The increasing use of long-dated credit lines by fund managers is of major concern to Olivier Carcy, global head of private equity at Indosuez Wealth Management.
“More and more GPs are using credit lines extensively and I would say, to some extent, abusing the use of these credit lines by carrying investments for a long period of time,” Carcy said in an interview with Private Equity International.
“GPs are pushing hard to increase credit lines in their funds, extending sometimes maturity above one year, for an amount that could reach 30 to 40 percent of the fund.”
Carcy, who manages $3.2 billion allocated to private equity, clarified that credit lines “are very useful and make sense to manage short-term cash-flows” but added that, in his view, these should not extend beyond one quarter.
“As long as it remains a pure short term working capital facility to ease the life of everybody, I’m fine with it. As a fund of funds manager, we even have one in that context to avoid multiple drawdown to our own investors.”
However, those extending beyond this introduce a new risk into the fund, he said.
“We are happy to invest in PE funds as long as they remain not leveraged. I mean I’m not buying a CLO, I just want to be unlevered exposed to the underlying assets. We feel that this leverage may create some risks and a certain disalignment of interests.”
What’s more, Carcy said, if LPs’ credit rating is being used to secure a loan that benefits the GP, the LPs should be compensated for it.
“Credit line providers use the credit rating of the LPs, and I do not think, as LP, I’m remunerated for that. As an LP, I should be remunerated for this credit risk that I guarantee with the other investors,” he said.
“My job is to deploy capital, and ultimately to be invested, so why [should I] have to support, even as part of the cost of the fund, some additional indirect costs, when I would prefer to put more money at work into the fund?”
Carcy added that delayed capital calls disturb Indosuez’s cash flow projections and its ability to be correctly deployed. While some LPs may “seem to be fine” with the use of credit lines thanks to the boost it gives to IRR, for Carcy it is more important to be fully invested.
“Do you prefer 10 percent per annum IRR with being fully invested or do you prefer 15 percent per annum with only being half invested? I want my money to be invested. I want my money to have the right return based on the underwritten underlying assets risk profile.”
Moreover, the use of long-dated subscription credit lines could affect fundraising for some managers, as a key perk to committing to a fund before the first close has effectively been erased, Carcy said.
“A long time ago it was great to enter into a fund at the first closing because you make some equalisation interests for bridging the investors that are coming in at the subsequent closings, so it was also a way to optimise our return,” Carcy said.
“Now they intend not to call any investors from the first closing but they wait until all the investors are committed. At the end of the day there is no longer a benefit to coming in at the first closing. Before they used LPs in the first closing to do the bridge, now they use banks.”
Carcy said Indosuez goes “deeply into our due diligence” and carefully reviews the limited partnership agreements on the topic of fund financing.
“We intend to try to limit the use of credit lines as much as possible,” he said, adding that a particularly aggressive subscription credit line “could be a deal-breaker for us”.
“We try to push [fund managers] to adjust a little bit,” he said. “Sometimes they listen, we have been able renegotiate the credit line terms and conditions with one fund recently. They accepted our concerns about the amount, they wanted 40 [percent], they accepted to go down to 25 [percent].”
Carcy said the issue of long-dated subscription credit lines is one “on which LPs should act collectively a little bit more, and try to lobby the regulators to establish best practices”.