Ben Davis - Unitranche Financing
The corporate lending market has experienced substantial structural change in recent years. Traditional banks have retreated from the market, new challenger banks have emerged and alternative lenders have revolutionised the market by providing unitranche financing. But who are these alternative lenders, why is unitranche finance becoming so popular and what further developments can we expect to see in this part of the market?
Unitranche finance has come to be defined by the types of alternative lenders providing these facilities and their alternative philosophy to corporate lending. These institutions are non-bank institutional lenders such as ICG or new private debt funds such as BlueBay or Crescent. They seek to deploy capital on a long term basis and free of the regulations imposed by banks, and they are fast becoming the new relationship lenders in the European corporate lending market.
Why are private equity sponsors and corporates turning to these alternative lenders and their unitranche product for their debt financing requirements? Firstly, the answer is deliverability. They offer simplified credit approval processes, compressed timelines, larger hold levels and a fresh approach to assessing credit risk. This can simplify a process significantly and allow strategic objectives to be met. Secondly, they can structure transactions more flexibly – whether that be higher leverage, a reduced requirement for shareholder funding, greater covenant headroom or providing funding for further growth and bolt-on acquisitions. These flexibilities can drive growth in equity value and their advantages are becoming more widely recognised, notwithstanding the more expensive pricing associated with this type of financing.
Some commentators have queried whether alternative lenders will displace banks from the market completely. In the US, where the unitranche market originated, the share of the market taken by institutional (non-bank) lenders is c.80%. We’re not quite there yet in the UK or Europe, but non-bank lenders account for nearly half of mid-market lending in the UK. There will still be a role to play for banks in providing working capital facilities, hedging, ancillary banking lines etc, however we are witnessing a fundamental realignment in the market with improved options for corporates looking to raise debt finance.
What further developments will we see in the corporate lending market in the coming year?
The first very discernible trend is the launch of larger private debt funds, such as BlueBay’s €2.1 billion direct lending fund and ICG’s €3 billion senior lending fund last year. These jumbo funds give certain unitranche providers increased armoury to underwrite larger transactions and some can provide underwrites in excess of £200-300 million (which is a substantial increase on their original underwrites of c.£30-60m). This allows them to compete in a market otherwise dominated by traditional bank-led high yield and syndicated loan financings. ICG’s £155 million underwrite for Caledonia’s acquisition of Gala Bingo and Ares’ €250 million underwrite for Eurazeo’s acquisition of Fintrax are good examples of these larger deals. At the opposite end of the size spectrum, we are also seeing other private debt funds focus more on the smaller transactions and financing businesses with EBITDA of c.€5m upwards.
Secondly, the continued innovation and flexibility of private debt funds is driving the development of ‘blended’ unitranche transactions, where the unitranche facility sits alongside a cheaper term loan or ABL facility provided by a bank and thereby reducing the overall cost of capital for the borrower. These transactions can take the form of ‘first out/second out’ structures and what we are seeing is that each transaction is customised for the most appropriate capital structure.
The continued evolution of the market is also taking private debt funds further afield geographically. While unitranche is the dominant mid-market financing product in the UK and France, and continuing to take hold in Germany, we are seeing the unitranche product being accepted in new European markets, such as the Spanish, Benelux and Scandinavian regions.
There are exciting developments in the corporate finance market and the established presence of unitranche lenders is providing much needed liquidity and driving innovation in the lending market. Expect to see further developments as these alternative lenders adapt to suit the ever changing requirements of borrowers.
Ben Davis, a partner at Reed Smith LLP, where he leads the leveraged finance practice.