Dezember 06. 2023

Subscription Credit Facilities: Understanding Funding Ratios in the Applicable Requirement


Introduction / Background

Corporate pension plans, governmental pension plans and public retirement systems (“Plan/System Investors”) are common investors in private equity and other similar investment funds (each, a “Fund”). This legal update will focus on the role that funding ratio thresholds play as metrics of the financial condition of Plan/System Investors in a lender’s underwriting process and determination of borrowing base criteria for subscription credit facilities extended to Funds.

Subscription credit facilities are lines of credit established by a bank or other credit institution in favor of a Fund. The collateral package for the lending arrangement is comprised of the unfunded capital commitments of the Fund’s investors to make capital contributions to the Fund when its general partner issues a capital call notice. The entry into a subscription credit facility by a Fund provides it with a convenient source of additional liquidity that can be used, for instance, for working capital purposes, to make investments, and to bridge capital calls from the Fund’s investors. These types of facilities are often employed as part of a Fund’s strategy to increase overall returns for its investors.

Like other types of asset-backed loans, borrowing availability under a subscription credit facility is commonly tied to a borrowing base model. The overall structure and criteria for a subscription credit facility’s borrowing base hinge on the make-up of the Fund’s investor base, as well as certain other factors, such as the current stage of the Fund’s life cycle (e.g., fundraising or harvesting investments). Lenders and borrowers work together to identify certain of the Fund’s investors that are eligible for inclusion in the borrowing base. The investors that are included by a lender in the borrowing base are the investors whose uncalled capital commitments the lender is willing to advance against. The percentage of each investor’s uncalled capital commitment that is included in the borrowing base depends on the investor’s creditworthiness. As more fully explained below, the analysis for a Plan/System Investor involves an examination of its funding ratio.

What are Funding Ratios?

Attracted, in part, by the expected long-term returns that are typically associated with investments in a Fund, many Plan/System Investors are drawn to the private equity market. Given their prevalence in the market, lenders in the Fund Finance market developed a customary approach to determining the creditworthiness of Plan/System Investors for purposes of a subscription credit facility.

As part of a lender’s underwriting process for a subscription credit facility, as well as its creation and monitoring of the borrowing base, a lender considers the financial health of a Fund’s investors to determine the overall credit of the Fund and, if the lender is willing to proceed with the transaction, the ultimate role that each investor will play in the borrowing base. With respect to Plan/System Investors, this assessment takes the form of a special, two-prong analysis that is inapplicable to most other types of investors. In a traditional borrowing base model, highly rated investors that meet a pre-defined set of objective criteria, such as a certain minimum senior unsecured debt rating (often set at BBB or better by S&P or Baa2 or better by Moody’s) or its equivalent, are designated as rated investors and included in the borrowing base with a high advance rate (typically 90%). This step of the analysis applies to any type of rated investor. However, in addition to satisfying the first step’s minimum credit rating requirement, a second criterion is imposed on a Plan/System Investor, in order for a lender to be assured that the investor’s financial condition is sufficient to merit its inclusion in the borrowing base: a Plan/System Investor (or its sponsor or responsible party, as applicable) must also have a minimum funding ratio above a certain, specified threshold.

A funding ratio reflects a Plan/System Investor’s current financial position. It is frequently defined as the percentage obtained by dividing (i) the total net fair market value of the available assets of the Plan/System Investor, by (ii) the actuarial present value of the total benefit liabilities of the Plan/System Investor. A funding ratio thus serves as an indicator of whether the Plan/System Investor has sufficient reserves to meet its obligations to pay pension benefits to its members. A Plan/System Investor’s funding ratio is usually reported in its most recent annual audited financial statements (with respect to governmental plan investors) or its most recently filed Form 5500 with the United States Department of Labor (with respect to other pension plan investors)—both types of reports are publicly available.

Corporate pension plans are subject to ERISA regulations, which require that, if a corporate pension plan’s funding ratio decreases below a certain threshold, the plan’s sponsor must fund the plan to achieve a higher funding ratio or it could be taken over by the U.S. Pension Benefit Guaranty Corporation. Governmental pension systems, by contrast, are not subject to ERISA. The funding obligations of a governmental pension system must instead be evaluated in light of the applicable state and local statutes and regulations. Governmental pension plans and systems may be set up on a state-wide, county-wide or city-wide basis and may include employees of a single governmental employer or multiple governmental employers, such as local school districts or police departments.

Often, the loan documentation for a subscription credit facility sets the minimum funding ratio threshold for purposes of the borrowing base at 80-90% if the Plan/System Investor’s rating is BBB (S&P Rating)/Baa2 (Moody’s Rating) to BBB+ (S&P Rating)/Baa1 (Moody’s Rating); either a lower threshold or no minimum funding ratio is applied to Plan/System Investors with credit ratings of A- (S&P Rating)/A3 (Moody’s Rating) or higher. These levels are commonly viewed by the market as appropriate thresholds for indicating sufficient financial health of a Plan/System Investor for purposes of a subscription credit facility (i.e., that the Plan/System Investor is likely to be able to meet its funding obligations to the Fund, which the lender is relying on as its primary source of repayment for credit extensions that it makes to the Fund under the subscription credit facility). The average funding ratios of corporate pension plans are often higher than those of governmental pension plans.

The minimum funding ratio, taken in conjunction with the minimum credit rating (i.e., the “first step” mentioned above), constitute the “Applicable Requirement” for purposes of a subscription credit facility. Note that, even if a Plan/System Investor does not have a rating and thus does not fall into the purview of this two-step analysis, an unrated Plan/System Investor may nonetheless qualify for borrowing base credit if the lender so elects in its sole discretion. In that case, the lender would likely still examine the investor’s funding ratio when making its evaluation.

A lender will sometimes bestow borrowing base credit on a less-creditworthy investor if the lender receives satisfactory evidence of the investor’s link to a more-creditworthy entity that is liable to fund the investor’s obligations. However, in the context of a Plan/System Investor, this type of credit linkage process can be a little more complicated and may require a case-by-case analysis. If it can be clearly demonstrated that (i) with respect to an investor that is a governmental pension plan or public retirement system, a county, state, municipality or other governmental subdivision is ultimately responsible for the investor’s obligations and is liable to fund any shortfalls,1 or (ii) with respect to any other pension plan that is subject to ERISA, it has a creditworthy sponsor,2 then a lender may choose to look past the Plan/System Investor’s own financial profile and instead examine the credit quality of the relevant responsible governmental entity or sponsor, respectively, in connection with the lender’s calculations of whether the Plan/System Investor (through its responsible party/sponsor) satisfies the Applicable Requirement or otherwise merits borrowing base credit (perhaps at a lower advance rate).3

The methods to establish a credit link between a Plan/System Investor and a more-creditworthy responsible party/sponsor will depend on the legal regime that applies to the Plan/System Investor, as well as a lender’s own internal underwriting standards, which can vary depending on the lender. While the exact requirements to establish credit support may vary, it can be a useful approach for borrowers and lenders to keep in mind when navigating borrowing base discussions in order to help facilitate inclusion of a Plan/System Investor in the borrowing base.

The occurrence of certain negative events (termed “Exclusion Events”) during the life of the subscription credit facility will automatically result in the exclusion of certain borrowing base investors from the borrowing base. One such standard exclusion event is the failure of a rated included investor to continue to satisfy the Applicable Requirement. The exclusion of an investor from the borrowing base due to the occurrence of an Exclusion Event may negatively impact the Fund’s borrowing availability under the subscription credit facility. Further, if, when the Exclusion Event occurs, the Fund’s outstanding principal obligations under the subscription credit facility exceed the resulting re-sized borrowing base, the Fund may be required to make a mandatory prepayment.

Value of the Applicable Requirement as a Tool for Measuring Financial Health

The Applicable Requirement is often considered to be a meaningful metric for the creditworthiness of Plan/System Investors, as it helps a lender to measure the likelihood of a Plan/System Investor’s ability to fulfill its capital commitment to the Fund. While this is the view commonly taken in the market and the layered, two-prong analysis admittedly does provide additional information (and, perhaps, comfort) with respect to a Plan/System Investor’s anticipated long-term financial health, some market participants question whether the funding ratio component of the Applicable Requirement is overly stringent for purposes of a subscription credit facility’s underwriting process and borrowing base requirements.

While a funding ratio speaks to a Plan/System Investor’s ability to meet its long-term obligations, a subscription credit facility’s tenor is often only one to three years. Moreover, the key focus of a subscription credit facility is the investors’ capital commitments to the Fund, which by nature may be obligations that are shorter in term than a Plan/System Investor’s long-term obligations. Furthermore, in practice, many Plan/System Investors (or their responsible parties/sponsors) maintain a higher credit rating than the minimum typically required under loan documentation, which may defeat the purpose of (or at least diminish the value of) undertaking the analytical exercise of the second prong’s examination of funding ratios. Finally, a Plan/System Investor’s funding ratio often remains fairly stable, changing only slowly over time. Thus, analyzing funding ratios in the context of borrowing base requirements, which are ongoing in nature, may provide less value than otherwise may have been anticipated.

Current Market Conditions.

Milliman, Inc., the consulting and actuarial firm, reported in October 2023 that the “funded status of the 100 largest U.S. corporate defined benefit pension plans increased by $4 billion during September [2023]…As of September 30[, 2023], the funded ratio inched upward to 103.6%”, as measured by the Milliman 100 Pension Funding Index (PFI).4 Millman estimated the funded status of the 100 largest U.S. public pension plans to be “73.2% as of September 30, 2023, as measured by the Milliman 100 Public Pension Funding Index (PPFI).”5

Key Takeaways

The funding ratio and minimum credit ratings criteria that together make up the Applicable Requirement for purposes of borrowing base availability under subscription credit facilities serve as tools for a lender when underwriting a subscription credit facility for a Fund that has Plan/System Investors and in structuring and monitoring compliance with its borrowing base. Ultimately, consistent with other borrowing-base requirements that are customary for subscription credit facilities, the Applicable Requirement assists a lender in matching its exposure under the facility to the quality of its collateral.



1 Some state constitutions provide this type of guarantee of funding for some or all pension plans in the state.

2 That is, the entity that established the plan and is responsible for its maintenance and, in the case of a plan that has a sponsor and participating employers, the entity that has the ability to amend or terminate the plan, and in the case of an ERISA investor that is an individual retirement account or individual retirement annuity, the owner of such account or annuity for whose benefit the account or annuity has been established.

3 For a more-detailed overview of governmental plans and systems and discussion of credit linkage to plan sponsors, please see Mayer Brown’s Fund Finance Markets Legal Update, “Governmental Plan Investors and the Borrowing Base.”

4 See Pension Funding Index October 2023 (

5 See Public Pension Funding Index October 2023 (

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