Unitranche Loans and the Intercreditor Question

From the chief financial officer’s desk, a unitranche is the simplest financing a company can take on. There is one credit agreement to sign, one set of covenants to track, one agent to call when a question comes up, and one interest rate to budget for. The borrower does not have to reconcile a senior loan with a junior one, does not pay two sets of fees, and does not have to wonder which lender is going to object to a request. For a business coming out of months of sale process, that simplicity is the product being bought, and it is worth real money. The company is right to value it. It is wrong only if it assumes the simplicity extends past the agent to the institutions that funded the loan.

The problem hidden inside the single rate

The blended rate is an average. Behind it, the lending group has often divided the loan among its members into a piece that is paid first and carries a thin spread, and a piece that is paid last and carries a wide one. The bank or fund holding the first out piece is making a conservative senior loan. The fund holding the last out piece is making something much closer to a junior loan, with the risk and the return to match. The borrower pays the average and sees one instrument.

In a good year this split is invisible and harmless. Both holders are paid in full, on time, and neither has reason to think about the other. The trouble starts when the company weakens. At that point the two holders want different things, because they will recover different amounts.

The first out holder is well covered by the collateral. Its instinct is to move early, protect the value that exists, and accept a quick sale or a restructuring that repays it in full, even if that sale leaves little for anyone behind it. The last out holder sits near the edge of the collateral, where its recovery depends on the business being given time to heal. Its instinct is to wait, to extend, to fund a turnaround, and to resist any outcome that crystallizes a loss today. Both are behaving rationally. They are simply standing in different places in the same capital structure.

A company in trouble therefore does not face one lender. It faces two creditors who have privately agreed on how to disagree, and that private agreement is where the outcome is decided.

The mechanism, an agreement the borrower does not sign

That private agreement is usually called an agreement among lenders. It sits beside the credit agreement, binds only the lenders, and is often not shared with the company at all. It governs three things that matter in a workout.

The first is the payment waterfall. In normal times, interest and principal flow to both holders according to a set formula. After a trigger, typically a payment default, an acceleration or a covenant breach that goes uncured, the waterfall flips and all recoveries go to the first out holder until it is repaid. The trigger definitions decide when the last out holder stops being paid, and the last out holder will have negotiated hard over them.

The second is control. Someone has to decide whether to waive a breach, amend a term, release collateral, or begin exercising remedies. Agreements typically give the first out holder the power to direct remedies, often after a standstill period during which the last out holder can try to arrange its own solution. Voting on amendments is usually split so that certain changes, such as extending maturity or cutting the rate, need both holders to agree. The length of the standstill and the list of changes that need unanimous consent define how much patience the structure contains.

The third is the exit for the unhappy party. The most important clause in many of these agreements is a purchase option. It lets the last out holder buy out the first out piece at par, plus accrued interest, once trouble begins. The purpose is plain. If the junior holder believes in the turnaround and the senior holder wants to sell, the junior holder can take the senior out of the room and own the whole decision. A purchase option with a short window and a clean price is a real tool. One that is hedged with conditions is decoration.

There are other terms. Some agreements govern who may provide rescue financing and on what priority, how new money ranks against the existing loan, and whether either holder can sell its piece without the other’s consent. Each one shapes the negotiation that follows a default.

What to read, and in what order

Handed a unitranche position, I read the lender agreement before the credit agreement, because the credit agreement tells me what the borrower promised and the lender agreement tells me who gets to decide what happens when the promise breaks.

I start with the triggers. I want to know exactly which events flip the waterfall and whether any of them can be reached through a technicality, such as a reporting delay, rather than through real weakness. A waterfall that flips on a paperwork failure hands power to the senior holder at a moment when the business may be fine.

Next I read the control provisions. How long is the standstill? Can the senior holder release collateral or accept a sale without the junior holder’s consent? Which amendments require both? If I hold the last out piece, a short standstill and broad senior discretion mean my recovery depends on another institution’s patience. If I hold the first out piece, a long standstill and wide junior veto rights mean my safe loan can be held hostage.

Then the purchase option, with attention to the price, the window and any conditions. After that, the rules on transfers, because the identity of the other holder matters. A patient partner who plans to hold to maturity is a different counterparty from a fund that buys distressed pieces in order to force an outcome. A transfer clause that lets either piece be sold freely means the counterparty I underwrote may not be the one I negotiate with.

Last I read the provisions on new money. In a restructuring, whoever funds the company’s next stretch of cash needs usually gains the most influence. An agreement that lets one holder provide that funding at a priority above the other can reshape recoveries without any change to the original loan.

None of this is exotic. It is simply the document where a unitranche lender’s real rights are written down, and it rewards the same patience as any other part of a credit file.

The rate describes the loan. The side agreement describes the lenders.

The company still has its single loan, its single covenant package and its single agent, and in most years that is all it will ever need to know. What it never sees is the page on which its two creditors agreed, before the money moved, who would get to decide its future if the plan went wrong, how long the other would have to wait, and what price would buy the silence of whichever one disagreed.