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).

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.

Pros and Cons 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 it deals with a single lender and thus streamlines the documentation process, saving time and legal fees and enhancing the flexibility of the private equity sponsor of the LBO to close the transaction. In addition – should there be a need for credit agreement waivers or consents in the future – the borrower only has to turn to the single lender for execution.

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.