Lending against limited partner fund commitments has generally been a safe bet for banks… so far. What happens when this is no longer the case?
At a recent private equity event in London a panel of experts (two lenders, two lawyers) discussed the state of the fund finance market and reflected on industry common practice.
A question from the crowd: “Has anyone seen one of these go into default?”
A short silence and glances between panelists, before: “We are aware of just one,” says one of the lawyers, “a certain firm in the Middle East.”
The unnamed firm is Abraaj, the demise of which has thrown facilities with two lenders into default.
First, the firm was a significant investor in its own funds. This was undoubtedly a source of comfort for other investors when the funds were being raised, but now that Abraaj Holdings is insolvent, its other limited partners are being urged by Barclays Bank, one of the facility providers, to cover defaulted drawdown notices relating to its Latin American, Turkey, Pakistan and Africa funds.
Second, Abraaj was halfway through raising a $6 billion global fund when it began to unravel. Investors were released from their commitments, which totalled $3 billion by that point, but not before the fund had made an acquisition (the Turkish franchise of KFC) using a credit line provided by Société Générale. The bank has now appointed receivers to issue drawdown notices to these LPs for their pro rata share of the amounts outstanding under the facility, according to documents prepared by Abraaj’s joint provisional liquidators. The parties are in dispute. SocGen did not respond to a request for comment.
Given that major credit line defaults have been a rarity, the outcome of these two situations will provide valuable insight into how these scenarios should play out.
Credit facilities have become an integral element of private equity fund management. It has been the topic of much debate in the industry over the last two years, being seen by some as an “artificial” way to use leverage to boost fund performance and others as a useful way of managing cashflows. The size of the market is often cited at an estimated $400 billion (although it is not clear where this estimate comes from).
It is logical to imagine that a credit line default is most likely to be caused by an institutional investor in a fund – perhaps a listed feeder fund, for example – running into liquidity issues and being unable to meet capital calls. Even in the depths of the global financial crisis, this was relatively rare: in instances in which large LPs experienced difficulty, solutions were found that allowed for an orderly reduction in that LP’s commitment.
The Abraaj case shows us that such defaults will come from more complicated or unexpected scenarios than an LP simply running out of cash; something that LPs, GPs and lenders should all take into consideration.
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