Q. So this refers to a pretty big new trend in middle market PE transactions… what is it?
A. To explain this one, let’s first step back and look at how most large corporate loan financings are done today. Historically, banks just made one big loan to a company for what it needed. But then things got more sophisticated, with different “tranches” of debt: a senior piece, which is secured and carries a pretty low interest rate as a result, and a junior piece, which is unsecured and carries a higher interest rate. That combination usually results in the lowest total interest rate for the borrower.
Q. So something tells me that “unitranche” must therefore combine these different kinds of loan into a single facility…
A. Yep. It’s another case of “back to the future” in finance. With a “unitrache” loan the lender makes one big loan to the company that covers what otherwise would be both the senior secured and junior unsecured tranches… just like used to happen in the old days.
Q. Why? What’s driving the trend?
A. Several things. First: simplicity, time, and legal structuring costs. We’re talking middle market and smaller companies here. When you do a senior and junior tranche, there are very complicated intercreditor agreements to negotiate between the different lenders and the company. In many deals, its just not worth the trouble.
Q. And who’s making these loans?
A. One big source is BDCs– the “junior varsity” PE firms that are publically traded, which means this is one source of decent income for a lot of investors who want to stick to publically traded securities. But a lot of midmarket PE and SIBC funds are, too.
Q. And then what? Do they just hold the loans to maturity?
A. That’s actually a very interesting point. Often, the PE firms will turn around and essentially do a mini-securitization themselves, selling off senior parts of the loans to… banks that are hungry to put dollars to work, but don’t have the infrastructure to find and make these loans in the first place. It’s one way banks are getting back into the lending game.
