The past decade has witnessed a profound change in the financing climate for sponsor-backed companies and other leveraged borrowers. In a financing market once dominated by banks, alternative credit providers have managed to gain a robust position, driven by a low interest rate environment and stricter capital requirements regulation for banks, among various factors. In line with this development, alternatives to traditional bank lending have become increasingly available to leveraged borrowers, with the Term Loan B, the Unitranche, and High Yield bonds entering centre stage.
Despite growing similarities between these instruments, each still has its own particular features and drawbacks. This means that choosing the most suitable financing option requires careful analysis and planning as well as upfront discussions with various groups of potential financiers. This article compares the key features of these products and can serve as a starting point for borrowers.
Term Loan B
The Term Loan B (TLB) is a form of term loan financing typically provided by institutional investors (such as CLOs, debt funds, pension funds, and insurance companies) instead of by banks, and documented in the European market in an LMA-style facility agreement. One or more banks normally act as Mandated Lead Arrangers and Bookrunners and agree on the terms before starting a broad syndication process. As such, TLBs have certain capital market elements, often including substantial "flex rights".
TLBs have a maturity of five to seven years and often have minimal amortisation (1% of principal per annum, if any) before a bullet repayment on maturity. These features distinguish the TLB from the Term Loan A, which typically amortises in full over the life of the loan and is traditionally held by one or more banks. In addition, TLBs often allow borrowers to incur substantial additional debt, whether under the terms of the facilities agreement or as side-car debt. These features allow the TLB loan parties to focus on growth instead of on servicing debt payments. As a result, it is a popular product with sponsor-backed companies and an attractive option for investors seeking longer-term financing. In terms of pricing, TLBs are significantly more expensive than the Term Loan A, but cheaper than both the Unitranche and High Yield Bonds.
Over the years, convergence has occurred between the terms of TLBs and High Yield bonds. Pivotal to this development is the growing role of institutional investors in the leveraged financing market, since they are typically more familiar with High Yield bond documentation than (LMA) bank documentation. The increasing flexibility in TLB terms is especially visible in the financial covenant terms. Where a typical bank deal includes four financial covenants tests – a leverage ratio, interest cover ratio, debt service cover ratio, and capital expenditure limit – most TLB deals only include one or two financial covenants (cov-loose) or, sometimes, none at all (cov-lite). This flexibility can be an important draw for the TLB, but whether a cov-loose or cov-lite transaction is feasible depends on the circumstances of each case.
A Unitranche is a single tranche term loan that combines senior and junior debt into one facility. It has a single "blended" interest rate, which combines the separate rates of the senior and junior components of the loan. Unitranche loans are usually documented in a single loan agreement and are provided by non-traditional lending entities (often debt funds). Although Unitranche loans are often provided by a single lender on a bilateral basis, they can also be provided by a group of lenders or sold down by the original lender. In such multi-lender cases, the lenders often take on different levels of risk (which is reflected in the pricing they receive) and set the arrangements between them in an agreement among lenders and not in a customary Intercreditor Agreement as seen in the bank financing, TLB or High Yield Bond context.
Unitranche facilities feature minimal (if any) amortisation and more flexible terms than bank facilities, with most direct lending deals being "cov-loose" and providing the borrower with significant additional debt capacity. Similar to the TLB, the Unitranche product is therefore an attractive option to investors seeking to make acquisitions. Executing Unitranche deals is often more efficient and less costly than the execution of bank financing or TLB deals, due to the limited documentation required and the often small number of transaction participants. A clear disadvantage for borrowers is that the blended interest rate that applies to Unitranche loans is comparatively high, though still lower than the interest rate that applies to unsecured High Yield bonds (but similar to or higher than the interest rate that applies to senior secured High Yield bonds). In addition, the borrower is not aware of the existence or terms of any agreement among lenders (if any), which can cause complexities in a restructuring context.
High Yield bonds
High Yield bonds are debt securities issued by non‑investment grade issuers to institutional investors. High Yield bonds feature a bullet maturity, generally flexible terms and limited covenants (typically cov-loose or cov-lite). High Yield bonds often support a relatively high leverage ratio, and their default provisions are typically more lenient than for term loans, such as the TLB or the Unitranche. Issuing High Yield bonds furthermore allows issuers to access a very large investor pool. Since High Yield bonds are securities, issuers must take into account any applicable securities laws (including the U.S. Securities Act 1933).
An important difference between High Yield bonds and term loans concerns the commitment provided at the outset. In the case of a term loan, one or more lenders may commit to provide the loan against pre-agreed pricing and terms, subject only to limited adjustments if needed for syndication purposes. In the case of High Yield bonds, investors only commit to placing or underwriting the bonds, while the pricing risk remains with the issuer. The pricing is generally set around a week before closing of the transaction and depends on the appetite of investors in the market. High Yield bonds are characterised by a high interest rate, especially when unsecured. Other disadvantages of High Yield bond deals are that they typically include significant call protection, are difficult to amend once in place, and require a lengthy and costly documentation process, including extensive disclosures and a roadshow.
Combination with revolving credit facility
Since institutional lenders do not typically provide working capital facilities, the TLB, Unitranche and High Yield bond products are sometimes accompanied by a revolving credit facility (RCF) provided by a bank. This is already a well-established practice in High Yield bond-backed deals, but is also becoming increasingly common in term loan deals. Borrower appetite for RCFs is particularly high in an acquisition scenario, where the amounts borrowed under the TLB, Unitranche or High Yield bonds can be applied towards payment in full of the purchase price at closing, while the RCF provides working capital for the target group.
There is an imbalance between the demand for and supply of RCFs, as making (undrawn) RCFs available is not very profitable to banks and restricts their ability to lend capital elsewhere. To make the RCF product more appealing, the RCF is often included in the leveraged capital structure on a supersenior basis, ranking ahead of pari passu debt (such as the TLB, the Unitranche or High Yield bonds) and having priority in relation to the proceeds of security rights enforcement. The terms of the super senior RCF are relatively well established in the market, and the rights and obligations of the different lenders are governed by a separate intercreditor agreement.
In view of the increasing convergence between the TLB, the Unitranche, and High Yield bonds on the one hand, yet their substantial differences on the other, a thorough assessment of the financing options available is becoming both more essential and more complicated. We recommend that borrowers map optionality and timely engage counsel if they wish to enter the leveraged financing markets - especially if they are a first-time issuer.
Click here for a table setting out the key features of each instrument.