The unitranche lending market has enjoyed a meteoric rise in the last three years. Data provider Preqin estimates European-focused direct lending funds raised around $50bn from 2013 to 2016. In Europe, individual deals have topped €600m, and pricing has compressed by some 200bp across the market to around 675bp on average since 2013.
Nonetheless, the market faces tough opposition to further expansion. Leveraged loans have great appeal for issuers, with strong CLO issuance and inflows into managed accounts driving pricing below 400bp and eroding deal terms viciously.
The unitranche product offers non-amortising, unlisted, unrated, and confidential credit, often with terms such as covenants and headroom tailored to individual borrowers.
There is also much faster execution, as deals have one facility agreement. A direct lender says he recently did a deal from start to finish in under three weeks. With few lenders involved, the product offers flexibility. Larger market players such as Alcentra, Ares and GSO Capital, for example, were all sole lenders in deals of over €200m in 2016.
However, this convenience does make the product, at 6% and above, more expensive than a typical syndicated leveraged loan, and it has gained traction predominantly among small and medium sized issuers seeking up to €250m of debt.
Rating agency Fitch says the conditions that led to the unitranche’s rise after the 2008 credit crunch are, if anything, now in reverse.
It cites the advent of negative rates and the Solvency II capital regime for European insurers as propelling capital toward leveraged loan funds, through managed accounts and/or CLOs. Leveraged loan pricing has dropped sharply since mid-2016.
“The product is used less and less for normal credit strategies and more and more for very credit-specific growth stories,” says Arnaud Martin, a director in principal investments at BNP Paribas in Paris.
Pascal Meysson, a managing director in Alcentra’s direct lending business, says unitranche is appropriate for acquisitive companies or those wishing to maximise internal cash flows and redirect them to growth.
“For a firm with a different cashflow profile or more modest expansion strategy it will probably be less appealing,” he says.
It is hard to persuade issuers to look beyond leveraged loans to unitranche. Fitch noted an average spread of 200bp between unitranche and leveraged loan pricing in deals it tracks, and a growing divide between the two on documentation such as covenants, which have become rarer in leveraged loans.
“We would probably walk away from considering a unitranche deal where we know there will be a very strong syndicated loan bid, in current market conditions,” Meysson says.
Steffen Wasserhess, head of non-investment grade and high yield syndicate at UniCredit in London, goes further. “Some issuers aren’t prepared to do it, regardless of the potential benefits,” he says. “The question as a borrower is: do you want to be exposed to only one lender?”
Meysson has been busy nonetheless. He recently closed a $245m unitranche deal for medical equipment firm Lumenis, offered financing for several deals of up to €350m in size, and his firm has just raised €4.3bn, bringing assets under management to nearly €6bn specifically for direct lending, locked in for at least six years.
Unitranche has senior and subordinated components, offering different yields to investors dependent on their risk appetite. However, the price to the borrower is blended into a fixed coupon, hence its name. Fitch notes a median tenor of six years in its portfolio of unitranche deals, which lenders typically hold to maturity.
Big deal
Demand from end investors is still strong in 2017, as Hayfin, another large lender, showed in February when it completed a €3.5bn funding round.
This is starting to filter through to deal sizes. The largest by some distance came last May — €625m from GSO Capital to finance the tie-up between US chemicals group Reichhold and Italian polymers maker Polynt. More blockbusters followed, with €475m for UK speciality biopharma firm Mallinckrodt and €350m for German hydrocarbons maker HCS Group, both also by GSO.
Meysson expects more. “We could see the €1bn mark be breached this year for a single unitranche deal,” he says. Credit market conditions will need to be volatile for such a deal to occur — conditions that gave birth to the market and in which it thrives — but, given the potential for political flashpoints in Europe this year, that is certainly plausible.
As private debt money is locked up for six to eight years, managers could continue to lend in volatile markets.
“Issuers could complete a large unitranche financing faster than they would do through the syndicated loan or bond market,” Meysson says. “This could for instance be attractive to a sponsor trying to complete an acquisition particularly quickly, or pre-empt in an auction.”