Non-bank participants in the fund finance market are getting ready for an expected major uptick in their market share on the back of a confluence of phenomena benefiting them and their investors.
At the Fund Finance Association’s European Symposium in London in late June, a poll taken during a standing-room only session showed more than two-thirds of over 100 respondents had non-bank lenders in their deals to date, and more than three-quarters said they planned to use non-bank lenders in the future.
Subscription credit lines offer attractive pricing to institutional buyers compared with many triple-A rated asset-backed securities, as well as being easier to analyze, while acting as a good diversifier in private credit books held by institutional investors, panelists said.
“One of the trends we’ll all be familiar with over the past decade is the continuing growth in the allocation to alternatives [and] the increasing size of private markets funds,” said one non-bank lender panelist at a large asset manager.
“It’s not uncommon to see these mega-funds that are raising an excess of $10 billion, and there is the accelerating pace of the fundraising cycle as well. And those trends together are absolutely outstripping the ability of bank balance sheets to keep pace with that growth.”
That is where non-bank lenders, which position themselves as partners rather than competitors to banks, can work to solve problems arising from borrower-related limits as well as help to provide banking-side solutions, for example balance sheet or regulatory capital constraints, the panelist said.
They added that their institution has relationships with more than 40 lenders, alongside advisers and law firms, giving them a broad overview of how the market prices risk, how it reacts to stresses such as those caused by the conflict in Ukraine, how structural terms are developing, and more – a potential advantage for bank lenders, who know primarily what they see from their own direct experience.
Anecdotally, banks have participated in syndicated deals, but it involves conflicts that both they and their borrowers dislike, as participants almost certainly need access to LP lists for due diligence, and banks do not want competitors undercutting them on future deals.
Rising rates? All the better
For non-bank lenders, rising rates offer an immediate benefit. Most sub-lines and NAV facilities are floating rate, and since non-banks don’t have to fund themselves on the interbank market – rather using cash on their own balance sheets – increased borrowing costs are largely irrelevant. But their own investors benefit from both increased rates and, potentially, increased spreads as geopolitical events drive myriad uncertainties.
“Looking at the two-year dollar swap at the moment, we could potentially have 150 basis points extra return for our investors,” said the asset management lender. “So this is actually a really good thing for non-bank lenders and has facilitated a massive increase in the inquiries [from investors] who are looking for an asset class where the credit risk is relatively stable.”
No matter the cost to borrowers?
But at what point does rising rates cause subscription credit lines to become uneconomical to borrowers?
“I’ve spoken to a lot of lenders that have much longer experience in this asset class than I do,” said the asset manager panelist. “And they remember a time when interest rates were [3.5 percent to 5 percent] in the past. The feedback I received is that borrowers were still happy to use this type of credit facility when the all-in rate was 9-9.5 percent because the operational benefits are so huge to GPs and financial sponsors, and that it is now very difficult to be competitive without using them.
“So I think we’re still quite far off that tipping point” where demand from borrowers drops off, they said.
A second non-bank lender noted that rising rates may cause some to worry about increased credit risks, but that sub-lines in particular are “really high quality,” and reiterated that their firm uses cash on balance sheet.
And a third market participant, whose institution both buys into NAV facilities as well as originates them, said they have found that insurance companies are great lenders now because of their ability to lend on fixed-rate terms.