‘It’s not like there’s some other money centre bank that’s going to suddenly fill this gap of supply,” a subscription facility lender (who we’ll call ‘Banker 1’ for the remainder of this story) tells sister title Private Funds CFO.

“There’s smaller banks like ours, and we’re all growing, but we’re not growing at such a pace that we’ll be the next Wells Fargo or Bank of America,” he adds, referring to the two banks often said to have the largest market share in subscription line lending.

As covid-19 began to roil markets in the US and Europe, some of the biggest lenders in subscription credit lines were said to have all but stopped new lending, focusing on assessing their exposures and servicing existing clients.

Demand overflowed to smaller lenders, who started seeing deals they couldn’t previously have competed for. Even some blue-chip sponsors have been left out in the cold by their relationship banks, wandering from lender to lender, only to find they too are prioritising existing relationships.

Loan terms and structures have generally shifted significantly in favour of banks, with market sources saying they are only going to get more lender-friendly. Initially, market participants and onlookers expected a wave of repayments in May to follow the binge in available supply in March and April, thus allowing banks to turn the taps back on.

As May rolled into June, that hope subsided. Various factors converged to force key players to stay selective, or to restrict their appetite or ability to resume lending at the previous scale.

No bank can be said to have stopped subscription line lending entirely – this is a private market and transactions are often executed bilaterally. New deals are still getting done; some even say the market remains robust – it depends on who you ask. At Wells Fargo, one of the major players said to have pulled back on new lending, more than half of the sub line book is bilateral, known only to the individual borrowers and lenders and their representatives.

“I can definitively say that we continue to be engaged in extending credit to core clients, albeit I’m sure everyone wishes we could do more,” says Jeff Johnston, head of asset management at the bank.

Yet it is clear a new, more complex supply/demand dynamic has emerged and is still evolving. The market for these products, which we will refer to broadly as subscription credit facilities (SCFs), is estimated at some $500 billion in commitments among some 70-plus lenders, each with different underwriting approaches and target client bases. There are little market data. No one view gets the whole picture.

Illustration of arrowsHowever, the trends Private Funds CFO identified over the course of several months and dozens of interviews with more than 20 lenders, borrowers and other stakeholders show a market that is undergoing what could be lasting changes.

Banks were, no doubt, busy in March. On the corporate lending side, estimates of how much corporate borrowers had utilised their revolving credit facilities by the beginning of April hovered around $200 billion – an amount JPMorgan estimated to be 77 percent of total facility capacity at the time.

Banks’ first-quarter earnings reports showed a simultaneous surge in demand for credit of all kinds, even as banks posted stunning increases in loan loss provisions. The top 15 US banks saw 12 percent loan growth year-on-year in the first quarter, according to S&P Global. The top seven banks posted some $27 billion in loan loss reserves.

As the pandemic intensified, demand for SCFs was pulled forward from the second quarter into March. Borrowers wanting to get ahead of any liquidity crunch or upward move in pricing looked to close on extensions, refinancings and new lines. Many obtained or used existing qualified borrower joinders, drawing on their lines and downstreaming the proceeds to struggling portfolio companies.

All those new commitments caused some banks to hit product or concentration limits, says Michael Mascia, partner at Cadwalader, Wickersham & Taft. “In this environment banks aren’t that likely to increase a particular risk maximum,” he said at the time. “Other parts of banks – ie, the corporate lending areas – were drawn so heavily in March as the crisis commenced that it does stress overall liquidity positions, which has made banks slow down new lending a little bit.”

Focus shifts inward

Key lenders in the market began focusing on core relationships and examining their exposures immediately in mid-March. Some felt increasing pressure to keep new lending domestic. “If you’re a UK bank, and you’re getting European fund managers looking for funding, you’re going to be under a lot of political and internal pressure to make sure you’re funding the UK economy,” one London-based risk manager whose bank is highly active in sub lines said at the time.

A banker on that institution’s SCF platform said in April: “We’re not doing every deal that comes through our door. Now, we’re focused on servicing the needs of our customers.” That sentiment was echoed throughout April, May and into June by most of the banks Private Funds CFO spoke to.

Other, smaller players eagerly rushed in to absorb the overflow in demand. Players from various corners of the market repeatedly singled out banks traditionally seen as smaller players, passive participants or servicing specific market segments, as showing up on deals they might not have been able to compete for previously. Banks like Silicon Valley Bank (especially in Europe, according to one source), First Republic and Signature – which last year hired two managing directors from Wells Fargo’s sub line business – were cited most often.

Of course, a pullback from some lenders in an economic crisis is not a huge surprise.
“It’s a little bit inevitable,” said Matt Hansford of Investec in May. “If you look at the prior crisis, most banks in Europe stepped away from this kind of lending.”

But he added: “It’s also one of the asset classes where money comes back quicker … If you’re a bank looking for liquidity you can shut off the tap, and the capital flows back into the bank because you get repayment paydowns and renewals of facilities.”

That may yet be the case for some banks. But there is a sense among market participants that more lasting challenges may be at play for some lenders.

Banks are facing a variety of difficulties, as in any down market, and SCF businesses sit in different places at different banks – within securitisation, corporate or real estate lending, or private banking, for example – so the combination of causes behind a slowdown or halt in new lending varies between them.

It’s not credit performance (yet)

No one knows what even the medium term looks like in this unprecedented crisis, but SCF performance so far is not the source of any lender heartburn. In May, the Fund Finance Association noted that, among its members, there had been only one institutional investor default on a capital call so far.

“That investor is a corporate entity in a completely disrupted industry,” wrote Cadwalader’s Mascia, who is also a Fund Finance Association board member. He added that “high-net-worth investor funding continues to have 99 percent-plus funding performance.”

“I can definitively say that we continue to be engaged in extending credit to core clients, albeit I’m sure everyone wishes we could do more”
Jeff Johnston, Wells Fargo

Nonetheless, greater scrutiny of exposures began in earnest in March and April. “In our discussions with banks, there’s a sense that the product is viewed as a little more risky than it used to be,” says Pierre Maugüé, partner at Debevoise & Plimpton in London.

“I’m not sure every bank really understands the risk they have on their books,” says a second banker who didn’t have permission to speak to the press (Banker 2). “There’s really no uniform underwriting methodology across all the banks.”

Johnston says: “There are funds that we’re lending to in the market that have 30 percent or 50 percent write-downs in NAV in their investments. Of course, there’s increased risk throughout credit markets, and that is surely influencing some lenders’ more conservative approaches.

“Clearly some of your borrowers aren’t in as strong a financial position as they were earlier in the year, and that ripples through to the underlying investors, and it ripples through to the financial stability of the fund managers – in every aspect there’s additional risk today than there was previously. That’s something we’re certainly focused on.”

For some ‘newer entrants’, Johnston thinks “there are real credit concerns that are slowing down their deployment of capital” in this market. For most SCFs the collateral is the uncalled capital of investors, which are contractually obligated to fund capital calls by their GPs.

However, lenders are increasingly aware that prolonged damage to the economy and certain industries could affect LPs’ willingness to fund, as they too become selective over where to put their money.

$500bn no longer enough?

Some see the pandemic as having caused a temporary condition whereby the March and April rush caused some lenders to hit up against product or concentration limits, while others faced liquidity constraints as a result of massive drawdowns at corporate banks, resulting in an uneven and idiosyncratic lending landscape.

Should SCF performance continue to hold up through the length of the crisis, and fundraising and dealmaking activity regain their blush, supply will likely return in force to meet any increase in demand, proponents of this perspective say.

Others think the pandemic exposed a dynamic that existed well before it.

Banker 2 says despite lowered levels of fundraising now, there is still “more appetite from funds than there are banks to service it,” adding: “I think there was already a ton of banks that were hitting up against their limits” before the pandemic struck. That banker posits the top 10 banks represent around half of the $500 billion in outstanding commitments, with the remainder spread across around 70 other banks – an amount he sees as already close to capacity: “I don’t think $500 billion is enough anymore.”

Private markets are increasingly replacing public markets, a trend few see reversing. That leads both Banker 1 and Banker 2 to think further evolution is needed – be it in the form of insurance companies becoming a growing part of the syndication market (for some banks, including Investec, they already are) or other non-bank players outside of already-active credit funds. From their perspective, borrowers may have to adjust to a new pricing landscape resulting from constrained supply and the strategic rethink some banks may be taking on underwriting and allocation.

Cadwalader’s Mascia argues that, even now, the market is busier than it was at the same time last year, and that funds are forming and closing deals for new lines: “I think there’s a lot of supply in the market and if there’s difficulty on the supply side there will be new entrants that will fill any supply gap. There are a number of banks that would love to be in this space.”

Zachary Barnett, co-founder and managing partner of debt advisory firm Fund Finance Partners, is less sure. “We think the existing pipeline eventually will get worked out and 80-90 percent of those sponsors will get sufficient financing, but if funds keep coming online and banks continue to be patient with re-entry there will be a significant problem,” he says.

Post-covid terms for sub lines

Pricing on subscription credit facilities immediately shot up in late March as the new supply and demand dynamics coincided with a flood of demand pulled forward from the second quarter. Pricing remains elevated, and some think it will continue to rise.

Market participants representing both the lending and borrowing side say pricing for syndicated subscription facilities, in which one or a few banks take the lead on a loan and others participate passively, for top sponsors rose from pre-pandemic levels of around LIBOR plus 150-180 basis points to as much as 225bps. In bilateral deals, which tend to get tighter pricing since banks don’t have to shop them to other lenders that may have higher rate thresholds, some say top sponsors can achieve as low as LIBOR plus 185bps.

LIBOR floors began creeping into deals in April. By mid-May, “meaningful” ones were commonplace, according to Cadwalader’s Mascia, though others have added they aren’t universal. LIBOR floors are heavily negotiated, but market players have suggested anywhere from 50bps to 100bps is now common.

Tenors have generally shortened as well, from as much as three or four years with two one-year extension periods prior to covid-19 to as little as a year or two for the initial maturity.

This is an abridged version of a feature first published in July in sister title Private Funds CFO.