The role of language is to clarify, but it can often have the opposite effect when trying to keep up with the complexities of financial markets.
Shortly after the global financial crisis, unitranche started to become popular in the US market. Unitranche products were a useful tool for complex leveraged buyouts, where greater flexibility and higher leverage attracted sponsors. Simplicity was key as the senior and junior positions were moulded into a single tranche.
What was taking place in the US served as a blueprint in the European market, but the definitions have diverged. US structures typically refer to a stretched and bifurcated loan, involving an agreement among lenders which addresses, among other matters, which lender is to be paid first in an enforcement scenario.
In the UK, unitranches refer specifically to a bullet repayment structure providing extra turns of leverage, and which do not have a full set of covenants. A bank typically provides a revolver taking the super senior position over the term loan, and the facility can involve more than one lender.
For investors looking at strategies on both sides of the Atlantic, the problem lies in contemplating two markets divided by a common language, to reference George Bernard Shaw.
In the UK, many in the market have recently expressed concerns about the blurring of distinctions between unitranche and senior debt products – especially as a number of funds are managed by US firms. A recent report by bfinance estimated that the majority of senior debt funds are made up of 30-80 percent unitranche loans.
While the UK market saw a fall in the number of unitranche deals last year (arguably because of Brexit uncertainty), 93 were completed, according to AlixPartners. This was a drop from a high of 120 in 2015, but the firm reported a rapid increase in the use of the structure in France.
At this late stage of the cycle, senior debt funds are offering both stretched senior and unitranche loans to remain competitive. Where a stretched senior product offers speed and flexibility to a potential borrower, a unitranche loan can provide an extra turn of leverage. And by upping the gearing and blending the average in a unitranche structure, managers can obtain the returns expected from investors across their portfolio in a competitive market.
Where the problem arises, however, is the exposure to greater risk in the increasing prevalence of unitranche. Fund managers can still retain the senior position within the capital stack but, at higher leverage multiples, that position does not look as safe as it does on the surface.Without a concrete definition of either stretched senior or unitranche, investors are left to work out for themselves the risk profile of a senior debt fund.
Language evolves, but as the debt fund market finds itself getting tangled up in a hunt for yield, it is imperative for investors to work out the reality behind the words.