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Nothing to see here: LP defaults are fake news

by Alice Murray 15 April 2020

Last week, the Fund Finance Association (FFA) convened its most active bank members, as well as fund finance, fund formation lawyers, and fund sponsors to discuss recent developments. The banks collectively represent $150bn in fund finance commitments.

The key message of the resulting statement was that contrary to reports, there have been no investor defaults and lenders are extending credit facilities to support both LPs and GPs.

Credit and liquidity concerns

There have been reports of rising concerns around LP liquidity, as well as suggestions of LP defaults.

In a separate note, US law firm Haynes and Boone wrote: In the past week, a Private Funds CFO headline announced LP defaults “already happening”, reporting, with little detail, that two European LPs had defaulted on capital calls and more were rumored. We were skeptical, because we have seen this before.

On further inquiry, it turns out that several high net worth investors may have, in fact, failed to fund a capital call, but as far as we can tell, no cascade of defaults has yet followed by other investors in that fund, and the fund apparently did not have a subscription-secured facility in place.

The FFA group came to the same conclusion. It said: “Despite last week including the end of a quarter (traditionally quarter-ends involve a heavy volume of capital call activity), no participant on our FFA group call reported having seen a single institutional Investor default on a capital call.”

Instead, the group reported that lenders have extended sub lines to funds backed solely by high-net-worth investor bases. The FFA said: “Even in those SCF’s (subscription credit facilities), the lenders reported that the high net worth Investors have been funding their capital calls to-date normally (there are a few minimal high net worth delinquencies, as from time to time was the case pre-disruption as well).”

The GPs on the call reported no investor defaults.

Mike Mascia, co-founder of the FFA and head of the fund finance practice at Cadwalader told The Drawdown, “There are some examples of things on the margins, and then they get written about and it feels like a trend. The FFA tried to distinguish what’s happening a little bit with what’s happening market-wide. For example, while there are certainly a handful of funds that have drawn on their sub lines just to have cash on their balance sheet, it’s important to understand that this is not a widespread activity.”

According to Mascia, looking at the behaviour of bank portfolios across the spectrum, “Everything has been behaving largely normally.”

Capital call activity

It has been reported that GPs are calling capital early and at an increased volume, suggesting that managers are attempting to get ahead of potential liquidity challenges in the future.

According to an Institutional Investor article, reporting on a Campbell Lutyens’ LP survey, Andrew Bently is quoted as saying GPs are doing this defensively before investors ask them not to. This behaviour is in response to the last financial crisis, where LPs requested managers hold off on drawdowns.

FFA members said this activity has been marginal, and by no means a trend. “We are not sure capital call activity through the date hereof has in fact actually even been occurring at an unusually high rate or volume at all,” reads the statement.

In response to reports of increased call activity, Mascia is unsure why this is being raised. “We had one of the largest lenders in the fund finance space look at their data, and they found that capital calls at the end of the first quarter were half that of the end of the year. It’s hard to square that, maybe concern levels are high and so it feels as though there have been more calls. Or maybe this lender banks primarily the bulge bracket sponsors and increased call activity is happening in the middle market, we just are not sure.”

Best practices

Here are the FFA’s top tips for market practitioners:

1) Our fundamental guidance for market participants is for all parties to communicate as early and robustly as possible with their counterparties. If a lender is not able to go forward with a prospective transaction or extend a facility, notify the Fund Sponsor as soon as possible in the process to enable the Fund Sponsor to have time to find alternatives.

2) Fund Sponsors should give lenders as much notice as possible in advance of wishing to join a Qualified Borrower.

3) Fund Sponsors should provide Investors a forecasted capital call schedule as far in advance as possible.

4) When it is feasible, Fund Sponsors should extend their capital call notice period for longer than the standard ten business days provided in their partnership agreements. Accelerating capital call time frames would be unproductive for the market as a whole. Where possible, Fund Sponsors should stick to and not accelerate previously forecasted capital call schedules. Borrowing to keep cash on the balance for Funds should be discouraged. Lenders should make good faith efforts to accommodate requests for Facility extensions and amendments.

Click here to read the full statement.

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