Shaky liquidity strains European sub-lines market: Cadwalader

A European subscription lines market beset by insufficient liquidity helped big GPs at the expense of mid-size ones in Q2, according to findings from Cadwalader.

The law firm found that pricing fell from Q1 levels for big sponsors while rising for mid-size ones. Cadwalader used its own definitions for GP size.

Lenders prefer big over medium

Michael Hubbard, head of European GP solutions at Cadwalader, tells Private Funds CFO that big sponsors were impacted in Q1 by challenges for lenders that caused illiquidity for them.

“There were lenders going through capital planning processes,” he notes. “There were banks that were completely shut off, as they were up against various caps and they had to recycle limits.”

Hubbard adds that many wrapped up their capital planning processes, and while he cautions that the sub lines market isn’t liquid, there are “pools of liquidity that are opening up.”

But mid-size GPs have effectively been left behind.

Hubbard explains that lenders preferred engaging with bigger managers in Q2. Lenders are attracted to larger sponsors because of their perceived credit risk due to more diversified borrowing bases, he says.

These pricing discrepancies are also a clear sign that there isn’t enough credit from banks to go around for both groups of managers, or even all of the largest managers.

“The amount of capital across the banking market for subscription lines is not infinite,” notes Samantha Hutchinson, a partner at Cadwalader.

And growth in big GPs’ fund sizes means that they need more sub-line capital, posing allocation challenges for banks.

As a result of this growth, Hutchinson says “balance sheet allocation to subscription finance across the finance sector cannot keep up with the amount of fundraising by some of the largest managers.”

Longer fundraising periods are also contributing to higher pricing for mid-size sponsors because they have less diversified LP bases when they seek sub lines at their first close, Hubbard notes.

Notably, these problems aren’t hitting the smallest GPs. Cadwalader also found that pricing for them declined from Q1 to Q2.

These sub lines’ smaller amounts draw interest from banks and thus help sponsors with pricing.

“You’ve got a small number of banks essentially bidding against each other to get those facilities providing some competitive price tension, where replacement capital is an option in contrast to larger syndicated transactions,” Hubbard says.

Facing an ‘artificially buoyant’ market

While liquidity is uneven, it could worsen if fundraising improves, Cadwalader notes, as demand outstrips supply.

“I think we’ve got an artificially buoyant loan market at the moment,” Hubbard says.

And what is Cadwalader’s solution to avoid this looming supply-side crunch? Attract funding from institutional investors.

The law firm is spending more time exploring models to accommodate non-bank capital providers.

“For that to have gone from taking up very little of our time three years ago to taking up a considerable chunk of our time really just underlies how big an issue this is for the subscription market,” Hutchinson says.

One way to attract non-bank lending would be to offer sub lines with term tranches in addition to revolving credit – a solution that Private Funds CFO has previously covered.

Hutchinson says that Cadwalader has worked on them with lenders for several years, while talk of deploying them is up.

“We’re definitely hearing of more conversations between GPs around introducing a term option,” she says.