Unitranche pointing up Down Under

Australia is beginning to follow the US and Europe by embracing the structure. Adalla Kim explores why

Private real estate fund managers in Australia are becoming more accustomed to unitranche structures, not only through M&A transactions but also through debt financings.

In its market outlook for 2018 published in January, Partners Group, the Switzerland-headquartered global private markets firm, said it had seen increased demand for institutional unitranche debt in Australia over the past six months.

Brae Sokolski, chief investment officer at MaxCap Group, a real estate debt and investment firm based in Melbourne, tells Private Debt Investor he has recently seen unitranche structures in senior lending strategies.

“We recently lent A$100 million ($78 million; €64 million) to residential developers in Melbourne through the unitranche structure with 75 percent loan to existing value of the project ratio,” Sokolski says, adding that MaxCap had been mandated by an Australian superannuation fund to provide development finance through one of its real estate debt funds.

Daniel Erez, a managing partner at Brisbane-headquartered real estate manager Newground Capital, says around 60 percent of the requests he receives are for unitranche structures.

A structure like unitranche, where a single facility covers both senior and mezzanine tranches, means a single party at the negotiating table. This brings simplicity and an increase in the premium that borrowers are willing to pay for the facility, says Erez, whose firm has $385 million in projects under active management.

“From the lenders’ perspective, given their nature, they typically don’t want the money back from quarterly instalments. They prefer a single drawdown and single repayment at maturity of the deal,” says Richard Hayes, a Sydney-based partner at law firm Hogan Lovells.

“From the borrowers’ perspective, they like not having an additional drain on their cashflows, which frees them up for investment in their business and other purposes, rather than paying back their debt,” he adds, noting that having no loan repayments until maturity gives borrowers more flexibility.

When a borrower generates surplus cashflow, a portion of it will not be swept to repay the loan, but kept on the balance sheet under the unitranche structure, he says.

As banks retreat from lending to developers amid tightening regulatory requirements, more institutional lending deals are being backed by non-bank lenders, which are not subject to leveraged loan guidelines.

For instance, banks have been pulling back from lending to real estate developers since the Australian Prudential Regulation Authority, a financial services industry regulator, took a stricter stance on institutional lending in 2015.

10 percent constraint

APRA said in March 2017 that the annual growth rate of investor lending, which includes lending activities from all authorised deposit-taking institutions in Australia, had remained below 10 percent since October 2015.

“The 10 percent growth benchmark continues to provide an appropriate constraint in the current environment, balancing the need to continue to moderate new investor lending with the increasing supply of newly completed construction which must be absorbed in the year ahead,”  Wayne Byres, its chairman, said last year.

Erez explains that as recently as 18 months ago, developers could still access up to 80 percent of their development cost from the major banks. Now, it is down to 50 or 60 percent, creating opportunities for private credit lenders.

In addition to local non-bank lenders, a number of global players including Barings, ICG, KKR Credit, Partners Group and Bain Capital, are looking to replicate their unitranche success in Europe and the US, according to Hogan Lovells.

The firm published Unitranche: On the Up, Down Under in October, which aims to explain the growing appeal of the structure. Hogan Lovells said documentary flexibility is key, particularly in relation to covenants.

Edward Tong, a Singapore-based senior vice-president and head of private debt in Asia-Pacific at Partners Group, says the firm has exposure to a value-add strategy in the form of a construction financing deal to build out an existing shopping centre in Australia. Partners Group is active in providing senior-secured financing for construction projects.

“The leverage level [of unitranche structures] is generally in excess of 4.5x EBITDA and pricing is north of L+500 bps,” Tong says, adding that he underwrites based on hard assets’ collateral as well as the cashflowing income portion of buildings.

Unitranche is interesting because, for the same cost of capital, lenders can add more leverage and more capital, according to a Sydney-based real estate investment firm with over AS$5 billion in assets under management.

“For instance, within unitranche structures, it is possible to source capital with 80-85 percent less cost along with additional 10 percent leverage,” a managing director at the firm says, adding that his company has provided unitranche debt to developers in the construction phase.

As Hogan Lovells points out in its report, the structures are still in their infancy in the Australian market but on the rise.

“We expect to see some of the successful mid-market private equity firms here in Australia begin to adopt the unitranche structure to finance their deals, which allow for higher levels of debt and less onerous covenants,” Hayes notes.

The rising usage provides borrowers and lenders with greater flexibility as their deals are not subject to regulatory scrutiny despite higher leverage levels.

However, non-bank private lenders, including real estate debt lenders, should be wary of this flexibility as it can sometimes undermine the quality of their loan books.