Gone are the days when a general partner in need of subscription credit could go out, find a lender and then focus their attention on the terms on offer. In today’s market, following the well-publicized issues in the US banking industry, borrowers are forced to ask probing questions in order to differentiate potential lenders.
Khizer Ahmed, founder and managing member of advisory firm Hedgewood Capital Partners, says borrowers used to have a much keener focus on the terms of a specific transaction and less concern about the stability of a lender.
This has changed – at least in the US market – since February this year, says Ahmed. “Now, gaining comfort about a lender’s business model, its stability and future strategy is as important as the specifics of the terms for a given transaction. Clients want to know more about business models and, for those banks insisting on opening depository relationships, how their deposit ratios have held up through the crisis.”
Considerations might include what steps they have taken to provide comfort to clients about the safety of deposits, what they are doing in general terms to retain their clients and what initiatives they have for continuing to grow while remaining stable through this period of stress.
LPs have also sharpened their focus on the counterparty risk that the funds they invest in have across the board, Ahmed says.
A second layer of evaluation, which is not new but is gaining weight, focuses on the lender’s footprint in the subscription lending business, how long they have been around, the type of client base they service and the type of clients they want.
Ahmed says: “Historically, lenders have differentiated themselves through their longevity in the business, whether they service a particular sector or subsector in a given asset class or are sector-agnostic, how client-friendly client-facing teams are, the experience of the team, the flexibility and commerciality they exhibit when applying their advance rate methodology and where they are from a pricing perspective.”
The number of lenders active in the subscription finance market has dropped significantly in the past year and so borrowers must be prepared to win them over, rather than vice versa.
Zachary Barnett, co-founder of Fund Finance Partners, says: “In the 20-plus years I have been doing this, I have never seen a market so dislocated. In terms of sub-line differentiators, the normal list of 50 lenders is basically now cut in half and further narrowed to seven to 10 that are interested in new client opportunities.
“In almost every instance, there needs to be a strong business case from the bank’s perspective as to why they are utilizing their balance sheet for subscription lines. Those that are can be very selective and they require other business from sponsors.”
Not all borrowers will have the same experience, Barnett adds: “If you are a borrower, you certainly benefit if you can dangle more carrots to the banks in terms of deposits, fund administration and sell-side M&A work, etc. Each bank has a unique set of capabilities and appetites for other business; this is very challenging for borrowers to navigate.”
Size is key. “If you are a top-10 global sponsor, you are still going to be able to get a subscription line, though it’s going to be smaller than you might like,” he says. “If you are a lower mid-market fund sponsor you might really struggle to find a lender, especially if you are on fund two or three without a well-established relationship with a bank. First time funds are often out of luck.”
Borrowers are understandably prioritizing relationships when they can. Dave Philipp is a partner and co-head of fund liquidity solutions at credit fund Crestline Investors, which is a borrower of sub lines and a lender of NAV financing. “As a user of the subscription line market right now, relationships are probably the most important thing,” he says.
“Groups we have had a historical relationship with appreciate our business and now is not necessarily the time to run around and find a bunch of new providers unless you have to. We are trying to focus our attention on big names, groups that have been active for a long time, lenders that have capital dedicated to this and people that we know are going to be there for the long term.”
He adds the bigger banks are being more selective and choosing to work with larger funds where they can have a franchise-to-franchise relationship.
“For us, we are looking for stability and flexibility in a lender. We take flexibility and reliability over price. A lot of banks are maybe unwilling to commit as much as they used to, especially if you don’t need it at the front end, so we want confidence they will be able to upscale as our fund grows.
“We have lost coverage teams as some of the smaller banks have been absorbed. So, continuity is not just about the franchise and the balance sheet, but also the individuals within the bank are important.”
Competitiveness of terms is important, and it matters that the covenant structure the lender comes up with is commercially tenable from a borrower perspective, says Ahmed: “Some lenders have strict policies on how frequently lines need to be cleaned down; others are more relaxed.
“Our experience ranges from some clients cleaning down on a monthly basis, which takes away some of the utility of using these facilities as a working capital tool, to the other end of the spectrum where lenders do not have any periodic clean-down requirements and the borrower could keep the line outstanding for the duration of the transaction if they wanted to.”
Meanwhile, for borrowers seeking NAV loans there is no shortage of supply. Philipp says those lenders can now better segment themselves with multiple pools of capital targeting different parts of the market, affording borrowers more choice and flexibility.
“We believe that the winners in this space will be groups with dedicated investment teams and capital just for NAV lending,” says Philipp. “As borrowers in the sub-line market we look for longevity, market position and a strong relationship from our lenders, and those are the same criteria that differentiate lenders in the NAV space.”
Looking to the future
Market players are hopeful that some of the constraints currently holding sub-line lenders back will start to ease
“We hope that the banks in the fund finance market will get some relief from the Federal Reserve to be allowed to unlock more balance sheet to the product, but no one knows whether that is coming or not,” says Fund Finance Partners’ Zachary Barnett.
“Then we also need those regional banks to stabilize, which may calm fund sponsors and allow them to see those banks as a viable option again. For now, there are a lot of frustrated borrowers out there with limited options.”