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PRIVATE FUNDS CFO: ALTERNATIVE FUND FINANCERS TO THE RESCUE, BUT IS IT ENOUGH?

April 23, 2020

Concentrated NAV lenders and preferred equity financers are seeing historic dealflow. But only a handful of alternative lenders exist, and banks active in concentrated NAV are scarce and rarely transact. With potentially thousands of funds looking for liquidity for their portfolio companies, will this rare source of fund liquidity be able to sate demand?

By: Graham Bippart

There are only a handful of players in the concentrated net asset value (NAV) lending and preferred equity financing markets, but since early and mid- March they’ve seen a tremendous boost in dealflow.

At Crestline Investors, managing director and senior portfolio manager Dave Philipp says dealflow is up some five to ten times historical levels. At Investec in London, banker Matt Hansford says he’s looking at more than one new concentrated NAV deal a day. One banker in New York, who declined to be identified because he didn’t have permission to speak to the press, says his team was seeing “multiples” on usual dealflow, adding that “we expect it to go up from here.” Pierre-Antoine de Selancy, managing partner at preferred equity financer 17Capital in London, told sister title Secondaries Investor last week that the firm saw $2.5 billion in dealflow – a quarter of 2019’s total – in two and half weeks. A week later that number hit $3.5 billion, he tells Private Funds CFO: “It’s not slowing down. If anything, it’s increasing.”

“It’s really just a ton of stuff we’re looking at,” says Doug Cruikshank, head of fund financing at Hark Capital, which primarily lends to mid-market sponsors (though it has lent to other asset classes), with a target investment size of $5 million-$80 million and target coupon of around 10 percent, according to its site.

Who, what, when, why?
With the turmoil in markets caused by the covid-19 pandemic, GPs and LPs alike are facing strains on liquidity. GPs are propping up their portfolio companies, many of which have seen their cashflows freeze up, with injections of cash from whereverthey can get it – existing fund equity, capital call lines, LP commitments. But with the GP-led secondaries market all but closed – and likely doing so for months as market multiples and EBITDAs become clearer. Banks are reportedly becoming more cautious in how much they lend and to whom, and with no end yet in sight for the confusion thrown upon economic activity, firms are looking more closely at rarer forms of fund financing.

Both concentrated NAV lending and preferred equity are considered niche forms of fund financing. While the latter has been around since before the crisis, concentrated NAV is relatively new. Traditional NAV lending tends to focus on funds with diverse portfolios (often large secondaries purchases, for example). In concentrated NAV, lenders make a loan to funds that are usually somewhere mid-way through their lifecycle, with generally 10 or fewer assets left in the portfolio, and most equity already deployed. Structures differ and maturities are flexible, but loans generally come in the one to five-year range, with bullet payments, often structured as payment- in-kind (allowing the borrower to preserve cash on hand, while being expensive enough to incentivize borrowers to have a goal and a timeline for the capital, and to stick to it). Lenders often have payment priority to LPs, or et seniority to all distributions if the loan defaults. Loans can be cross- collateralized with some flexibility to pull assets out of the pool, or not – it’s a highly bespoke market.

Borrowers are usually funds that need to make capital injections to portfolio companies, make distributions to investors in the case a realization event has been delayed, boost portfolio company growth or make additional acquisitions, among other things. They’re more expensive than most bank financing, which is most often on diversified portfolios. That said, a handful of banks other than Investec are or have been active – if infrequently and with varying risk appetites – and concentrated NAV lending tends be done by a different business line than diversified, like the leveraged finance or special situations desks. Keeping in mind significant differences in lending styles, multiple market sources say the odd bunch of banks that have been active in the market include: Goldman Sachs, JPMorgan, UBS, Nomura, Macquarie, National Australia Bank, Commonwealth Bank of Australia, and Silicone Valley Bank. (As for Investec, it generally looks at loans with anywhere from 5- 35 percent LTV, with a pricing of Libor plus 500-1000bps, in sizes from $20 million-$250 million, though it can arrange much larger deals.)

Non-bank players are fewer, but more active. They include the firms mentioned above, as well as Origami Capital Partners in Chicago. Concentrated NAV loans can have interest percentages that run anywhere from the middle single digits into the teens.

Because of those potentially high rates, many funds tend to exhaust their other liquidity options first: capital calls, qualified borrower joinders within credit agreements (subscription line clauses that allow a portfolio company to become the effective borrower), hybrid lines, among them. But the sector is attracting new interest under the circumstances.

Jocelyn Hirsch, partner at Kirkland & Ellis in Chicago, says interest in NAV loans, both diversified and concentrated, has rallied. “We are seeing funds that weren’t always interested in NAV lending becoming interested, because they have liquidity issues and don’t necessarily want to call capital because they think this is short-term, or maybe the fund is at the end of its life,” she says. Banks tend to be more active in diversified NAV (for example, loans made to purchasers of secondary interests), but fund finance professionals say banks have been ‘pencils down’ on many of those transactions. Indeed, two sources said in March that a large secondaries purchaser was rejected for by their relationship diversified NAV lender, putting up 100 percent of the equity for the buy (that report could not be verified, but secondaries deals are sometimes done with high LTVs of more than 50 percent, making them less attractive in times of uncertainty).

Banks reign it in
Banks – infrequently and (apparently) quietly active in concentrated NAV – are largely busy assessing their current exposures and prioritizing their best relationships, even in areas where they highly active, like in subscription credit lines, diversified NAV and hybrid credit line lending.

“We’re seeing increased pricing, funds are becoming more lender friendly, tenors are shortening; but banks are prioritizing resources and being very selective,” says one sub-line lender whose bank also provides diverse NAV facilities and, on occasion, concentrated NAV loans. (GPs speaking to Private Funds CFO have so far reported thattheir sub line lending banks are still being accommodating.)

“The thing that we’re running into is that these banks are understandably busy with their existing trades and existing relationships. There are new deals getting done, but it’scertainly not as fast as many of our clients would like,” says Zachary Barnett, managing partner at Fund Finance Partners in Chicago.

Indeed most of the deals lenders, speaking with Private Funds CFO, were looking at were from existing clients inquiring about tapping them again for rescue capital, curing covenant breaches, buying out LP interests in their own funds to facilitate their liquidity needs, or for working capital (in some cases also for ‘accretive’, growth capital). In mid-March, Hark’s Cruikshank told Private Funds CFO that many of the sponsors were being proactive, anticipating severe stress. “Sponsors know there are going to be some issues, and what they’re trying to do in a very thoughtful manner – and actually I’ve been really impressed with how on it everyone’s been – they’re trying to assess potential weak spots in their portfolio, in advance of them becoming weak spots, and trying to come up with some contingency plans to try to handle what they think could be inevitable,” he said. Cruikshank said later in March that Hark had closed a tack-on loan for an existing client that month, adding that the firm expected to close more deals in the coming 30 to 45 days.

New clients, new plays
But new clients are also beginning to make calls. “We’re beginning to see the fruits of our marketing efforts,” said the bank NAV lender who wished not to be identified. And two of the people speaking to Private Funds CFO indicated that they have taken calls from investors considering, or are considering themselves, taking down loans big enough to syndicate between themselves (many NAV lenders will offer direct co-investment to their own LPs and other non-traditional market players on larger loans). “I think we’re going to see more of that because some of the deals are bigger in scale than the capitalization of the main NAV lenders today,” said the unidentified NAV lender, who added that while smaller funds have been the traditional borrowers of concentrated NAV loans, new interest was coming from managers with as much as $10 billion in AUM.

All the lenders spoken to said they were taking calls from GPs already considering making offensive purchases, as well, though given sellers will likely sell only if severely distressed themselves, those talks were considered very early stage as of late March.

“We’ve… seen sponsors come to us trying to provide new capital to their portfolio companies to pursue a variety of market driven opportunities,” says Crestline’s Philipp. “Several funds are looking to deliver some equity gap financing in order to close an acquisition as the underlying debt capital market has pulled back orseized up, right now,” he adds. Crestline aims for $25 million-$100 million loans (with flexibility on either side) for lower-middle and mid-market funds, as well as growth equity, real estate and infrastructure funds.

Investec’s Hansford says others have their eyes out for “bolt-ons and tuck-ins for the portfolio to be really value-creative and maybe differentiate themselves versus their peers, who they think will be more focused on defending value.” He adds that many of the conversations he’s having regard funds from 2015-2017 vintages.

Many funds, unable to do much in the way of new transactions while pricing is so unclear, are taking closer looks at their portfolio companies’ debt, and considering buying it out – yet another arena where concentrated NAV lenders are eager to play. Hark has entertained interest from potential borrowers on this front, Cruikshank says. Crestline’s Philipp says his firm is also active on this front: “We have done several deals where we are extinguishing portfolio company debt with equity or buying the debt itself or issuing new debt.”

“Getting leverage for debt purchases is very much top of the list for many firms given the current environment,” says Kirkland & Ellis’ Hirsch. Funds are looking to buy the debt of their own portfolio companies, or even that of companies that they have previously done due diligence on, but didn’t close. “Even PE shops that haven’t looked at purchasing debt as an asset class before are getting interested. Some firms are setting up special situations funds or annex funds on anemergency basis to enable them to purchase debt.”

Demand surge, but supply is the question
Alternative lenders like those active in concentrated NAV and preferred equity are highly selective. Due diligence on these deals is not a quick and easy task, for any player. Concentrated NAV deals are bespoke, and approaches to assessing the borrowers vary, from the amount of emphasis placed on the residual value of the underlying, to the amount laid on the history and performance of the GP, to the accessibility of the assets in the case of a default in cases where the loans are secured.

At the start of April, Investec’s Hansford had said the bank hadn’t yet closed concentrated NAV deals since the intensification of the pandemic began. Over in the preferred equity space, 17Capital’s de Selancy says the firm only transacts on about 5 percent of dealflow, and this year it’s more likely to be around 2 percent. Demand is also causing increased pricing – in 17Capital’s case by around 500 basis points, Selancy says (17Capital primarily provides preferred financing, but also does some NAV lending, depending on customer requirements). “It’s a moving environment, but the scarcity of capital is driven by the fact that demand has gone through the roof.”

Hark lists eight NAV deals done in 2019 on its website, and Crestline has done more than 20 since it began playing in the sector, according to Philipp. The bank NAV lender who declined to be identified said that while he had about a dozen deals on his desk in late March, he and his team had been busy in recent weeks talking to their current borrowers and assessing their portfolio. “We haven’t been making a lot of outbound calls; shame on us,” he said.

With the pandemic causing almost ubiquitous stress on business’ cash flows, demandis likely to far outpace supply.

“These alternative lenders are providing much-needed financing to the market,” says Fund Finance Partners’ Barnett. “But to be honest, there’s not going to be enough ofthat to plug the gap for many of the 4,000 private fund sponsors that are going to be in search of liquidity, some for accretive and others for protective purposes.”

“If there were more of them now, we’d all be better off, because they are providing the types of liquidity, rescue financing and short-term gap financing that banks aren’t likely to be able to execute on over next 6 to 12 months,” he continues. “This is the type of efficient deployment of capital the market needs right now.”Read Original Article

Filed Under: News

PRIVATE DEBT INVESTOR: THREE KEY DEVELOPMENTS IN FUND FINANCE

April 6, 2020

Fund Finance Partners looks at the current priorities of a market that has experienced rapid growth through the good times, writes Andy Thomson

The fund finance market has grown rapidly in recent years as alternative asset managers have found themselves able to access a useful source of liquidity at low cost. But how has COVID-19 changed the game?

You can find all Private Debt Investor’s coverage of coronavirus and its impact at here.

In a conversation with Private Debt Investor, Richard Wheelahan and Zachary Barnett of Chicago-based fund finance specialist, Fund Finance Partners, identified three key dynamics in the market today. They are as follows:

1. Fund sponsors are drawing down and/or extending their fund level credit lines

This would include subscription facilities, net asset value and hybrid lines of credit, as applicable. Proceeds of which are being used to either shore up portfolio investments or position for offensive capital deployment. We anticipate these requests will only increase in the coming weeks.

2. Credit fund balance sheets are being tested for the first time in a decade

Deterioration of borrower earnings leads to requests (or demands in the case of unfunded commitments) for supportive follow-on investments by the fund. At the same time, as earnings decline, valuation adjustments at the end of Q1 and Q2 will stress fund liquidity when NAV-linked covenants are breached.

3. Attention bandwidth among fund finance providers (both banks and speciality finance companies) is being stretched.

Though everyone is getting accustomed to new work routines, lenders are still plugged in, and deals are getting done.

In a client note, FFP said it had been in discussions with several debt fund managers over the past week with a view to developing finance-based or stop-gap liquidity solutions to either temporarily or indefinitely refinance credit facilities in danger of being pulled.

Also being looked into are partial refinancings in which performing loans are left in place, securing the existing credit facility, and fallen angels being used to collateralise new, rescue or curative financing. The note concluded that funds needed to act sooner rather than later. “Debt funds that act now, before the inevitable margin calls …will receive better terms than those that ‘wait and see’ or hope for a v-shaped recovery.”Read Original Article

Filed Under: Featured Post

PRIVATE CREDIT FUND AND BDC LEVERAGE STRESS TESTING COMES TO LIFE: IT’S TIME TO ACT

March 23, 2020

Only a few weeks ago (although it now feels like another era), Fund Finance Partners (“FFP”) published an article on the numerous ways that direct lending funds and BDCs (collectively, “Debt Funds”) could finance their investment portfolios in order to increase liquidity, enhance returns and offer more competitive spreads to borrowers.  (Article)  Now, though, is the time for Debt Funds to confront challenges in their portfolios, and fund-level leverage defaults, aggressively. 

Since the outbreak of COVID-19, followed by the ensuing dramatic social and economic isolation meant to contain it, the entire economy is showing its first signs of widespread contraction in over a decade.  Practically all asset classes and sectors are impacted, but for purposes of this alert, we are focused on how this economic slowdown, which severely impacts corporate earnings and liquidity, is impacting the ability of Debt Funds that have, over the course of the past decade, increasingly met their financing needs, to continue to do so.  

Debt Funds, in the aggregate, have billions of dollars of unfunded commitments to portfolio companies, whether in the form of revolvers or delayed draw term loans.  Likewise, Debt Funds will be called upon by portfolio companies to provide incremental rescue financing as practically the entire economy struggles to hold onto precious liquidity.  Prior to the onset of this crisis, Debt Funds had been availing themselves of more, cheaper and even structured leverage for a while.  Most of these credit arrangements were made with financial and other covenants that the Debt Fund must maintain in order to access debt capital.  The fact of the matter is that the banking system, which largely left the small and medium-sized business leveraged lending market to the Debt Funds, after the downturn, is once again a critical source of liquidity to small and medium sized businesses, as well as middle market companies.  

For most Debt Funds’ credit facilities, one of the covenants that must be maintained in order to be able to access precious debt capital is some type of “NAV” or “asset coverage” covenant.  The valuation component of this covenant moves up or down, based on the value of the underlying portfolio of loans.  Many of these loans are valued by applying an enterprise value, based on an EBITDA multiple, to the company’s capital structure waterfall.  As earnings decline across the board, those enterprise values are expected to fall precipitously, and loans marked at par today, or on December 31, 2019, may not be on their next valuation determination date. 

Deterioration of asset values is expected to lead to NAV or asset coverage covenant violations, for many Debt Funds, resulting in credit facilities being unavailable (or worse, called), only further starving small and medium sized businesses and middle market companies’ liquidity.  Meanwhile, Debt Funds that are out of covenant compliance due to NAV deterioration are expected to be negotiating amendments or forbearances with their lenders, or seeking liquidity from other sources.  Margin calls and mandatory repayments are undoubtedly coming, and some Debt Fund managers are – painfully – considering selling valuable, performing assets in a market where all asset prices are falling. 

FFP has been in discussions with several Debt Fund managers over the past week, developing finance-based or stop-gap liquidity solutions to either temporarily or indefinitely refinance credit facilities that are in danger of being pulled from Debt Funds, or to arrange for partial refinancings, in which performing loans are left in place, securing the existing credit facility, and fallen angels are used to collateralize new, rescue or curative financing.  All refinancing possibilities should be considered and discussed with your advisers, prior to distressed sales of good assets.     

Whether your Debt Fund’s assets are quotable on a daily basis, and a covenant breach is imminent, or your Debt Fund’s loans are not quoted, but subject to quarterly revaluation on March 31, or June 30, now is the time to educate yourself regarding all options.  Debt Funds that act now, before the inevitable margin calls (in TRS-financed portfolios or CLO warehouses), mandatory paydowns (resulting from loan quality deterioration) will receive better terms than those that “wait and see” or hope for a V-shaped recovery.   FFP is available now, to help implement solutions.  

Filed Under: Featured Post

PRIVATE EQUITY INTERNATIONAL: GPS PONDER EARLY REPAYMENTS FOR CREDIT LINES AS CORONAVIRUS THREATENS LIQUIDITY

March 19, 2020

March 17, 2020

By: Alex Lynn

Drawdowns could enable managers to pre-empt liquidity issues arising from the pandemic but may compound the problem for certain LPs.

Some general partners are considering early repayments for subscription credit line drawdowns in anticipation of potential liquidity issues among LPs arising from coronavirus.

Modern limited partnership agreements typically specify a clean-down period, or a deadline by which individual loan drawdowns need to be repaid. The Institutional Limited Partners Association suggests this period be no longer than 180 days, though it can vary from fund to fund.

“Funds with outstanding loans that are closer to the end of such clean-down periods could call capital to repay these loans early because they want to pre-empt any liquidity issues that LPs may have in a couple of months,” Fi Dinh, a Singapore-based fund finance director at ING, told Private Equity International.

 “A number of GPs that we spoke to have indicated they may consider [this option].”

Institutions such as underfunded pensions could face a liquidity crunch in the coming weeks and months following a rout in the public markets and slowdown in private market exit activity. Q1 is expected to be a write-off for sales, with Brookfield Asset Management among those shelving deals following disruption to travel and market stability.

The spectre of diminished liquidity could make early loan repayments an unappealing prospect for some LPs.

 “Some of our sponsor clients have received calls from LPs instructing them to utilise subscription-backed credit lines as much and as long as possible,” Zac Barnett, managing partner at debt advisory Fund Finance Partners, said.

“This is because LPs are expecting to receive numerous capital calls from GPs looking to stabilise certain of their portfolio companies in the downturn or amass cash so they’ll be able to seize opportunities in the new world of attractively priced assets.”

FFP is negotiating two credit line extensions for that reason.

Borrowing could be easier said than done. ING is among those taking a closer look at underlying portfolios as LPs are more likely to prioritise capital calls to a better-performing fund when facing liquidity issues, Dinh noted.

“Overall our lending rate has slowed in Q1 because there are fewer funds and facilities being raised, but generally the market is still seeing this as a short-term issue and there is still plenty of optimism around the long-term nature of this asset class.”

At a broader level, the US Federal Reserve announced several measures on Sunday to encourage banks to lend, including slashing interest rates to nearly zero and lowering reserve requirements. The People’s Bank of China and The Bank of Japan have also taken similar action.

“It’s a little harder to get banks’ attention on new transactions right now as they’re understandably busy reviewing their existing portfolios and facing logistical and technological issues due to the disruption to traditional office working,” Barnett said. “The end result is a much longer period from term sheet to execution.”

The rise of uncommitted debt in recent years might be cause for concern as lenders are under no obligation to honour a drawdown. Such a move is, however, unlikely given the potential reputational impact to lenders that veto a utilisation request.

“We’re aware of some difficult conversations around uncommitted draw requests and expect them to increase in frequency,” Barnett noted. “Lenders will be reviewing their exposure to any one particular GP or – derivatively – LP during times of stress.” Read Original Article

Filed Under: Featured Post

MITIGATING CONFLICTS OF INTEREST IN FUND FINANCE

March 11, 2020

March 11, 2020 – Since FFP’s inception in 2019, the vast majority of our fund sponsor clients’ mandates stem from our collective expertise in and around the fund finance markets.   Between the number of fund finance transactions our principals have executed and our long-standing, deep relationships with virtually every bank and alternative lender in the space, our clients recognize the unique value we offer.

In addition to those (expected) value propositions, discussions with fund sponsors have made us aware of other supplemental or (surprisingly) even primary reasons for mandating FFP:

  1. Conflicts Clearinghouse: Large, multi-strategy sponsors with multiple investment vehicles are accustomed to evaluating whether to enter into affiliated transactions (i.e., joint transactions involving affiliate funds). For instance, a sponsor may manage a private credit fund that provides a participant loan to a private equity fund that it also manages. The private credit and private equity vehicles have distinct, sophisticated investor bases that have received extensive disclosures of the potential conflict. Perhaps the respective investors have also consented to the joint transaction with the other fund. Even in this example, most sponsors want to take every precaution to ensure that each fund transacts on market, arm’s-length terms and consistent with its fiduciary duties and the SEC’s regulations.  Fund sponsors may engage FFP as a third party advisor in the joint transaction. Given FFP’s (i) neutral, unaffiliated role in the transaction and its (ii) singular awareness of market terms for transactions such as these – including FFP’s ability to obtain legitimate, third-party bids validating the sponsor’s terms, the sponsor is assured of being able to authoritatively support its transaction in the event of potential inquiries into the transaction’s structure.
  2. Mitigating Conflicts: In addition to the multi-strategy manager example, above, a mature private equity fund with an investment in a company needing follow-on investment capital in excess of such fund’s uncalled capital presents a different challenge.  The sponsor may manage a newer private equity fund, with ample uncalled capital, with an investment strategy identical to the legacy fund.  As in the previous case, the investors in each of the vehicles are sophisticated and have consented to the sponsor’s conflicts provisions in the respective fund governing documents. By engaging FFP in considering the range of capital solutions (whether allowing the newer fund to make a co-investment alongside of the legacy fund, in the same company, or procuring a tactical, NAV-based credit facility for the legacy fund’s financing of follow-on investments, so as to avoid a joint transaction among affiliate funds), the fund sponsor can attest to having truly evaluated all options. FFP’s (i) neutral, unaffiliated role in the transaction (ii) in depth experience in resolving complicated conflicts of interest among funds and investors, and (iii) unique ability to obtain the most attractive terms available to the market, the sponsor is assured of being able to respond to any and all questions regarding potential conflicts in the transaction’s structure.
  3. Fiduciary Duties: As all sponsors know and understand, they owe a fiduciary duty to their limited partners to achieve the best terms, including but not limited to the best price point for any financing. This is particularly pertinent when it comes to subscription financing, given it is the investor’s unfunded commitments that are the collateral. This is often reinforced by more and more frequent requests by limited partners to review subscription facility terms to verify that the terms are indeed the best that could have been achieved. An additional basis for fund sponsors’ mandating FFP has been our experience, market knowledge and our unique, un-biased, competitive process.  The result has consistently been financing terms that are virtually unassailable to any limited partner inquiry. 
  4. Ethical Considerations:  Not all conflicts of interest contemplated by fund sponsors are limited to investors or funds.  Sometimes, a fund sponsor will have to confront a possible, or perceived, conflict of interest between funds and the general partner or fund sponsor, itself.  One such potential conflict arises when a fund sponsor is procuring fund-level leverage (whether a subscription line or other type of financing) and leverage in respect of the general partner’s capital commitment to the fund.  While investors obviously support general partner alignment through “skin in the game”, and leveraging GP commitments has become the norm, rather than the exception, fund sponsors are rightfully cautious when a lender proposes to provide both financings.  It is reasonable for limited partners to inquire into the fairness of the general partner’s leverage terms, in light of the same lender’s financing of capital calls.  When FFP oversees a fund sponsor’s comprehensive leverage strategy, limited partners are assured of the fairness of the financing terms, for both the general partner and the fund, by demonstrating the thorough, competitive process and transparency of the range of financing proposals obtained.  

In addition to fund sponsor community’s recognition of FFP’s unparalleled market reach and knowledge, FFP’s usefulness in identifying, mitigating and resolving potential conflicts of interest and support for fiduciary duties to investors have been called upon by fund sponsors who have trusted FFP to advise on their leverage strategies.  Both general partners and limited partners can rest assured that their overall financing goals are being optimized cost-effectively and ethically.  

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PRIVATE EQUITY INTERNATIONAL: UNCOMMITTED DEBT – HOW TO AVOID GETTING STUNG IN A DOWNTURN

February 6, 2020

February 4, 2020

By: Alex Lynn

GPs can avoid potential liquidity issues by drawing down loans early and performing greater due diligence on their lenders

Uncommitted capital call facilities have taken the private markets by storm, but fund managers should be cognisant of the potential for lenders to withhold financing during a liquidity crunch.

The notional value of debt facilities provided on an uncommitted basis is estimated to have grown 12 to 15 times over the past decade, Zac Barnett, managing partner at debt advisory Fund Finance Partners, told Private Equity International. These facilities mean the lender has agreed to provide capital at set terms when asked but is under no obligation to do so.

Such loans are often cheaper than committed facilities as banks don’t need to set capital aside to meet liquidity requirements, according to a 2017 report from Mayer Brown.

“Private fund sponsors have eaten up uncommitted debt, which is where the bubble would pop, if anywhere,” Barnett said.

Subscription credit lines have grown in popularity as they enable capital to be called in one lump sum, often only on an annual basis, rather than relying on LPs to act quickly to finance each individual investment. Capital calls can take up to 12 business days to provide, making debt a useful tool in completing investments in a timely fashion.

The Fund Finance Association, an industry trade group, estimates that existing subscription line commitments have grown to approximately half a trillion dollars, reports sister title Private Funds CFO.

Terms of endearment

For committed lines, GPs pay an upfront commitment fee, a margin on drawn capital and a fee on undrawn capital, according to Matt Hansford, head of UK fund finance at Investec. Uncommitted lines only charge a margin on what is committed, meaning a GP only pays for what they need.

This debt can sit on top of a committed facility, much like an expansion valve. A GP could, for example, arrange an $80 million committed facility with an optional additional $20 million portion that can be accessed if required, provided the bank approves the request.

“People have gotten comfortable with uncommitted capital call facilities because the conditions under which a bank is lending will remain pretty constant, provided the fund hasn’t faced any major changes like a secondaries transaction or the loss of a key person,” Hansford said.

“There’s also the potential for reputational impact to the lender if they veto a utilisation request.”

That uncommitted lines can be withheld – however unlikely – could be problematic in a downturn if GPs are unprepared. Liquidity constraints due to macroeconomic conditions could limit the speed or ease with which LPs can meet a capital call, placing undue pressure on their relationship or potentially delaying an investment if the GP can’t access leverage.

 “You’ve had around 40 new entrants to the capital call space in Europe alone in recent years,” Hansford noted. “There was a big pullback from the capital call space in the last crisis, so there’s a risk that the field would narrow again in the next downturn.”

One solution is to ask banks to commit the loan in advance of when it’s needed so that the money can be called from investors in due course if necessary, he added. Borrowers also need to consider how large the lenders’ capital call business is and whether they continued to be active during the last downturn.

Some uncommitted lines in the US are provided on demand, meaning a lender has the right to call in debt at any time in exchange for a cheaper fee. An untimely demand from a lender could force a GP to call capital or exit certain assets to repay debt when they’re not ready, Barnett said.

Committed to the cause

FFP was launched in late 2019 as a negotiator of more favourable credit terms for GPs. Barnett, an 18-year veteran of Mayer Brown’s banking and private investment fund practices, co-founded the business with Richard Wheelahan, a former general counsel at private credit manager Capitala and fellow Mayer Brown alumnus.

The firm, which operates from Chicago, Illinois and Charlotte, North Carolina, is sector-agnostic and has worked for private credit, real estate and multi-strategy fund sponsors globally. Although subscription lines are its core business, FFP has also arranged NAV lines, hybrid lines and advised on GP-interest deals involving private and bank debt, as well as sales of equity stakes.

Barnett and Wheelahan say moving from an uncommitted to committed facility impacts returns by as little as 0.1 percent. The pair also advocate greater due diligence on potential lenders to ensure they’re able to weather a recession without calling in loans.

“Everyone professes discipline,” Wheelahan said. “But they’ve got to maximize and justify returns in a valuation environment that’s gotten more exuberant every year, and nobody wants to see tears when the correction comes.”

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