Recently we hosted a webinar on how COVID-19 is impacting sponsors access to capital and liquidity from a fund finance perspective. Cliff Pearce, Global Head of Capital Markets and James Rock-Perring, Head of Fund Finance Advisory at Intertrust, were joined by panelists Mike Mascia, Partner and head of the fund finance practice at Cadwalader, Samantha Hutchinson, Partner at Cadwalader and Stephen Quinn, Managing Director at 17Capital to talk about the current financing disruption in the European and US Private Markets. James Rock-Perring reflects on the key insights and themes of the discussion.
These are unprecedented times with a lot of noise around lender caution, increasing capital calls, reduction in mark-to-market fund values and potential Limited Partner (LP) defaults, to name a few. The crisis is somewhat different to the 2007/08 crisis and the panel during our webinar aimed to cover these issues across the fund finance product spectrum both in the US and Europe, as well as share some thoughts on how the future may look.
Subscription line market
The subscription line market has grown into a $500bn+ global business driven mainly by the significant growth in private market fund raising and increased lender liquidity. The current COVID crisis is, however, placing stress on private markets with key impacts, activity and behaviours all being driven by the need to maintain liquidity, whether it be from a General Partner (GP), LP or lender perspective. There’s been an urgency to get deals done, lock in terms and pricing, and renew existing facilities. Lenders are focused on managing their balance sheets and due to the current uncertainty, there’s pressure on hold levels, pricing and focus on servicing existing client’s needs. LPs are focused on managing their liquidity to meet future capital calls and are keeping a close eye on private equity allocations. This is due to the risk that they become overallocated to private equity as public market equites values fall versus the lag in reporting of the private equity positions. A material reduction in subscription line activity is likely to happen in the next three to six months as private market fund raising is stalled.
During the webinar, we conducted polls asking participants:
What would be the most likely reactions in the subscription line market as a result of the COVID crisis?
41% of the attendees who responded thought that lenders would increase hold levels and 31% thought new sublines would be impacted by the slowdown in fundraising. In terms of hold levels and pricing, this is consistent with what we’re seeing in the market as banks manage their balance sheets and assess their funding requirements considering the extreme uncertainty around the global impacts and severity of recession. It’s without a doubt that fundraising will slow down and this will in turn have a follow on impact on the level of subscription line activity. This would also be consistent with the 2007/08 crisis where the lenders’ subline exposures reduced significantly in the months post crisis. 18% of attendees expect to see significant additional borrowing on subscription lines by managers and a further 10% expect to see an increase in capital calls as a likely market reaction. There was an initial increase in borrowing on lines and an increase in capital calls but that appeared to be an initial reaction to the crisis and generally it appears lines are still being used and capital calls still being as normal for now.
Whilst traditionally NAV facilities have been a solution for fund of funds, secondary funds and debt funds, COVID has sparked a substantial increase in enquiries by private equity managers for these types of facilities, both for diverse and concentrated portfolios. This has all been driven by liquidity needs at the portfolio level with a definite shift to more defensive solutions (to fund distressed companies, cure covenants etc.) rather than offensive measures for now.
However, we’re still very much in a ‘wait-and-see’ position as sponsors try to accurately assess liquidity needs at the portfolio level and indeed get a handle on the valuations. We may have to wait until post-Q2 to understand the full picture before these situations move into deal execution mode.
We also asked the participants:
What they thought would be the main benefit of using a NAV / asset recourse facility during and post the COVID crisis?
Nearly half of the respondents (48%) thought that NAV facilities would be used for defensive reasons (i.e. to “fight fires”) in the portfolio and provide liquidity for distressed portfolio companies. Interestingly only 5% thought that it could be used to distribute cash back to investors. For now, this makes sense but as we move into the next year and beyond, it’s going to take longer for assets to be sold. NAV facilities will come more into play as a source of liquidity to distribute cash back to investors in lieu of an asset sale.
The GP-led solutions market is essentially on hold for now until sponsors and investors can get a better handle on valuations and because it’s difficult for bidders to perform full due diligence in the current environment. GP-led solutions are a new tool now compared to the 2007/08 crisis and it’s likely that we’ll see an uptake in GP-led deal activity in the later half of the year.
Participants were asked:
What would be their reaction if the COVID crisis resulted in them needing more time to create value in their portfolios?
The majority (60%) of respondents would seek to extend their investment period or fund term if they needed more time to realise value in the portfolio and 23% believe they would create additional financing at the fund level. Only 11% would either seek a secondaries process or form a continuation fund. This is consistent with the fact that they’d like to retain future upside to their investments, but we may see more secondary processes than referenced here when valuations recover, and secondary buyers become more active.
Europe and the US
Up to the point of COVID, the European landscape had become saturated by the emergence of US, Australian, Asian and new fund finance entrants (c. EUR150bn+ market) and the issues experienced aren’t dissimilar to those in the US. It appears that more than around 40% of the US banks are experiencing challenges both from a liquidity perspective as deal flow has been pulled forward, product caps are hit and, more practically, in terms of bandwidth as they deal with increased reporting internally and to regulators. Also, there appears to be more innovation in Europe from the NAV banks’ perspective and we may find that that technology becomes more common over in the US – albeit there are some fund participants on the concentrated NAV front.
There are more fund finance products now, more lenders, more fund finance advisors and the market is much bigger and therefore more solutions to solve for liquidity needs. In the last crisis, the fund finance market performed well through the cycle and there were no LP defaults, however the market was very relationship focused and it’s much wider now.
Whilst sponsors arguably go through two phases, phase one being “fighting fires” in the portfolio (resulting in increased use of NAV for defensive pays) to a phase two of financing solutions for delayed sales processes, we’d expect to see a larger number of restructurings over a prolonged period than the last crisis. We’d also expect to see more special situations and distressed funds raised, more GP-led solutions and a substantial increase in secondaries market activity. Additionally, managers have invested more in their operational capabilities to add value at the portfolio company level compared to the last crisis.
Generally, the fund finance market remains solid with a focus on existing clients, bank liquidity and an eye on the behaviour of investors. We believe that it’ll be part of the solution in this crisis and seen in an increasingly positive light from an investors’ perspective.
Intertrust Fund Finance
In 2019, Intertrust launched an independent advisory service designed to help alternative investors establish fund finance facilities. The team helps funds to navigate through the process of establishing fund finance facilities or debt lines. Their expertise can add significant value through a fund’s life cycle, having a full overview and understanding of the lender market as well as the wide range of lending structures available across the fund finance spectrum. To find out more about our fund finance advisory services, click here.