MIDDLE MARKETISSUE

THE

Representing the Asset-Based Financial Services & Factoring Industries Worldwide August 12

IN THIS ISSUE:Done Deal: Junior Capital’s Role in Debt Financings P10

Challenges and Opportunities in the Middle Market P16

Reverse M&A: Structural And Legal Considerations P20

DEPARTMENTS:Collateral P6 / Policy Watch P24

UNCITRAL Update P26 / Brief P27 / Revolver P32

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D O N E D E A L : J U N I O R C A P I TA L ’ S R O L E I N D E B T F I N A N C I N G S

Junior capital has become an important component in many debt

financings and a vital source of capital to many middle-market

companies. How have its uses evolved and expanded in recent

years? What new types of products and structures are now available?

What are their advantages, challenges and potential pitfalls?

We invited four prominent leaders in the lending industry to discuss the

role of junior capital in today’s lending world. The roundtable participants

are: Cheryl Carner, managing director of Crystal Financial; David Gaito,

regional marketing manager and senior vice president of PNC Business

Credit, a division of PNC Bank, N.A.; Leonard Sheer, managing director

and head of Debt Capital Markets at Cowen & Company; and Timothy

Tobin, managing director of Corporate Retail Finance at GE Capital. The

discussion moderator is Peter Antoszyk, a partner in the Multi-Tranche

Finance Group of Proskauer Rose LLP.

theseCuRedlendeR August201211

D O N E D E A L : J U N I O R C A P I TA L ’ S R O L E I N D E B T F I N A N C I N G S

Junior capital has become an important component in many debt

financings and a vital source of capital to many middle-market

companies. How have its uses evolved and expanded in recent

years? What new types of products and structures are now available?

What are their advantages, challenges and potential pitfalls?

We invited four prominent leaders in the lending industry to discuss the

role of junior capital in today’s lending world. The roundtable participants

are: Cheryl Carner, managing director of Crystal Financial; David Gaito,

regional marketing manager and senior vice president of PNC Business

Credit, a division of PNC Bank, N.A.; Leonard Sheer, managing director

and head of Debt Capital Markets at Cowen & Company; and Timothy

Tobin, managing director of Corporate Retail Finance at GE Capital. The

discussion moderator is Peter Antoszyk, a partner in the Multi-Tranche

Finance Group of Proskauer Rose LLP.

Cheryl Carner

Timothy Tobin

David Gaito

Peter Antoszyk

Leonard Sheer

12 RegisteRnowfoRCfA’sViRtuAlAdVoCACyConfeRenCe,septembeR19-21,2012,www.CfA.Com/AdVoCACy

lenders can be very conservative. Then

there’s a sweet spot in the market, about

$75 million to $250 million of debt, where

a unitranche facility is underwritten by

one or two parties. This provides financing

certainty to an equity sponsor, eliminating

the need for a syndication process and

facilitating a buyout.

Carner: At Crystal, our junior capital

transactions have been used in all these

situations. Often, we see instances

whereby there is a term loan need that

exceeds a level as a percentage of the

total facility commitment that banks are

willing to provide.

Antosyzk (Moderator): Banks, commercial

finance companies, hedge funds, BDCs and

insurance companies have all been very

active in providing junior capital. Do you

see many differences in terms of their ap-

proach to pricing and underwriting?

Sheer: All of those funds have a similar

view of the world. The differences are the

quality and size of the credit. We generally

see banks financing the larger, higher-

quality companies with the cheapest form

of capital. The others do smaller, more

out-of-favor industries and companies, and

charge higher rates.

Antosyzk (Moderator): Cheryl, as a junior

capital provider, how does Crystal distin-

guish itself from competitors?

Carner: We try to be flexible and creative

in terms of how we structure our lien

positions and what types of asset classes

can support a loan. We’ve done bifurcated

collateral deals that Tim referenced earlier,

but there are some loans where we have

either a last-out position (e.g., FILO) or a

second lien. We have structured transac-

tions utilizing a wide variety of asset

classes, including machinery and equip-

ment, real estate, intellectual property

and pools of receivables. In addition, we

have been involved in more conventional

cash-flow facilities where we rely on the

enterprise value as the source of repay-

ment. Having all of these tools allows us to

work with companies on both ends of the

life cycle spectrum. Whether the use is for

buyouts, acquisitions and dividend recaps,

or for companies that are going through

some type of revitalization or transition.

Antosyzk (Moderator): We’ve talked about

the providers, now let’s look at junior capi-

tal structures. Which structures are most

prevalent in today’s market?

Tobin: In retail ABL deals where the junior

lender is underwriting a second lien se-

cured facility, we’re still seeing the second

lien lenders require that the combined

senior and junior debt stay within an

expanded borrowing base. Often the

second lien lenders are allowing advance

rates for inventory, and AR assets reach

the high 90s. Sometimes other assets will

be added into the second lien borrowing

base, including IP, which never would have

happened years ago.

Gaito: The bifurcated collateral structure

where the asset-based lender has the

accounts receivable and inventory while

another lender has the term assets, such

as IP or real estate, is becoming more

commonplace. Then there are traditional

first-in, last-out deals that are tranched in

many different ways. You generally have

an asset-based lender on top, who might

have a piece of the term, and then there is

another tranche or two between the ABL

and a true junior capital provider.

Sheer: In the high yield market, we’re see-

ing a preference for first lien, second lien

structures. If you’re looking to maximize le-

verage, you start with the second lien and

still retain an option to add an unsecured

debt tranche.

Antosyzk (Moderator): At Proskauer,

we’ve been very active, particularly with

“unitranche” deals. I find, however, that

the “unitranche” structure is not very well

understood. How would you describe a

“unitranche” and what are the advantages

of a “unitranche” structure?

Carner: Unitranches can generally be

characterized as either cash-flow or asset-

based-oriented. Instead of an execution

Antosyzk (Moderator): The use of junior

capital has evolved considerably over

the last five years. To set the stage, what

do we mean today when we speak of

junior capital?

Carner: Historically, junior capital generally

meant unsecured mezzanine debt. Today, it

is a much more nuanced term and can take

many other forms, such as a FILO tranche,

a second lien tranche or even a unitranche

facility. When I receive an inquiry for junior

capital, I first ask questions to understand

the need or objective of the financing and

can then assess how the various options

within the broad realm of junior capital

can fit what they’re really looking for.

Tobin: On a number of retail transactions,

in addition to the second lien on the inven-

tory, A/R and other borrowing base-related

collateral, we are seeing the junior lender

obtaining a first lien on IP, FF&E and other

assets that haven’t traditionally been in

the borrowing base. These so-called “split”

or “bifurcated collateral deals” are becom-

ing more commonplace.

Antosyzk (Moderator): Are certain types

of deals, industries or assets more suitable

for the use of junior capital?

Sheer: We’re seeing that dividend recaps

and LBOs tend to require the junior capital

component much more often than acquisi-

tions or financing for general corporate

purposes. Sponsors utilize junior debt to

maximize their leverage and minimize

their equity contributions.

Tobin: Alternatively, in addition to LBOs,

we see the use of junior capital as an ad-

ditional source of liquidity for companies

that have hit a bump in the road and who

need incremental funds to effectuate their

turnaround.

Gaito: We’re experiencing a growing need

for unitranche financing, which combines

senior debt and some form of junior capi-

tal, in two particular areas. The first is in

out-of-favor industries and/or in situations

with unusual collateral, including interna-

tional assets and IP, where many U.S.-based

theseCuRedlendeR August201213

provider, I expect that we are likely to have

some different concerns should operat-

ing performance deviate from plan. A

cash-flow lender may be more focused

on EBITDA leverage, while I’m always go-

ing to be focused on cash and liquidity. I

would expect an asset-based junior debt

lender to be focused on the borrow-

ing base and corresponding liquidity,

because, like us, they are likely to view

those assets as their primary source

of repayment. In either case, I look for

someone who trusts us to do our job as

the administrative and collateral agent.

Antosyzk (Moderator): Given that lenders

at different levels in multitranche financ-

ings have competing interests, their rela-

tionships are often governed by complex

intercreditor arrangements. How do you

approach these discussions?

Carner: Communication is critical. It starts

with clear definitions and an understand-

ing between both parties of their roles and

their respective lien or collateral positions.

Any misunderstandings in these areas can

cause a deal to go sideways or unravel.

When we’re in a junior position, we’re

very focused on our first lien partner as

the steward or agent of the relationship,

both in terms of dialoguing with senior

management as well as monitoring the

company’s collateral and finances. We

want to make sure that we have a high

level of comfort with their capabilities,

their thought processes and culture. It’s

also critical to have experienced counsel

on both sides, as they can make things

go much more smoothly.

Gaito: The interesting thing about these

arrangements is that they’re a zero sum

game. Whatever the senior first-out gets,

the senior second or last-out loses, and so

one of the critical issues is voting rights,

particularly in regards to liquidating col-

lateral. Who has the right to access the

collateral? Who can do what and when?

This issue becomes even more complicated

with a bifurcated collateral structure. For

example, say Lender A has a lien on current

assets and Lender B as a first lien on the

M&E. In the intercreditor agreement, Lend-

er A may seek a “use clause” from Lender B

to utilize the equipment to complete WIP

inventory or convert raw materials into

finished goods.

Another critical issue is when the

most risky piece can buy out the seem-

ingly least risky piece (senior first lien

debt). We don’t want someone holding

a buyout provision over our head on a

technicality.

Antosyzk (Moderator): So what becomes

tricky is negotiating triggers and what is

evergreen or expiring?

Tobin: Yes. Once again, this comes down

to the experience and character makeup

of the junior lender. On the ABL side, I also

want these agreements to give me the flex-

ibility to provide needed liquidity should

containing an asset-based loan plus a

high-yield tranche or a middle-market

cash-flow term loan plus mezzanine

debt, the borrower gets one facility.

Whether the unitranche is cash-flow

or asset-oriented, the benefits to the

borrower are one loan document, and

a simplified execution that generally

does not require a syndication. In addi-

tion, unitranches can often be more at-

tractive from a cost of capital perspec-

tive because amortization payments

are applied to the one tranche instead

of to the lower-priced term debt, while

the higher-priced mezzanine debt

remains in place.

Sheer: The groups that are leading uni-

tranche lending are doing large holds, and,

when combined with an asset-based loan,

the hold sizes are typically larger than

their commercial bank counterparts. You

can often team up and take down a fairly

substantial deal with two or three parties

raising their hands. A lot of these deals are

being won by groups that have worked

together; it’s a very small community.

Antosyzk (Moderator): Multitranche

financings necessarily involve close eco-

nomic relationships between providers of

debt capital. David and Tim: As the senior

lenders, what do you look for in a good

junior capital provider?

Gaito: Like everything in life, you want to

work with people whom you like and trust.

We can be fairly agnostic about the partner

for unsecured mezzanine in a sponsored

deal, because the sponsor is likely driving

that process. But as that junior piece gets

more active, our partner universe shrinks.

There are certain rights and agreements

near and dear to both parties’ hearts, and

you have to know that your partner is go-

ing to behave like you would if you were in

their position.

Tobin: I agree. Also, given that we are

sharing our collateral with another lender

whose interest may not always align with

ours, I want to see that the second lien

lender is providing appropriate additional

liquidity and flexibility. If it’s a cash-flow

“When we’re in a junior position, we’re very focused on our first lien partner as the steward or agent of the relationship, both in terms of dialoguing with senior management as well as monitoring the company’s collateral and finances.”

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our decision makers to hammer out a well-

defined structure. The next day we reached

an agreement and closed the deal in two

weeks. That never would have happened

if our communication had not been very

explicit and open.

Antosyzk (Moderator): Junior capital

providers had a boom year in 2011. While

this year started off less robustly relative

to the same time last year, things seem to

be picking up. What do each of you see for

the balance of 2012?

Sheer: While it’s true that overall debt

capital volume is down slightly year-to-

date 2012, 2011 was one of the most robust

years in a long time. And with interest

rates at 40-year lows and plenty of cash to

be deployed by all of the capital lenders,

on a year-to-date basis we’re still looking

at near-record volumes. Everyone wants

to put money to work, particularly when

you’re sitting on cash earning less than 50

basis points. Certainly for the foreseeable

future, say the next three to six months, we

anticipate a high level of transaction activ-

ity in the capital markets.

Tobin: We expect our retail lending

group will see more junior lending

opportunities for M&A in the middle

market for most of 2012.

Gaito: Absent a recession, I think the mar-

ket will be very robust in 2012, particularly

for junior capital or unitranche financing.

As Len mentioned, money is available for

the right deal. And because an election

year brings uncertainty, I think a lot of

groups will be going to market before year-

end to try to leverage up companies to a

reasonable level. Anecdotally, if you talk to

any kind of investment bank, many will say

their pipelines are stronger than ever.

Long-term unitranche financing also

can be a real growth area for us, as it

allows a bank to work with a junior

capital provider as a club participant. A

commercial bank can pick its leverage

entry point, price that amount of debt

at a lower cost and then allow the junior

capital provider, whose tranche carries

more risk, to layer in the more expensive

debt and earn its desired (higher) return.

This generally allows commercial banks

to stay in or enter a credit at what most

institutions would view as relatively

conservative leverage levels.

Carner: I, too, have a bullish outlook, and

would like to mention one other factor

that will create more opportunities for

junior capital providers. As the regulatory

climate becomes more restrictive and

requires higher levels of capital allocation

from traditional financial institutions,

bank debt will gravitate even more strong-

ly toward high-quality credits. Companies

having performance challenges or are in

the midst of a transition will find bank

capital less available and will therefore

seek out alternative financing solutions

that involve junior capital. I see this hap-

pening not just in 2012, but over the next

several years.

Antosyzk (Moderator): Thank you all for

participating and sharing your knowledge

and viewpoints. TSL

Roundtable participant contact information:

Cheryl Carner (ccarner@crystalfinco.com),

David Gaito (david.gaito@pnc.com),

Leonard Sheer (len.sheer@cowen.com),

Timothy Tobin (tim.tobin@ge.com),

Peter Antoszyk, (pantoszyk@proskauer.com).

the company get in trouble. It’s the com-

pany’s job to fight for flexibility in good

times, but we need to know that we have

the ability to provide funds which allow us

and the company to preserve and protect

our collateral, no matter what that does to

the borrowing base. Making sure we have

the ability to manage and fund a reason-

able sale process is going to be a priority.

Antosyzk (Moderator): We’ve talked about

the importance of clearly defining and

communicating the lien and collateral

positions and the challenges of inter-

creditor agreements. What are some of the

other potential pitfalls or hurdles that can

undermine multitranche deals?

Carner: The parties also need to have clear

understanding of the diligence process.

Who will be leading this? Is everyone satis-

fied with the resources or parties to be

utilized? On this point and the other issues

mentioned previously, the senior lender

and junior capital provider need to work

through the hot buttons upfront and nego-

tiate a path satisfactory to all parties.

Gaito: Intercreditors are very techni-

cal agreements, and it’s really hard to

understand where someone is coming

from unless you talk to them. For example,

PNC and Crystal were competing on a deal

last year for a 363-bankruptcy exit that had

to close in four weeks. Two weeks before

close, we concluded that we’d be better off

partnering and had an all-hands call with

“Long-term unitranche financing also can be a real growth area for us, as it allows a bank to work with a junior capital provider as a club participant.”