Ever since private debt emerged as a serious competitor to traditional underwriting, banks and direct lenders have been looking for ways to work together on bigger deals.
One shape this collaboration could take is a so-called “hybrid” structure — whereby high yield bonds or term loans sit alongside unitranche financing on a pari-passu basis — and this month one of the first examples of such a structure was seen with a deal from UK insurance broker The Ardonagh Group, where the unitranche remains the bigger tranche alongside a smaller bond portion.
Ardonagh’s three-part debt raise launched on Feb. 5, via a Morgan Stanley- and Goldman Sachs-led bookrunner group. It included $750 million (upsized from $500 million) and €500 million issues of seven-year secured notes via Ardonagh Finco Limited, and a $1 billion eight-year unsecured bond issued out of Ardonagh Group Finance Limited.
The transaction wrapped on Feb. 9 at the tight end of price talk, with the seven-year, dollar-denominated senior secured notes printing at 7.750%, the seven-year euro secured notes at 6.875%, and the eight-year unsecured dollar paper at 8.875%.
In this case, the deal came alongside renewed commitments from Ardonagh’s direct lenders, and will be used alongside proceeds from the sale of its retail business to refinance a £3.48 billion-equivalent unitranche.
The acquisitive broker — which has a history dating from UK insurer Towergate, but is now unrecognizable after more than 150 acquisitions — signed a record £1.5 billion-equivalent unitranche in 2020, but kept a publicly traded piece through a $500 million issue of 11.50% PIK-toggle bonds which it placed alongside the private debt.
“It’s a classic case of a deal which the broadly syndicated market can address now that rates are more attractive,” said a London-based portfolio manager. “They’ve always had to report for what is a tiny bond, so it’s a perfect company for banks to pitch to come back to the public market.”
Back to the future
There is also an example of a similar structure in the past, when Ardian-owned Biofarma supported the acquisition of US Pharma Lab with a hybrid bond and unitranche structure. Goldman Sachs AM, CVC Credit, Apollo Credit and KKR Credit all provided a cov-lite unitranche of roughly €330 million in this case, which sits in the borrower’s capital structure with a €345 million high-yield bond.
At the time the deal was likely the first of its kind, but the bonds here had a higher quantum, and would be repaid first if any problems arose. Biofarma Group is an Italian specialist in the development, manufacture and packaging of supplements, medical devices, probiotic-based drugs and cosmetics, exclusively for third parties.
“Despite the increase in syndicated loan market activity, which is largely down to the availability of CLO dry powder, these hybrid structures may well become popular as a powerful blend of products which offer sponsors additional flexibility in larger capital structures,” said Aymen Mahmoud, partner at McDermott Will & Emery. “In particular, it is hard to imagine any slowing of what is a burgeoning private credit market, and anything that can work alongside private credit will be an attractive bet in the coming years.”
Currency factor
Private credit also holds an advantage for those borrowers with a need for less-liquid currencies.
Dependent on the fund, direct lenders are more likely to be currency neutral, so may not charge a significant premium to lend in denominations such as sterling, for example, which would typically come with a 150 bps to 200 bps premium in the syndicated loan market — and that’s assuming the liquidity is available.
There is deeper liquidity for the UK currency in high yield but the investor base here tends to be limited, meaning the associated bid is often patchy.
Market conditions
Furthermore, in periods when adverse market conditions are in play and high yield paper becomes difficult to price, then having a private creditor in the structure can offer certain advantages. “At the first sign of a bump, then you just go back to the private debt,” explained another source.
The real worry would come in times of credit distress, the same person noted. “Bond investors would not be concerned here, as they just want to capture fixed-rate bonds before they are going down. For that reason, we are going to see more of those hybrid structures.”
“However, these kinds of structures have not really been attempted much before, and it’s therefore questionable whether all the necessary thinking has been done in regards to crucial aspects such as intercreditor agreements,” the source added.
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