As growth in the sub-line market surges, fund finance is entering another new stage of its evolution. Funds are becoming more complex, new lender entrants are pouring in and sponsor borrowers are becoming more sophisticated in their use of finance products – all part of an evolution market players are terming “fund finance 2.0.”
“Our business continues to innovate… [lenders need to] innovate their products, and not just narrowly think about subscription finance,” one GP said, using NAV lending as an example, and saying that lenders could start thinking about how that can be applied across other asset classes and strategies.
The GP called subscription credit lines “the lifeblood of how we operate our vehicles,” and added that “there’s a ton of applications, and we continue to grow as an industry and deploy capital to different areas from pure private equity into private credit, for example. The use cases continue to expand.”
More lender participants and larger facilities will drive further competition and innovation, another sponsor borrower said. “We’re always looking for new ways to finance our funds,” the sponsor said.
One mid-market sponsor speaking to Private Funds CFO on the sidelines of the Global Fund Finance Symposium in Miami Beach on January 17 said that the firm’s next sub line could be as much as $3 billion – far larger than the line the firm obtained for its current fund.
Panelists noted the increase in hybrid subscription/NAV facilities, as well as totally new structures. While the innovation is welcome, one lender pointed to the Asian market as demonstrating some potential downsides. “I’ve seen some transactions [in Asia] that were marketed as subscription facilities, but they’re really not. They don’t have the right security structures” and have other features not consistent with sub lines. “By no means is that a bad thing. I love it,” the lender said, but it’s also important that the industry ensure products are properly labeled.
One lawyer panelist noted the use of “golden share structures” in the Caymans being used in NAV loans. These structures are usually used as a bankruptcy remote tool, giving the lender veto power over a coming bankruptcy event, preempting it. In NAV loans, such a structure gives the lender direct control over the underlying Cayman credit party.
The lender said that increased competition in the last year had been a little frustrating, but that, long term, it should result in more competitive structures and more market penetration. “But we see the pendulum swinging a little too far in some deals,” he said, adding that his institution is shoring up its portfolio management as a result and preparing for a swing in the other direction for the market, benefiting long-term players as others dip back out.
As deals get bigger and more complex, and as new kinds of borrowers like open-ended funds enter into the market, sponsors are looking for more convenience and flexibility than ever before, another lawyer noted. That lawyer said that all of their clients are looking to put lines in as early as possible – right after initial closing – and want to easily upsize lines, sometimes temporarily, for example.
Increased competition among lenders is helping to drive convenience and efficiency, but the lawyer said that all of these factors are creating a pressing need for documentation standardization. “Clearly the documentation needs to protect the bank, but from a compliance perspective it’s awfully hard to comply with 40 different credit agreements that have different standards across all of them,” the lawyer said. “You don’t want to have to pull down 40 different credit agreements and see if a notice is due two business days or five calendar days after a certain event.” She added that this is even true for smaller lenders with fewer lines and relatively fewer compliance resources.
That lawyer also cautioned borrowers to ensure that, as the market opens up beyond borrowers’ initial bilateral relationship lenders with knowledge of their borrowers and their needs to a more competitive market dealing with bigger and more complex deals, they ensure that their future subscription line docs still continue to work for them and their LPs. Many borrowers are moving to the syndicated market, she noted, but the documentation is vastly different between a bilateral line and a syndicated one. And, she said, “what worked in a bilateral relationship deal for your LPs and side letters might not work for a syndicated deal [with multiple lenders]. Those LPAs and side letters might not have all the bells and whistles that you really need in a syndicated, multi-year secure facility.”