Eligibility Spotlight for Private Credit ABL Facilities: Fully Funded Loans

This Legal Update explores why, in order for an underlying loan to be included in a warehouse facility’s borrowing base, the underlying loan must be fully funded (or, for any delayed draw term loan or revolving loan, a reserve set aside).

Examples of Fully Funded Eligibility Criteria:

• Such loan has been fully funded, and all amounts available to be borrowed thereunder have been fully advanced.
• Such loan has been fully funded, and all amounts available to be borrowed thereunder have been fully advanced; or, with respect to delayed draw term loans or revolving loans, any unfunded commitments (or applicable portions thereof) have been reserved in accordance with the Credit Agreement.

What does it Mean for a Loan to be “Fully Funded?”

Although nuanced in practice, from a lender’s perspective, the obligations under a loan facility generally fall into one of two categories: funded or unfunded.
A loan is “fully funded” when the lender has fully satisfied its obligation to lend funds to the borrower. Conversely, a loan is “unfunded” when any part of the lender’s obligation to fund remains outstanding.

Under a traditional term loan facility with a closing date commitment, the term loan would be deemed fully funded following the closing date when the lender satisfies its lending obligation. Under a delayed draw term loan facility, an aggregate term loan amount may be funded over a specified period of time, and will not be deemed fully funded until the earlier of (i) a specified termination date, and (ii) the date that the lender has funded all delayed draws. In such facilities, any amounts drawn and subsequently repaid by the borrower cannot be reborrowed.

Under a revolving credit facility, a borrower can draw and repay loans from the lender at any time during a specified commitment period. In such case, because amounts repaid may be reborrowed at any time during the commitment period, the facility would be deemed fully funded only after the commitment period has terminated and the lender has no further lending obligations.

Why do Warehouse Lenders Care if a Loan is Fully Funded?

When a warehouse lender (a “Lender”) is underwriting underlying loans funded by a private credit fund, as lender (a “Warehouse Borrower”), an underlying loan where the Warehouse Borrower retains funding obligations presents a different credit profile when compared to an underlying loan where the only remaining material obligation is for the underlying obligor to repay its obligations.

When underwriting a warehouse loan facility, Lenders analyze the Warehouse Borrower’s ability to cover its debt and funding obligations based on interest and principal proceeds received from its underlying loan portfolio. If a significant portion of the underlying loans consists of unfunded loans, the Warehouse Borrower will need additional liquidity to cover its unfunded obligations under the underlying loans as they become due. The timing of unfunded obligations under the underlying loans may be unpredictable, increasing the risk that the Warehouse Borrower may not be able to satisfy its unfunded obligations, the failure of which could result in the Warehouse Borrower defaulting under the underlying loan agreement, resulting in potential lender liability.

Unfunded obligations under the underlying loans also present risks for the warehouse loan facility and its Lenders. The Warehouse Borrower is typically a special-purpose vehicle of the private credit fund; therefore, the Lenders’ only recourse is to the collateral portfolio owned by the Warehouse Borrower. If the Warehouse Borrower is required to use interest and principal proceeds received from its underlying loan portfolio to satisfy unfunded obligations under underlying loans, there may be insufficient proceeds to pay the Warehouse Borrower’s obligations to the Lenders under the warehouse facility.

Why Are Revolving Credit Loans and Delayed Draw Term Loans Often Eligible Collateral?

Despite the foregoing risks, many warehouse loan facilities allow underlying loans that are revolving loans and/or delayed draw term loans to be considered eligible collateral, subject to certain protections and limitations.

Generally, underlying loans that are not fully funded are subject to concentration limits and/or hard caps in the eligibility criteria, thereby limiting the Lenders’ aggregate exposure to unfunded obligations.

In addition, Lenders often require the Warehouse Borrower to maintain cash reserves or other immediately available liquidity in an amount sufficient to meet potential funding obligations under the underlying loans. The extent of any such reserves may vary. However, typically, a portion of any unfunded obligations is required to be reserved during the warehouse facility’s revolving period (since the Warehouse Borrower can borrow under the warehouse facility to cover unfunded obligations during this time), while the full amount of unfunded obligations is required to be reserved following the expiration of the revolving period (since such amounts will need to be available to fund all obligations, and the Warehouse Borrower is no longer able to draw under the warehouse facility).

Conclusion

The decision to allow a Warehouse Borrower to hold revolving or delayed draw loan facilities with unfunded commitments is directly tied to the expected cash flows of the underlying loan portfolio. Because warehouse loan facilities are typically standalone facilities, with drop-down borrowers that are isolated from the creditworthiness of their parents, the evaluation of inflows and outflows is imperative to ensure the Warehouse Borrower has sufficient funds to meet its funding obligations. If Lenders choose to lend against an asset that is not fully funded, they should ensure that any unfunded obligations of the Warehouse Borrower are properly reserved within the warehouse facility structure. Including an eligibility criterion addressing these points mitigates the risk that the Warehouse Borrower will be left with insufficient funds to meet its funding obligations (and, in turn, protects the Lenders from potential losses).