What is a Senior Stretch Loan?

A senior stretch loan is a type of hybrid loan structure offered primarily to middle-market companies to finance leveraged buyouts (LBOs). Similar to "unitranche" financing, the senior stretch loan combines senior debt and junior (or subordinated debt) into one package, typically at a lower average cost to the borrower than a separate senior loan and junior piece (mezzanine or second lien).

Key Takeaways

  • Senior stretch loans are hybrid loans used by middle-market firms to fund leveraged buyouts (LBOs).
  • These loans combine senior and junior debt into a single package and are named as such because they "stretch" to accommodate the borrower's financing needs.
  • The blended status of a senior stretch loan makes it higher-risk than conventional senior loans, requiring a higher interest payment to the lender.
  • This type of loan provides convenience and speed to for the borrower, as well as savings on legal fees.
  • For the lender, they get flexibility, as well as an increased risk because they're now exposed to the greater overall leverage of the borrower.

How a Senior Stretch Loan Works

Senior stretch loans "stretch" to accommodate the financing needs of the borrower, but at a higher risk to the lender than a conventional senior loan. With this higher risk comes a higher blended interest payment to the lender.

These types of loans have taken market share away from the traditional method of financing a leveraged buyout by securing a commitment for a senior loan for a portion of the total funding need, then obtaining junior debt in the form of mezzanine financing or second lien debt for the balance.

Senior stretch loans can be convenient for the borrower, but they involve greater risk on the lender's part.

Advantages and Disadvantages of a Senior Stretch Loan

For the borrower, the senior stretch loan provides speed and convenience. The borrower does not have to negotiate separately with two different parties, the senior loan provider and the junior loan provider.

Instead, the borrower deals with a single lender and thus streamlines the documentation process, saving time and legal fees, while also enhancing the flexibility of the private equity sponsor of the LBO to close the transaction. In addition, if there is a need for credit agreement waivers or consents in the future, the borrower only has to turn to the single lender.

Senior stretch loans have allowed smaller businesses to take advantage of financing that's previously been reserved for larger companies. These loans help small- and medium-sized businesses find the necessary mix of financing and bring together required specialty lenders.

However, the senior stretch loan presents additional risk to the lender because it is exposed to the greater overall leverage of the borrower. If a bank provides only a senior loan, it could be exposed to 4x debt-to-EBITDA, for instance, but with a senior stretch loan, the leverage might be 6x or 6.5x. Also, and related to the risk that comes with higher leverage, the single lender would stand alone without a syndicate to share the risk.