Unitranche, Mezz or Subordinated – How does the Trustee add to your IRR?

Private credit managers (and your trustee!) are highly innovative when it comes to the design and execution of tailored finance solutions for mid-market borrowers.

Credit Cycle

Managers' strategies adapt over the credit cycle. Post GFC saw growth of Unitranche, while 2019 saw a pullback in Direct lending.

APAC Q1 2021 has witnessed several large private credit fund raisings with an emphasis on Special Situations and Senior Debt.

Trustee role

Across the spectrum of private credit strategies (ie. Direct Lending, Distressed Debt, Mezz etc.) the Trustee’s role remains fairly consistent.

An essential governance role that aims to: (i) avoid cash leakage, (ii) establish priority, and (iii) facilitate enforcement.

Deal mechanics

During deal document review your Trustee will be keen to ensure:

(i) Covenants are well defined (ie onerous vrs lite/loose etc).

(ii) Payment flows are unambiguous (ie. on majority lender instructions); and

(iii) Security/collateral is perfected and enforceable (ie. real assets, equities, bank accounts etc).

The various deal mechanics are then adapted to reflect the Managers' investment strategy.

Direct Lending

Although there was a pull pack in new commitments in 2020, Senior Debt continues to be popular in APAC in 2021.

In DL deals the Trustee and Facility Agent will variously: hold collateral, undertake payments and monitor/enforce covenants.

Mezzanine

Senior and Mezz lenders are protected by a common security package, while Mezz lenders are structurally/contractually subordinated.

The Trustee plays a key in holding security/collateral on behalf of lenders and administering waterfall and turnover payments.

Unitranche

Anecdotally less popular in APAC than in USA and European markets, the product was adopted post GFC as liquidity flooded the market.

The Unitranche structure (ie. term loan, bullet repayment, no amortizations, call protection, covenant loose/lite facilities etc) combines ‘first-out’ and ‘second-out’ lenders into a single security arrangement.

The borrower benefits from a blended interest rate (ie. higher than senior, but lower than junior debt). Sometimes the Unitranche arrangement will be accompanied by a Senior revolving credit facility.

For the Trustee, Unitranche deals might simplify its role due to the existence of only a single security package and loan document (compared with a traditional subordinated deal). However any interest sharing agreement between lenders may complicate Facility Agent’s role.

As industries adapt to a post-pandemic economy, private credit Managers (and your Trustee) will continue to evolve new ways to solve the classic ‘borrower’ and ‘lender’ frictions.