Miami Here We Come – February 2022 | Edition n° 162 – NAV Covenants and subscription lines | Cadwalader, Wickersham & Taft LLP


For funds that are approaching the end of their investment period and have limited or no unfunded capital commitments, the need to maintain a subscription line for continued liquidity may continue to exist for these end of term funds. to support follow-on investments, recurring operating expenses of the funds, and costs associated with maintaining and winding down their portfolio investments. There are a number of financing options in the fund financing market for these funds to consider, including net asset value (NAV) and hybrid credit facilities, but, for many funds, the convenience and familiarity of their existing underwriting line of credit facility can continue to remain the most efficient and fastest way to extend their liquidity trail. In order to extend an existing subscription line facility to a fund after its investment period, there are a number of important threshold factors that a lender must consider, including the purpose for which the general partner may call capital – which is generally limited and excludes capital call for new portfolio investments that are not already under mandate – and whether the limited partnership agreement allows the fund to commit and repay the post-investment period from the proceeds of a capital call, including revocable capital if the limited partnership agreement allows it. In addition, structural changes are often made to the underwriting line loan agreement as the lender looks to the fund’s portfolio investments and the underlying cash flows from distributions from those investments to support the ease of credit in progress. These structural changes almost always include the implementation of net asset value-type covenants, including a loan-to-value (LTV) ratio or minimum net asset value, net asset value to portfolio cost, and a mandatory loan repayment feature. from fund distributions.

Credit facilities based on net asset value

We have seen increased interest in NAV-based credit facilities in recent years as funds seek to extend and leverage the equity value of their portfolio investments. NAV credit facilities are particularly attractive to later-stage funds that are approaching or at the end of their investment period with little or no unfunded capital remaining, but who intend to participate in investment strategies. monitoring and have ongoing fund maintenance needs. While the collateral for an underwriting credit facility is backed by the unfunded capital commitments of investors in the fund, the collateral for NAV-based credit facilities is often structured to include distributions and liquidation proceeds of investments in the fund’s portfolio and the rights to receive such amounts, and a pledge of the interests of the companies holding the interests. A NAV facility will look ‘down’ for collateral support, unlike an underwriting facility which will look ‘up’ for collateral. Unlike subscription lines which have a revolving credit facility structure with short term maturities and are light on financial covenants, a NAV facility will generally consist of a term loan facility with varying tenors depending on the investments. underlyings and at least LTV clauses that vary depending on the diversification of portfolio assets and a mandatory call feature that requires the fund to use all or a significant portion of the distributions received on the investment of the portfolio to prepay the outstanding obligations of the credit facility at net asset value. These structural features, coupled with higher NAV credit facility pricing, are generally less favorable terms for borrowers of funds relative to their existing underwriting line credit facilities.

Hybrid credit facilities

As with NAV-based credit facilities, there has been a corresponding increase in hybrid credit facilities or structured underwriting facilities with NAV covenants. Hybrid credit facilities are also particularly useful for funds that are nearing the end of their investment period and have only a small amount of uncalled capital or are dependent on revocable capital for follow-on investments. and fund expenses. Collateral pledged to secure hybrid credit facilities typically includes a mix of fund assets ranging from “upside” research to any remaining unfunded commitments and revocable capital if permitted by the limited partnership agreement and “down” in the value of the fund’s portfolio investments. Similarly, a hybrid credit facility will include a combination of underwriting and NAV-style covenants, ensuring sufficient callable capital and a minimum net asset value to support the credit facility. These features increase the complexity of a lender’s subscription to a hybrid facility and the corresponding legal due diligence performed by the lender’s attorney. Pricing for hybrid installs tends to be higher than subscription installs, but lower than NAV installs. A hybrid credit facility provides ongoing liquidity and flexibility for maturing funds under a single credit agreement. Even with this flexibility, the funds may decide that it is more efficient to maintain the underwriting credit facility with improved structural elements, such as net asset value type covenants, added by the lender to support the loan extension at – beyond the investment period of a fund when the value of the portfolio becomes an important secondary source of reimbursement.

NAV covenants of the subscription line

For funds with ongoing liquidity needs after the expiry of their investment period, and if the net asset value or hybrid facilities are not suitable, some lenders will agree to extend a fund’s existing underwriting line facility under subject to certain additional credit enhancements, including adjustments to the borrowing base and the implementation of NAV-type covenants. An extension of a traditional underwriting facility, even with these adjustments, in some cases may be more beneficial to a fund than restructuring into a NAV or hybrid facility. The fund is already familiar with the covenants and reporting requirements of the existing facility and has established a working relationship with a lending team over the life of the facility. The loan team knows the fund administration team well and works closely with them and the general partners to manage all aspects of the relationship. This report is invaluable and not always easy to replicate.

Significant adjustments to the borrowing base are generally required to increase the availability of the fund when the remaining uncalled capital is low or the fund has only revocable capital to include in the borrowing base. A substantial increase in borrowing base from a traditional blended advance rate of 50% to 90% is not uncommon. In return for this increased borrowing base availability, lenders typically require the implementation of NAV-type covenants to mitigate the reduced primary source of collateral and repayment in the form of uncommitted capital and look “to the decline” in the value of the assets of the investment portfolio. Net asset value covenants are designed to be strict, but should be manageable and tailored appropriately for the fund. Typical NAV-type covenants include one or more of the following:

LTV ratio. A minimum LTV clause will measure the ratio between the principal amount of the credit facility and the value of the portfolio assets held by the fund. The covenant may require the fund to maintain a minimum net asset value in a selected group of trophy investments or in the fund’s portfolio of investments as a whole. Having a diverse mix of underlying portfolio investments is another important factor for this covenant. Generally, lenders look more favorably on a broad diversification of portfolio investments to minimize the increased risk associated with continuing to extend credit to a fund whose uncalled capital has declined. A more diversified loan portfolio may allow a fund to obtain better loan terms and less restrictive covenants than funds with less diversified portfolio investments. A minimum LTV multiple of at least 25% to 35% is typical for primary PE funds.

NAV-Cost. A fund may also be required to maintain and report a net asset value covenant based on the fund’s total cost allocated to its portfolio investments, as disclosed in its most recent financial statements. It is important for a lender to follow the fund’s ongoing cost structure and require the fund to keep its expenses at reasonable levels to protect against unforeseen depletion of remaining uncommitted capital or revocable capital, if applicable. . A typical net asset value cost clause will require a net asset value of at least 100% to 110% of the aggregate cost basis allocated by the fund to its portfolio investments.

Compulsory refund. The credit agreement may require the fund to prepay any outstanding obligation with the proceeds of a distribution or the liquidation of a portfolio investment. In a traditional underwriting line facility, the distributions and proceeds received by the funds from its portfolio investments are considered a secondary source of repayment for the lenders. This secondary source of repayment becomes more important as a fund’s uncommitted capital is depleted over the life of the fund and the lender looks “down” into portfolio investments to meet liquidity needs. of the borrower of the fund. Therefore, it is not uncommon for a lender to require the mandatory repayment of outstanding obligations under a subscription line credit facility with cash flows from distributions received by the fund on its portfolio investments. .

Even with the addition of these NAV-type clauses, the convenience, familiarity and efficiency of pursuing an underwriting line credit facility may be the most advantageous and preferred approach for both the fund and the lender to meet the ongoing liquidity needs of funds approaching the end of their natural investment period.


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