We hope that everyone is keeping safe and healthy in these unprecedented times. As the world adjusts to the “new normal” of working from home and staying in place, the Mayer Brown Fund Finance team has addressed various questions pertaining to fund finance in the era of COVID-19. As we want to keep you current with what we are seeing in the market, some of our collective thoughts and observations are set forth below.

Fund Finance Market

  • There has been increased activity in the fund finance market over the last month as a result of COVID-19 and the related governmental actions. Many deals already in the pipeline were put on accelerated timetables for closing. We have fielded numerous requests for upsizes, maturity extensions and joinders of portfolio companies as qualified borrowers. The latter was a popular method for funds to bolster the liquidity of their portfolio companies. While the bulk of the activity was seen in the context of subscription credit facilities (“SCFs”), we also understand there are increased requests from sponsors and general partners (“GPs”) for liquidity through use of management fee, GP and partner loan programs.
  • Funds seeking to upsize SCFs may find lenders scrutinizing their historical usage of subscription facilities, including whether prior upsizes have been fully utilized, the current usage of the facility, whether the GP has made recent capital calls and if the limited partners (“LPs”) funded as required. We are not aware of any institutional LP defaults under SCFs, and we are not hearing anything contrary from our recent conversations with GPs and lenders.
  • In general, we understand that lenders under uncommitted facilities have continued to fund such lines and honor requests for borrowings.
  • There has been some discussion regarding pricing for SCFs in particular but also with respect to other fund finance products:
    • With respect to existing fund finance deals, it would appear that lenders are not yet looking to “increased costs” provisions in loan documents as a basis for raising pricing for existing facilities. With respect to deals closing as of last week, we understand that pricing was mostly held at or close to pre-COVID-19-negotiated levels.
    • Many lenders, however, are seeing an increase in their internal cost of capital. This has caused some lenders to revisit pricing for uncommitted accordions and deals in the pipeline as well as raising pricing for new transactions. Ultimately, each lender will need to make pricing decisions based on its cost of funds, allocation of capital and exposure to the markets it serves (including to non-fund finance products on such lender’s or financial institution’s books). There is no “one size fits all” approach, and we note that for some lenders the cost of capital may differ depending on currency. For this reason, pricing may vary by currency on multicurrency facilities.
    • Where lenders are considering pricing changes on SCFs, the majority have expressed that changes in applicable margin and/or instituting LIBOR floors above zero are the most likely near term outcome.
    • We also understand that, for some lenders, the internal cost of capital has grown disproportionately higher for longer-term facilities. We may see uncommitted extensions becoming more frequent so as to provide flexibility to address pricing on a mark-to-market basis in the future. We have also heard that pricing for SCFs in Europe and, in particular, those involving less established sponsors are likely to be subject to higher increases.

Fundraising and LPs

  • Given the fluid situation, it can be hard to predict the extent of economic disruption that will result from COVID-19, or any lasting effect on market activity. Lenders and funds are carefully watching how the next few weeks play out and, in particular, how LPs react to the unfolding environment in terms of their investment activities and portfolio liquidity.
  • With respect to fundraising activity, we understand that the majority of closings in the pipeline have continued. We have heard some funds in the market may be considering a smaller initial close size due to lower initial commitments from investors or a lower initial close with anchor investors only so that the ability to make opportunistic investments is locked in while future fundraising continues. For other funds, however, fundraising has not changed, and many LPs still need to make additional allocations.
  • We have also heard a number of sponsors have launched, or are contemplating launching, funds with distressed or opportunistic strategies to take advantage of disruption in both the private credit space and other asset classes where asset prices may have fallen.Additionally, some thought is being given by sponsors to upsizing existing funds with LP commitments to take advantage of market opportunities rather than raising a separate distressed fund. Many fund limited partnership agreements contain requirements to deploy a certain amount of capital prior to creating successor funds. Therefore, it might make sense to add on to an existing fund in the hope that an add-on to the existing fund would be more likely to garner requisite approvals from LPs than a competing successor fund.

While it has been reported that GPs may call capital to repay their subscription facilities, we have generally seen ordinary course payoff activity along with more borrowers seeking to extend or increase their borrowing capacity to mitigate the need for LP capital calls.

  • Moreover, we understand that some GPs with clean down requirements in their limited partnership agreements or side letters may be revisiting such requirements. Removing or lengthening the period during which borrowings may be outstanding may help the fund achieve greater leverage and additional liquidity. This may also benefit LPs in helping to manage their own liquidity as well.

Considerations for SCFs and other Fund Finance Transactions

As the COVID-19 situation develops, we think the following is also worth considering:

  • As we enter a period of likely market volatility, the asset pricing of investments in hedge funds, secondary funds, infrastructure funds and other funds is subject to change, and we have already seen GPs undertaking impact assessments on their portfolios. This can be a potential issue for funds utilizing NAV facilities and/or hybrid SCFs. Lenders and borrowers should discuss early any potential issues relating to quarterly valuations and possible LTV or NAV triggers that could require mandatory prepayments or cause covenant breaches. With respect to facilities where the borrower is a fund that is registered under the Investment Company Act of 1940 in particular, volatility in asset pricing may cause issues with compliance with statutory asset test requirements. We understand that some funds may have anticipated this and are making prepayments of loans in order to maintain appropriate asset coverage ratios.
  • We understand that there is some concern audited financial statements could be delayed due to the current work-from-home environment and constraints relating to the typical audit process. The custody rule requires that audited financials generally be delivered within 120 days. Although no new FAQs on audit delivery have been issued, the existing FAQ permits advisers to extend beyond such date (without any outside deadline) for “unforeseeable circumstances.” While the timeline for delivery remains a few weeks off, the market may see the need for future amendments or waivers on fund finance transactions. We are monitoring the situation and other potential SEC guidance regarding relief from regulatory requirements on financial statement delivery.
  • Even the basic mechanics of transaction closings—including executing signature pages, notarizing documents and being able to access secretary of state offices for filings, searches and good standings—have raised potential new issues that market participants are seeking to address on a daily basis. Fortunately, we have found solutions to the challenges presented, and many states are creating emergency legislation to address these new issues, such as permitting the ability to notarize remotely. We are always ready to help in brainstorming a solution.

The Mayer Brown Fund Finance team has worked with the vast majority of market participants during prior financial downturns, and while COVID-19 presents a unique set of challenges, we are fortunate to have the benefit of this prior experience. Should you have any questions about current market conditions or would like to discuss any challenges you are facing or opportunities you may be considering, please feel free to reach out to us.

Kiel A. Bowen
Charlotte +1 704 444 3692

Todd N. Bundrant
Chicago +1 312 701 8081

Doo-Soon Doos Choi
Hong Kong +852 2843 2201

Mark C. Dempsey
Chicago +1 312 701 7484

Ann Richardson Knox
New York +1 212 506 2682 

Aimee Sharman
London +44 20 3130 3386

Paul Tannenbaum
London +44 20 3130 3088

If you wish to receive periodic updates on this or other topics related to the pandemic, you can be added to our COVID-19 “Special Interest” mailing list by subscribing here. For any other legal questions related to this pandemic, please contact the Firm’s COVID-19 Core Response Team at FW-SIG-COVID-19-Core-Response-Team@mayerbrown.com.