The market for subscription lines remains stable and accessible to GPs even as some large banks have become more judicious about lending, according to industry sources. The signs of resiliency include a shift in the mix of participating lenders and an active syndication component.
Sources tell Private Funds CFO that certain larger banks are slowing down for different reasons – but not due to any broader pullback in the market.
“I do not think banks are pulling back from the subscription market as a result of the current economic climate or credit climate, per se, but rather many institutions are being impacted by liquidity, capital, [risk-weighted assets] and other considerations,” says an executive of a large sub-line lending bank.
Sub lines have held up this year without significant credit troubles in the space, notes Wesley Misson, who heads US fund finance for law firm Cadwalader, Wickersham & Taft.
“Nobody is expressing concerns over the credit performance of the product,” he says. “And in fact, we haven’t seen any material defaults this year. Credit performance continues to be pristine.”
There is no single factor behind why big banks choose to dial down their activity, sources say. They cite reasons ranging from banks having to manage RWA capital levels to hitting their own allocation limits.
Jeff Johnston, chairman of the Fund Finance Association’s board and former head of Wells Fargo’s sub-line business, notes that there is a “flip side” to these reasons for smaller banks that are newer participants. These institutions are using the opportunity to boost loan growth and deploy their capital, he says.
Big banks can also do U-turns in their approaches due to the nature of sub lines. Johnston says that large banks have sizable run-off portions of their sub-line books, and notes that the instruments are short term. In this type of situation, Johnston says that banks can redeploy their funds while also keeping overall sub-line exposure flat.
Johnston added that there is a distinction between banks that are reducing their exposure and those that are merely slowing down their ongoing activity.
A slowdown in GP fundraising is also affecting sub-line issuance, sources says. However, some say that the fundraising slowdown is attributable to GPs postponing fundraises due to adverse economic and market circumstances.
Affiliate title Private Equity International’s most recent quarterly fundraising report showed that the number of final closes in the first nine months of 2022 was 1,051, below the average of the past five years. However, overall proceeds raised were $516.9 billion, second only to the record $615.5 billion raised during the same period last year.
Diversification supports the market
The sub-line space is also less reliant now on big banks. Johnston notes that more lenders have gotten into them over the last five years, citing mid-sized banks, small banks and non-bank lenders.
“The market is healthy and vibrant, and arguably more diversified and more stable given the larger number of entrants and aggregate players in the space today,” he says.
Sources say that lender diversity is visible on the syndication side. What this means is that a big bank will have smaller counterparts join as participants while its relative role in taking on the sub lines shrinks.
“One thing that we are seeing is that some of the relationship banks are not able to hold the levels that they historically have in syndicated transactions,” says Shelley Morrison, head of fund finance at Abrdn in Edinburgh, which actively acts as a syndicate lender, buying portions of bank sub-line portfolios. As a result of that phenomenon, she notes, the syndicates increase in size.
Morrison says that banks take this approach to conserve capital for select clients.
“More often than not, when we speak to lead banks or agent banks, it’s because they just need to free up some capital to continue supporting those key clients for the next round of fundraising and the next fund,” she notes.
Cadwalader’s Misson says that the diversification is driven partly by overall market growth but is also “due to some of the larger banks being more selective.” The selectiveness is due to reasons including RWA capital management and precautionary approaches in the credit market, he notes, even as the market itself is holding up.
Smaller banks had more syndication opportunities due to mega-deals, Misson note]s, citing the need for large bank lenders to sell portions of their portfolios off.
Will bank/LP relationships suffer?
But any pullback by existing large lenders could hurt their ability to retain their LP relationships, some say. Sub lines are a low-margin business, but act as a gateway for banks to provide borrowers with ancillary, higher-profit services, such as transaction banking, collecting syndication fees and participating in leveraged finance as opportunities.
Sources shared their thoughts on what could happen to the ties.
Morrison says there is “a potential risk” that banks that ease up on sub-lines engagement may wind up with weaker sponsor relationships.
“I’ve always viewed fund finance as a relationship-driven asset class,” she adds. On one hand, she notes that lenders mostly want to develop “long-term partnerships” with GPs.
At the same time, borrowers want to work with “like-minded lenders in a syndicate” with similar credit appetites, she says. Morrison adds that borrowers also look for lenders that are responsive for things such as waivers and amendments.
Johnston is bullish that large banks will adapt because of their significant presences in the syndication space.
One way they may adapt is by acting in administrative capacities for the syndicates while having smaller direct exposure. As a result, they can have ongoing engagement with sponsors, Johnston says.