Seward & Kissel LLP is closely monitoring the impacts of COVID-19 on the financial markets, including the fund finance market. COVID-19 is placing significant stress on liquidity and financing markets, including with respect to the private equity industry. As such, it is crucial for sponsors to consider the impact on all of their sources of liquidity at both the fund level and portfolio company level, and for lenders to review their documentation and be prepared for issues and questions that may arise as a result of market dislocation and sponsor requests.

OVERVIEW OF FUND FINANCE MARKET AND SPONSOR ACTIVITY

Fund Finance Market Remains Generally Active

Despite the impact of COVID-19 on the financial markets and uncertainty regarding how the pandemic will continue to affect the economy and markets, as of now the fund finance market remains active. We are still seeing a number of new facilities and the timeline on closing many facilities is being accelerated to ensure that liquidity is available on an expedited basis should the need for an opportunistic investment arise. Notwithstanding the foregoing, the ability to put in place a new facility may be impacted by various factors, including bank relationships and allocation of capital, available liquidity, and fund structure and investor composition. While some markets have seen a dramatic increase in drawings in order to meet liquidity needs, the needs of drawings on underlying assets or to hoard cash on the balance sheet, market participants are not reporting the same leap in subscription facility drawings as most drawings are being used, as is typical, to fund opportunistic investments.

A number of sponsors are requesting increases in the size of their facilities and examining ways to increase availability. Many lenders are receiving requests from funds to extend existing facilities, increase the size of facilities, or increase availability thereunder through the addition of qualified borrowers. Requests for extensions and increases in availability are common across different types of deals in the fund finance market, including subscription facilities, management fee facilities, asset-based facilities, general partner facilities and partner loan programs.

Lenders and sponsors are fielding many calls about the status of the market and whether there have been, or if it is anticipated that there will be, investor defaults with respect to capital commitment obligations. The general consensus among market participants is that there have not been large institutional investor defaults on capital call obligations. There have been reports of isolated instances of individual limited partner defaults as a result of a lack of liquidity. However, so far, it has been reported that these isolated instances were not institutional investors and were not connected to funds with subscription facilities. Some market participants are indicating that they are seeing an increase in the size and frequency of capital calls. Our understanding is that this is not an across the board trend, and even where such increases have occurred, reports indicate that investors are making such capital contributions, even in funds in which the investor base is predominantly high net worth individuals. A number of other sponsors are taking investor liquidity concerns into account and trying to slow down the frequency and size of capital calls and are even revisiting clean down and frequency of capital call provisions. In any event, we have not been seeing significant adjustments to borrowing base calculations or mechanics as a result of concern over investor capital obligation defaults. We have seen some smaller funds with immediate liquidity concerns put in place small lines of credit from key anchor investors in order to bridge the gap until the markets stabilize or liquidity frees up from other sources.

Transparency and Communication

It has also been reported that sponsors are taking actions to increase transparency and communication with investors. Sponsors are monitoring investor liquidity concerns and, given the current market disruption, it is advisable for sponsors to give more advanced warning to investors of upcoming capital calls, to the extent possible. While investor defaults have so far not been an issue, actions should be taken by sponsors and financial institutions to minimize potential delinquencies and defaults and ensure that investor liquidity and timing issues are dealt with in an open and constructive manner.

Fundraising Activity

Fundraising activity varies widely across sponsors. Some sponsors are continuing fundraising at the same pace in spite of COVID-19 and the associated market disruptions. Other sponsors are continuing fundraising, but are closing capital raises with smaller amounts as a result of decreased interest or fewer anticipated investment opportunities. Some funds are accelerating closings to lock in commitments for short term opportunities while continuing to fundraise for an additional fund or a later closing for investment opportunities without an immediate funding need. A number of other sponsors are starting to launch funds with distressed and opportunistic strategies, while some sponsors are slowing down fundraising efforts and adopting a wait and see approach.

LENDER CONSIDERATIONS

Pricing Determinations

Despite the steady levels of activity in the fund finance market, and our work on both new facilities and amendments to increase size and availability, there are some considerations in connection with COVID-19 that lenders are taking into account. While not a market-wide trend yet, some lenders are beginning to consider and implement pricing increases upon an extension, amendment or with respect to new facilities, in each case as a result of a decrease in available liquidity and an increase in cost of funds. Lenders will need to make pricing determinations depending on market movement, increases in internal cost of funds, market exposure, internal allocations of capital and institution wide client management decisions and allocations. Any pricing changes could come in the form of an increase in the applicable margin or commitment fee. In addition, some lenders may adopt LIBOR floors above zero. As is typically the case, there will also be different pricing determinations for the U.S. versus European markets, depending on the history of the sponsor, and depending on the size and diversity of the fund.

Capital Call Considerations

Many lenders are also concerned about funds that have historically gone for long periods without calling capital from investors. Such lenders may require that funds call capital prior to the effectiveness of any amendments or extensions, or may institute a documentation requirement for periodic capital calls in order to receive comfort that investors will comply with their capital commitment obligations during this period of market disruption.

Uncommitted/Committed, Capital Allocation and Sizing Considerations

A number of funds with uncommitted facilities are requesting that the lender make such facilities committed. Some facilities are converting to committed programs, some are staying as uncommitted loans with lenders continuing to fund borrowings thereunder, and some facilities are being replaced by a committed facility with a new lender as a result of an uncommitted lender refusing to convert to a committed facility or making the decision to no longer fund such uncommitted loans.

Financial institutions are also having internal discussions about allocation of capital. Many lenders are providing priority to current sponsor relationships. This opens the door for other lenders to provide liquidity and establish relationships with smaller and newer sponsors that are being passed over by larger or more established market participants.

We are also hearing about more lenders having internal discussion as a result of concerns with the sizing of funds and facilities. Some lenders are increasingly cautious with smaller and less diverse funds with fewer institutional investors, as well as extremely large funds which require the outlay of additional funds and capital.

As described above, notwithstanding these additional considerations and discussions, the market is still active and we are still seeing new facilities close and enter the queue.

ASSET-BASED LOANS, NAV FACILITIES AND FUND OF FUND LOANS

NAV Based Loans

With many lenders at capacity or reallocating capital with respect to subscription facilities, a number of sponsors are asking lenders about asset-based loans. Sponsors are seeing NAV loans as a way of supporting requests for liquidity to meet the needs of investors and portfolio companies.

We have seen a number of NAV based loans that have breached or come close to breaching Loan-to-Value (LTV) triggers. However, many of those facilities include, in addition to the LTV trigger, borrowing base and asset coverage tests that provide lenders additional comfort and flexibility to waive any such breaches and to work in cooperation with borrowers to wait out the market volatility. Many facilities also have baked-in extended cure plans to handle an LTV breach. Borrowers and lenders should get ahead of potential breaches to put in place a plan of action to reduce leverage and/or access additional liquid collateral. In addition, loans to registered investment companies may be impacted by a borrower’s failure to comply with statutorily required asset coverage. Funds that think this may be an issue may preemptively reduce leverage or begin discussing options with lenders.

Fund of Fund Loans

Fund of Fund loans have not been drastically impacted yet, as net asset value statements are generally delivered on a delayed basis. Many borrowers in this space are making efforts to raise capital for potential investing opportunities. In the fund of fund loan market we have seen requests for commitment increases, along with adjustments to haircuts and portfolio guidelines in order to get more borrowing capacity out of existing collateral or anticipated new investments. In addition, a number of fund of fund borrowers have requested to renew their facilities ahead of schedule to ensure that lending commitments are locked in for another year. Consistent with the subscription finance market, these loan modifications are typically associated with increases to spreads and/or commitment fees.

Margin Loans

Margin loans were hit pretty hard in the first quarter and a number of facilities breached price and LTV triggers. This led to lenders and borrowers scrambling to find solutions, amending documents and waiving triggers. Margin calls were issued, positions were liquidated, forbearance agreements were put in place and additional credit support and collateral were required in exchange for waivers on loosening of triggers and thresholds.

Audited Financials

Another consideration for all of these facilities is that audited financial statements could be delayed as a result of the current environment, including administrative difficulties relating to their production. The market may need to amend and waive provisions relating to the delayed delivery of such financials.

Seward & Kissel LLP represents all participants in the fund finance market. We will continue to provide updates and insights on any Coronavirus-related developments. If you would like additional information about this or any other matter, or wish to discuss Fund Finance further, please feel free to contact Jeff Berman at bermanj@sewkis.com.

Seward & Kissel has established a COVID-19 Resource Center on our web site to access all relevant updates and alerts that we distribute relating to COVID-19.