Sometimes it pays to keep it simple, and in middle market lending nothing says simple like the unitranche loan. Unitranche loans, which blend senior and subordinated debt into one instrument, began gaining popularity during the height of the financial crisis, serving as a replacement for the traditional financings then scant. Seeing the product’s long-term potential, Monroe Capital added unitranche loans to its offerings in 2011. Since then, the Chicago-based firm has seen a roughly 25% increase in deal flow, says Tom Aronson, managing director and head of origination at Monroe.
“Many potential borrowers will now come directly to us for financing and then have Monroe bring in the senior lender to fill in the capital structure,” Aronson says, “whereas historically the senior lender would contact Monroe to stretch its capabilities if it was unable to provide the full financing requested by its borrower.”
Today, of course, capital is plentiful, but the unitranche loan has remained popular with borrowers, proving its appeal beyond a credit crunch tool of last resort. Most often used to fund acquisitions or leveraged buyouts, financial sponsors and companies alike find the product attractive for a number of reasons, chief among them simplicity, surety of close and speed. The unitranche borrower works with one set of documents, with the senior debt and the mezzanine or junior debt melded together into one credit agreement, which makes both closing the financing and amending it much simpler.
“The financing markets have become very competitive in recent years, even the middle market, though we’ve escaped some of the craziness of the large-cap markets,” says Lee Stern, managing director at Monroe, who joined the firm this past May. “One needs to be responsive and move quickly. When we have financial sponsors looking to acquire companies, they’re usually in an auction process competing against other financial sponsors, and they like to know they have the whole financing package lined up. The unitranche makes it a more simple process in that they don’t have to negotiate with two or three different parties. They’ve got the certainty of the financing. It has become much more popular.”
Also contributing to the product’s continued popularity is tighter pricing. Unitranche yields have always fallen somewhere between cheaper senior loans and junior or mezzanine debt. But while the unitranche continues to be more expensive than senior debt, unitranche yields — once in the 9% to 11% area — have tightened to the 8% ballpark, and lower in many cases, according to research done by Forbes magazine.
Furthermore, unlike the typical lien structure where the cheaper senior debt is amortized first leaving the more expensive junior debt, with a unitranche loan, the borrower’s free cash-flow is paying down a blended cost of capital, which can reduce costs in the long run.
Monroe offers two types of unitranche financing — a straight cash-flow loan structure and an asset-based structure. The latter provides companies, primarily manufacturers, that have historically used an asset-based formula with additional financing when an ABL lender can´t provide as much capital as the need dictates, say, for a buyout or acquisition, or a dividend.
Monroe clients that have borrowed using an asset-based unitranche structure include Nashville-based Thermal Solutions Manufacturing (TSM), a provider of temperature control products for the industrial automotive aftermarket; FABCO Equipment, which sells, rents and services Caterpillar and related products throughout Wisconsin and Upper Michigan; and Temple, Texas-based MooreCo, a visual communication products, technology support equipment and office furniture manufacturer.
Under a unitranche agreement, the ABL lender “runs the revolver under an asset-based formula and, in some instances, a portion of the term loan as well,” Aronson says.
Of course, the integrity of a unitranche structure depends on it coming together as one document, so participating senior lenders need to feel at ease with a credit agreement that blends junior and senior debt.
“They need to be comfortable with another lender as part of the capital structure,” Aronson says. “The ABL lender may either be part of a bifurcated structure, which means they will have a split lien with a lender like Monroe or a first-out position. In a first-out position they need to get comfortable with a shared lien with another lender such as Monroe. If they can, we don’t mind expanding our partner base,” he adds.
One criticism of unitranche lending has been that it doesn’t allow the borrower to develop as deep or broad a relationship with the lender. But Monroe disagrees.
“Relationships are really built on individuals and teams within an organization responding to the client’s needs, whether it’s a sponsor or an individual company,” Stern says. “I have not found that the unitranche provider has a different relationship than a senior or mezzanine provider. It’s true that mezzanine players sometimes fill in when banks can’t stretch further, so it may be perceived that they have a different relationship. I believe it has nothing to do with the financing structure. What matters is having a responsive team who are able to work with the sponsor or company and give quick answers and deliver what they promise. I think that’s what borrowers respond to.”
Because I’m Happy (in the Middle Market)
Stern joined Monroe’s New York office in May in part because he was attracted to the firm’s broad array of product offerings and pools of capital. Monroe runs a publicly traded BDC, a direct private lending fund, a collateralized loan obligation and separate accounts. Stern’s role is to expand Monroe’s capabilities and relationships in the Northeast. “Having our capital across different asset classes permits us to tailor a solution to a particular client,” he says. “It gives us more tools to solve problems for clients.”
Stern began his career in the 1980s, working on middle market transactions for the infamous Drexel Burnham Lambert. Though he did not work directly with “junk bond king” Michael Milken, Milken’s ability to solve problems for clients in creative ways greatly influenced the firm, and Stern took that piece of creativity away with him, he says. After the firm collapsed in 1990 because of its involvement in illegal activities in the high-yield market, Stern went on to help form a U.S. merchant banking group for Japanese financial services giant Nomura, where he spent the next decade. In 2002, he was hired to form and launch a BDC, Technology Investment Capital, where he headed the firm’s transaction and origination business. TICC focused on providing senior debt to technology companies, which many financial institutions were not inclined to do at the time, he says.
From there, he joined newly formed GSO Capital Partners in 2005, where he continued his work on middle market deals until the firm was acquired by Blackstone, a company that was more inclined toward much larger transactions not typically found in the middle market. “They started to grow in scale and accumulate a huge amount of assets, and as a result, the size of the transactions they needed to do kept going up and up and up,” he says. His work at GSO led to an opportunity in 2009 to join competitor KKR & Co. and help raise the firm’s first mezzanine fund, which totaled $1 billion. “There, too, similar to GSO, the focus tended to be on the larger-size transactions, given the nature of the firm and types of companies they dealt with. We were looking to do very large mezz investments, and it’s harder to find those.”
Now, Stern is happy to have returned to his middle market roots and to have a variety of products to work with after doing largely junior mezzanine transactions for his former private equity employers. Monroe’s product offerings, in addition to the unitranche, include senior loans, cash-flow and enterprise-based term loans, acquisition facilities, mezzanine debt, second-lien or last-out loans, and equity co-investments.
“To have the ability to use senior debt as part of the solution, along with all of these other structures is very refreshing and exciting to me. In my short time at Monroe, my experience has been that the firm has a great product offering that’s very relevant to a wide range of companies,” he says.
Founded in 2004, Monroe has $1.6 billion in assets under management and has invested upwards of $2.5 billion in more than 500 transactions since its inception. Like Stern, the firm itself is quite content as a middle market specialist, though its business plan does include continued growth — most importantly, expanding the capital and flexibility of capital it provides to lower-middle market companies.
“As the firm continues to grow, we can work with our clients though a longer life cycle,” Stern says. “So it’s not like we do one transaction for a small company and then it grows and becomes too big for us. We can stretch small transactions into larger ones.”
Both Aronson and Stern see the current market environment as ripe for growth, with robust capital markets activity continuing throughout the rest of the year. This includes the asset-based lending industry. “All of the ABL folks that we deal with have said it’s a very strong market place,” Aronson says.
Carol J. Clouse is a freelance business and finance journalist and a contributor to ABF Journal.