Investors see benefits of subscription line liquidity
Credit lines reduce the need for multiple capital calls and mean that managers can stay liquid without needing to hold large cash reserves
Seeking to improve their treasury operations, private equity-style managers are increasingly using ‘subscription line’ banking facilities. Used well, these give General Partners (GPs) the flexibility and liquidity to run their businesses more efficiently, while also reducing the cost of capital.
These credit lines are mainly used by traditional closed-end private equity managers, where investors have committed and uncalled capital. But they are also available to open-end real estate funds.
They benefit both the fund manager and the investors. The lines provide relatively low-cost financing for the manager, with the interest rate usually a base rate or LIBOR-based rate plus a margin. At the same time, they reduce the administrative burden of multiple small capital calls for manager and investors alike. Additionally, the manager does not have to hold cash reserves which could negatively impact returns.
What are subscription lines?
Subscription facilities are senior secured revolving credit facilities secured by the unfunded capital commitments of the fund’s Limited Partners (LPs). The facilities are underwritten to determine the value of the investors’ pledged commitments. Eligibility requirements and advance rates are based on the investors’ credit quality.
The loans typically provide liquidity for the fund on a faster basis than calling capital from the investors. Advances are usually available within 24 hours while the traditional LP investor capital could take seven to ten business days to fund. Traditionally, similar loans were used for short-term bridging of capital calls for deal closings. However, with open-end real estate funds they have also been used to bridge investor flows.
Fund managers also use subscription facilities as a bridge from investment closing to closing of permanent financing. Lines can also be used to warehouse acquisitions during the entire investment period.
How are they underwritten?
The creditworthiness of the underlying LPs is of primary consideration. Another key factor is concentration risk: no single LP can make up more than a certain percentage of the investor base. Investor consent letters in favour of the lender are another important item; in some cases the lender might even require additional credit information from the investors.
Other considerations include: investor side letters, co-investment, any feeder fund arrangements and transfer rights of LP interests. Lenders closely review the Limited Partnership Agreement to evaluate its structure, as well as the rights and powers of the GP. The GP’s ability to incur financing at the fund level and the LP’s ability to remove the GP are notable. The GP is looked at in terms of its history as an investment manager and the specific fund’s track record.
Insistence on credit lines
Subscription facilities are becoming more widely used and, in some cases, investors are requiring managers to put a facility in place. But fund managers should differentiate between specialist lenders and those that are relative novices.
In the experience of Citco Capital Solutions, working with an experienced partner will allow the investment manager to get the facility’s full benefits. Leveraging our expertise in the alternative investment sector, we arrange these and other types of fund financings.
8th September 2016