As a shortage of capital in the subscription finance market creates an environment where lenders hold all the cards, borrowers are approaching the sub line market differently. With banks constrained by a combination of market uncertainty and regulatory change, and rising interest rates focusing the minds of credit-seeking funds, sub lines are taking longer to negotiate and priorities are changing.

Jeremy Cross, a fund finance partner at Addleshaw Goddard, says the result is a new flexibility and willingness to embrace more innovative solutions: “What we are seeing is funds being more flexible with the terms on which they are able to pull down funding.
“LPAs have increasing flexibility built in so that subscription finance can be used for longer periods in some way and so that they can take further finance down if, for example, an initial sale process doesn’t happen within the anticipated period, and so on.

“So, they are writing more flexibility in to finance things down the track that probably wasn’t a feature of the discussions a few years ago.”

Meanwhile, on the lender side, there is also a sharpened focus on documentation and more rigorous due diligence. “There is more and greater emphasis on due diligence and more questions are being asked about what happens on termination or if a fund goes bust,” says Cross. “Those questions are more front of mind and, from a legal perspective, we are getting asked a lot more about the nuts and bolts of those eventualities.”

Fundraising slowdown

A slowdown in the fundraising market is also impacting the time it takes to secure sub lines, with pricing up and lenders tightening some of the terms.

Paul Tannenbaum, a partner in fund finance at Proskauer, says: “Clearly, a big issue at the moment is the timing of fundraisings. Sizing has held up but the time it takes to get to first close has really lengthened and that impacts sub lines, where there is still demand from GPs to get sub lines in place at the time of closing.”

Tannenbaum adds that this also impacts the structuring of sub lines because whereas first closes used to have large pools of diversified investors, lawyers are now seeing sub lines being requested with much smaller pools of investors on initial closing – “sometimes just one or two cornerstone investors.” That raises questions for lenders around pricing and security, he says.

“LPAs have increasing flexibility built in so that subscription finance can be used for longer periods”

Jeremy Cross
Addleshaw Goddard

Cameron Roper, another partner in the Proskauer team, believes that fund managers are thinking about sub lines differently right now, in terms of the time it takes to get them done, and are not necessarily relying on existing lenders for refinancing purposes. “Lenders can be pickier, so we do see a bit of a tightening of the terms they are looking for on things like tenor.

“GPs will want to see decent tenors with extension options, maybe even committed extension options, while lenders may be a bit tighter on what they can offer there. A lot of our fund manager clients would prefer longer tenors but are finding a three-year facility is a lot less common than it used to be.”

Constrained balance sheets

With far fewer active lenders creating a shortage of supply, sponsors are having to approach the market differently. Pierre Maugüé, partner at Debevoise & Plimpton, says: “Right now, many funds have become bigger and need larger sub lines while the capacity in the market is somewhat limited. As a result, some sponsors are having difficulties finding enough lenders to fill the book on their lines.

“Sponsors are diversifying their pools of lenders in order to create or identify additional options. We also see transactions where lenders drop before the finish line, so it is a good idea to speak to a few more lenders than you really need.”

Facility sizes are coming under pressure, with lenders with constrained balance sheets reluctant to provide any more capital than is required. There has been a lot of discussion about correct facility sizing and the use of accordion options to upsize lines as funds grow.

“Sizing has held up but the time it takes to get to first close has really lengthened and that impacts sub lines”

Paul Tannenbaum

Maugüé says another option for borrowers is umbrella facilities: “As part of an effort to limit the dollar exposure of a facility, we are seeing more and more sponsors putting in place umbrella facilities. Those are not completely new, but increasingly sponsors might go for a single facility of $1 billion that they can use across 10 funds instead of each fund having a facility for, say, $200 million. That can reduce the headline figure by just having one facility that the borrower can draw down across multiple funds.”

He adds that despite the shift in favor of lenders in the market, strong sponsors are still able to negotiate terms based on their precedent and it is more a matter of whether
lenders are willing to do the transaction or not.

The most active providers of sub lines are doing so in order to build broader relationships with sponsors: “These are revolving products and not everyone is set up to lend a revolving product. It is also a product that can remain undrawn for long periods of time, where the commitment fees and even the margin are not that high.

“Banks willing to develop long-term relationships with sponsors are therefore the natural providers, which maybe limits the universe of potential new entrants.”

Outside of subscription finance, NAV facilities secured by the underlying investments of the fund (as opposed to the right to call capital from LPs) continue to attract attention. “That market is extremely active,” says Maugüé, “even more so in Europe than the US, with the advantage that there are a number of structuring options for NAVs that allow sponsors and lenders to be really creative.”

At one end of the spectrum are facilities at the level of the fund secured by the equity investments in the underlying portfolio companies, while on the other side are facilities where the borrower is an SPV that does not own the underlying investments but rather relies on a contractual undertaking from the entities that own the underlying investments to turn over to the SPV the cashflow distributed by those investments.

That structure is more akin to preferred equity, with lenders increasingly willing to understand the concerns of the sponsors and structure bespoke facilities that accommodate their requirements, says Maugüé.

Tannenbaum says: “We are still at a point where no two NAV facilities are the same, which makes it interesting for us as lawyers and means pricing, processes, execution and terms can be a little bit more complex and take longer to negotiate than one might expect. The use case for those facilities has now been proven and there will be some settling down in the market as both traditional lenders and the alternative lenders bed down on their particular offerings.”

The interaction between sub lines and NAV financings is also growing, according to Cross. “We are also seeing more hybrid financings, looking at both subscription lines and NAV loans, with more interrelation between the two,” he says.

“That is driven by a combination of factors but in part by funds needing to have more financing flexibility in place to allow for orderly sales of portfolios and realizing value. NAV facilities are becoming more and more a feature of the market as they can help to bridge the gap at a time when subscription ­finance is more difficult to access.”

Ratcheting down on ESG

Liquidity issues and macro factors are eroding the subscription line market’s focus on environmental and social issues

Lawyers are spending less time on the ESG ratchets that had become a common feature of subscription line negotiations a year ago.

Roper says sub lines are less likely to feature while economic conditions remain tight: “We have seen a bit of a decreased focus on ESG over the last 12 months as fund managers have been a bit more stretched on just obtaining the liquidity they need in a more challenging environment.

“That’s not to say ESG elements are not being included on facilities, but there is a little less focus on that recently.”