Agreement (1L/2L), with separate Loan Agreements -  1L CA + 2L CA = 3 legal docs

Agreement Among Lenders (AAL) + CA = 2 legal docs

Hopefully that gave you additional stuff to think about. Happy to delve further, send you some materials or examples.

If anyone disagrees, or wants to add, please weigh in.

  • Intern in PE - LBOs
Dec 1, 2020 - 12:54am

Thanks for the detailed response. I am an undergrad non-finance major reading up on various debt primers and this is very helpful. Just wanted to ask for some clarification:

1. Intercreditor Agreement vs AAL: what are the implications of 1 additional legal doc? Does it slow down the process? Does it make a huge difference?

2. Non-rated vs ratings: do you mean unitranche loans don't need to be rated vs 1L/2L must get ratings?

3. Higher prepayment penalty: what's 102/101/NC1?

4. Which one has a higher attach point?

5. Could you explain the step-down a bit more in terms of multiples? I've only seen it in % before so bit lost on that example (Manitex - Total Lev: 5.00x at closing, step-downs to 2.85x, for total step-downs of 2.35x turns of lev)

6. Do you mean HPS/Ares/Comvest do unitranche for non sponsored deals?

Dec 1, 2020 - 1:08am

i'll answer the rest another time, some less important tthan others.

3. "Prepayment Premium" /  Call protection  - explanation

  • Term Loan A - no penalty
  • 1st lien TLB - 101 soft call only in repricings for 6 months
  • 2nd lien TLB - 102, 101
  • Unitranche - 102, 101 (minimum), often heavier prepayment penalties
  • Example: NC1, 104, 103, 102, 101 (Non-call - 0 to year 1, 4% fee - Y1-2, 3%, 2%, 1%)

see language below -n after NC1, as part of definition of:

"Prepayment Premium"

  • (ii) if such Prepayment Event occurs on or after the 12-month anniversary of the Closing Date but prior to the date that is 24 months after the Closing Date, a prepayment premium equal to 4.00% of the outstanding Loan Amount subject to the Prepayment Event;
  • (iii) if such Prepayment Event occurs on or after the 24-month anniversary of the Closing Date but prior to the date that is 36 months after the Closing Date, a prepayment premium equal to 3.00% of the outstanding Loan Amount subject to the Prepayment Event;
  • (iv) if such Prepayment Event occurs on or after the 36-month anniversary of the Closing Date but prior to the date that is 48 months after the Closing Date, a prepayment premium equal to 2.00% of the outstanding Loan Amount subject to the Prepayment Event; and
  • (v) if such Prepayment Event occurs on or after the 48-month anniversary of the Closing Date, a prepayment premium equal to 1.00% of the outstanding Loan Amount subject to the Prepayment Event (such amounts described in clauses (ii), (iii), (iv) and (v) are herein referred to as the "Repayment Premium").

#6 HPS / Ares / Comvest - yes. they do  non-sponsor

Ares:

  • "Ability to Commit $500mm+in a single transaction"
  • 13% of portfolio to non-sponsored companies"

5. Financial Covenants (step-downs)

Example below

(b) Leverage Ratio. Maintain as of the end of each fiscal quarter, a ratio (the "Leverage Ratio") of Funded Debt, calculated as of such date, to
EBITDA, measured for the period of four fiscal quarters then ended, of not greater than the ratios set forth below for the applicable fiscal quarter then
ending:

Fiscal Quarter Ending /  Maximum Leverage Ratio
March 31, 2017 and June 30, 2017 5.00 to 1.00
September 30, 2017 and December 31, 2017 4.75 to 1.00
March 31, 2018 through and includingDecember 31, 2018 4.00 to 1.00
March 31, 2019 through and including December 31, 2019 3.50 to 1.00
March 31, 2020 through and including December 31, 2020 3.00 to 1.00
March 31, 2021 and each fiscal quarter thereafter 2.85 to 1.00

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Dec 1, 2020 - 3:09am

Uniranche vs. 1L/2L

  • -limited # of parties
  • larger DDTLs - important for borrowers with tuck-in acquisition strategy
  • -no intercreditor complexity (AAL)
  • -higher WA cost of debt than 1L/2L (often) - varies tho
  • -limited investor base
  • -not as receptive to repricing compared to syndicated 1L
  • harder to get cov-lite structure
  • tenor: 5yr vs. 1L 7yr
  • Ratings - 1L  TLB / 2L -- need ratings (CLOs - largest investor, need a rating).
  • Non-rated deals - typically add a premium to pricing of ~50-75 bps for NR/NR, altho depends on deal (illiquid, smaller investor universe). 
  • 1L / 2L - slightly more ardous execution process - syndication requires creating Lender Pres, CIM, and RAP if rated. 

DDTLs w/ Direct Lenders:

  • While direct lenders are particularly sensitive to the terms under which additional debt may be incurred, they are, especially for borrowers with an acquisitive investment thesis, often willing to provide significant committed post-closing incremental financing in the form of delayed draw term loan commitments. While this feature is available in the BSL market, the conditions are typically more restrictive – for example, limited to funding specifically identified acquisitions that are scheduled to close within a relatively short period (typically six to 12 months following the initial funding) – and it is still generally disfavoured by institutional lenders seeking the yield certainty of fully funded investments.

Selected Challenges of Direct Lending

1) Revolvers - fund on short term notice

  • a borrower's desire for flexible and readily accessible revolving credit and letters of credit. This ability has long been a mainstay and competitive strength of commercial banks, and while many direct lenders have made strides in providing this critical function, it still represents a challenge to their ability to compete in this part of the financing market. In particular, direct lenders historically – and, in certain cases, still – fund borrowings by calling capital from their investors and/or borrowing under fund-level credit facilities. The time it takes for lenders to do so, however, may be inconsistent with a borrower's desire for funding on short notice. More recently, direct lenders have attempted to mitigate this disadvantage by restructuring their balance sheets to ensure that cash is available in order to make revolving loans on short notice and finding creative ways to issue letters of credit, either directly or through an arrangement with an acceptable third  party provider.
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