COVID-19 and the Fund Finance Market - A further update on the Subscription Finance and the NAV Facility markets

On April 14th we published a summary of the Fund Finance Association's (the "FFA") COVID-19 Response. A copy of the full publication can be found here (the "FFA Response").

Our further update on the market follows:

We continue to be unaware of any significant institutional defaulting investors within our subscription finance client base.

Private Debt Investor reports that The Institutional Limited Partners Association ("ILPA") is preparing recommendations that general partners report to investors on subscription line facilities with increased regularity and detail, so as to ensure that investors fully understand the usage of fund level facilities and how they may impact calls on investors.

An ILPA survey of its members published shortly after the FFA Response found that its members are experiencing a higher number of capital calls in recent weeks.

Trends we have seen in the Subscription Finance / Fund Finance market are:

• We are unaware of any lenders refusing to fund under a committed subscription line.
• We have seen lenders (tending to be participant banks rather than arranger banks) refusing to take up accordions and extensions, but have seen these implemented in any event through other banks taking up any such shortfall or extension.
• Extensions beyond one year are difficult at the moment given pricing concerns.
• New facilities and new relationships are proving challenging for some lenders. Increased usage of other facilities (e.g. corporate revolvers) is putting a strain on available funds for subscription lines. There is also a focus for some banks on facilities being linked to their home jurisdiction. Other lenders have been 'open for business' and are taking the new opportunities that have arisen.
• Pre-COVID pricing is being revisited. The increased pressures on liquidity and cost of funding are resulting in the cost of borrowing increasing and borrowers having to accept the same in current market conditions.
• We have not yet seen significant amendment and waiver requests, but expect to receive the same shortly as regards delivery of accounts and net asset value ("NAV") related covenants (in the case of subscription lines, where there is a NAV covenant).
• There has been a lot of press coverage of 'the denominator effect' - where the sudden decrease in public market values means that investors are over-exposed to private equity (or other illiquid assets), resulting in a need to sell current private equity interests and decrease new commitments into private equity. This could result in material changes to the borrowing base in facility agreements.
• Likewise, for facilities where the borrowing base includes rated investors, upcoming changes to ratings could materially impact the borrowing base.

Trends we have seen in the NAV market are:

• There has been increased media attention and client interest in NAV facilities, in particular for primary private equity funds (whereas to date NAV facilities have mostly been focused on secondary funds and private debt funds).
• An increasing number of lenders, including non-bank lenders, are looking carefully at entering the NAV market and are showing a willingness to lend on primary private equity portfolios. There is still however a shortage of liquidity in this market, with only a few established providers.
• Older funds looking at NAV facilities are finding that their limited partnership agreements ("LPAs") may not expressly provide the ability to inject NAV facilities into their fund structures - resulting in a requirement to either amend their LPAs (with requisite investor consent), or find an innovative structuring solution that accords with LPA requirements
• Similar to subscription lines, we have not yet seen significant amendment and waiver requests, but expect to receive the same shortly as regards delivery of accounts and NAV covenants. (Private debt fund borrowers are struggling in particular given the impact of market conditions on their portfolio of loans
  
  (See our previous insight The rise of NAV - a useful checklist on NAV facilities generally.)

Our thoughts on the likely impact of COVID-19 on both the subscription market and NAV market over the next few months are:

There will be a significant change to the make-up of Lenders in the market:

• in the subscription finance market, a number of the smaller players where this market was not core to their overall business will fall away, and those that have been able to fully support their clients will increase market share
• in the NAV market, given the number of queries we are fielding on a daily basis, we expect that there will be an increasing number of both banks and non-bank lenders entering the market, and that there will also be a significant increase in demand
• there will also be an increase in General Partner Priority Profit Share/Management Fee based facilities, as general partners also look to increase liquidity

Similar to the market impact of Abraaj and the last global financial crisis, there will be a lot of introspection and revisiting of subscription finance structures - but ultimately they will prove robust, and there will not be much in the way of fundamental change to how the market operates. That said, there will be further improvements in reporting to Investors and transparency of information about borrowing at fund level.

The denominator effect and the market generally may impact fund raising, which could in turn decrease subscription facility sizes (but not necessarily the volume).

Given the increased focus of funds on liquidity options, there will be much greater focus at fund raising stage around increasing flexibility in LPAs, for both subscription lines and NAV facilities, but this will not be without significant debate.

There will be discussions with investors around extending investment periods, and recycling provisions to avoid having to call on investors for new drawdowns.

Once valuations settle down, there will be an increased demand for secondaries for later stage funds where managers believe holding on to investments for a longer period will significantly increase returns – determining fair valuations to ensure all investors are treated equitably will also result in significant debate.

Just like in the wake of the global financial crises, special situations and distressed asset funds will thrive and grow (and will be looking for liquidity at fund level).

With our market-leading fund finance practice acting for both banks and funds globally, Ashurst would be delighted to have a conversation with you, if would like to further discuss our insights.