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Q: How would you describe fund financing lending capacity today?
Oliver Bartholomew: It is clear that bank capacity has expanded significantly in the area of fund finance over the last decade. There has been an uptick in the number of new entrants into the market and existing players have or are considering expanding teams to deal with the growing opportunity. Why? Fund finance is an excellent entrance into the general partner relationship, opening up the opportunity of wider firm engagement such as advisory work, leverage finance, FX and derivative services, and private banking services.
Fund finance and, in particular, capital call finance are highly attractive from a credit risk perspective. The market is typified by very low reports of default, and banks are seeing the relative value in the space. It must be noted that, in a general sense, the market is expanding beyond solely bank capital with the ever-increasing presence of institutional investors into the fund finance world. This is enabling the supply of capital to meet the increase in demand for fund finance products.
Q: Have you seen an increase in institutional appetite for fund finance of late?
OB: Absolutely. We have been working with institutional partners in the insurance and pension fund sectors for the past five or six years and have deployed over €4.5 billion in that time. From our perspective, the increase in appetite has allowed us to scale up our capital call offering: we recently closed a €700 million facility for a top-tier sponsor, for example, which would never have been possible in the past. And, of course, many of these insurance companies, pension funds and asset managers are LPs in these private equity funds already, so the connection with the GP is already there.
Helen Griffiths: The demand for capital call finance will always exceed the supply that is available solely from the banking sector. There is a real need for that institutional capital, because banks are reaching the limits imposed on them from both an internal risk diversification and regulatory perspective.
Investec has an established track record in the market in providing solutions for managers, whereby we deploy institutional capital while maintaining alignment with GPs and our institutional partners by having skin in the game. We can increase the quantum of the solution by innovative structuring and relationship lending, leveraging off the appetite of our institutional partners to deploy into this asset class.
“There is a real need for institutional capital, because banks are reaching the limits imposed on them from both an internal risk diversification and regulatory perspective.”
Q: In addition to the scale provided by institutional capital, how are master finance agreements (MFAs) benefiting borrowers?
OB: I tend to use the analogy of the Investec Master Facilities Agreement being that of a tailored suit which can be adjusted to fit the specific needs of the GPs, whereas traditional fully committed facilities tend to be more standardised and one size fits all. The financial benefit of the MFA is that the client only pays for what they use. This provides natural downside protection against deployment rates.
One of our clients a number of years ago had a deployment rate of zero for one of their funds, which therefore meant their usage of the MFA was also close to zero. An alternative fully committed facility would likely have cost that client between €1.5 million and €2 million for that period.
This is all in the context of LPs becoming more focused on increasing fund expenses, with fund finance borrowing costs being one of the highest costs a fund faces during its investment period. Where GPs can save is becoming a bigger focus for these operational departments.
There are further benefits associated with the Investec MFA – in particular, the ability to obtain a secured hedging line without the need to cash collateralise any mark-to-market exposures.
HG: That is going to be particularly relevant in light of the LIBOR transition. The market hasn’t settled on how to price risk-free rate loans, and is still trying to figure out if we need to price sterling and US dollar overnight index average loans differently. Further, we haven’t even started to get our head around secured overnight financing rate loans. The flexibility of the MFA will allow secured hedging to be put in place with recourse to the same capital call security package – in other words, the investor commitments. That will allow us to provide competitively priced FX solutions to clients in addition to or as an alternative to offering a multicurrency facility that would potentially price at different rates.
“Continuation vehicles are playing an increasingly important role towards the end of a fund’s life. I certainly think this will be a growth area over the coming years.”
Q: How is the rise of continuation vehicles impacting the provision of NAV financing?
HG: NAV solutions tend to work for the short to medium term and can be put in place at any point in the lifecycle of a fund. They can also often be structurally subordinated to allow them to co-exist with a capital call facility. But continuation vehicles are playing an increasingly important role towards the end of a fund’s life: they tend to offer a longer-term strategic play as an acquisition tool for the assets involved to allow investments to endure outside of the original lifecycle of the fund. I certainly think this will be a growth area over the coming years.
Q: What about the need for GP financing as fund sizes continue to grow?
OB: In 2022, we estimate that around $600 billion in fundraising will take place for the full year; at an average contribution of 3 percent, GPs will be looking to invest $18 billion into their own funds.
At the same time, the exit rate for previous funds significantly decreased, particularly during the early stages of the pandemic (though we are now starting to see this pick up). This has created a natural funding gap for many GPs, particularly junior partners, who are expected to provide a significant equity investment into a GP’s follow-up fund. With follow-up funds being typically larger and average GP commitments of 2 to 3 percent of fund size, this remains a significant ask. As a result, GPs are seeking options to reduce this funding gap, which can be bridged by the usage of a GP financing facility provided by institutions such as Investec.
Q: Do you expect to see opportunities emerging as more GPs consider going public in the wake of Bridgepoint’s IPO last year?
HG: Definitely. The institutionalisation of the mid-market is allowing GPs to focus more on financing structures and options that used to be reserved for the likes of KKR, Petershill/Goldmans and Blackstone. Private credit ratings can allow for a simplification of the recourse structure to extend across multiple strategies and funds that could create opportunities for investment-grade financing at a manager level.
This is an exciting opportunity for the mid-market, where Investec’s expertise across fund finance and the PE spectrum – generally through growth, leverage finance and advisory services – can bolster firms’ offerings. Access to institutional capital alongside our own will allow us to tailor the future shape of GP financing towards more of the investment grade financing structures that came to market last year.
*This article first appeared as the keynote interview for the February 2022 Fund Finance edition of Private Equity International.
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