The initial good intentions behind the use of subscription credit lines are “morphing” into something else, according to a managing director at one of the US’s largest public pension plans.
Speaking on a panel at the IPEM conference in Cannes last week, Allen MacDonell of Teacher Retirement System of Texas said that leverage is being misused in some cases.
“I know one fund that’s going to draw, in theory, five capital calls for an entire fund,” MacDonell said. “It’s one of my pet peeves. I’ve heard anecdotally that one GP sold [an asset] but hadn’t actually closed the process, so they’re drawing down to pay pre-carry.”
He added: “If [a credit line] is for an investment, I think six months max is appropriate. If it’s a management fee, a year is fine.”
Texas Teachers has around $21.27 billion invested in private equity, according to PEI data.
Alan Davies, a corporate partner in the European finance group at law firm Debevoise & Plimpton, told PEI that his firm is arranging $15 billion to $20 billion of bilateral and syndicated financings each year.
“Not only is there demand from the funds, but there’s also a larger number of providers than there’s ever been,” Davies said.
Subscription credit lines are typically used to allow general partners to deploy capital rapidly, rather than having to wait for limited partners to respond to capital calls. They can also distort a fund’s internal rate of return if used over longer periods.
A model created by private equity advisor TorreyCove Capital Partners shows that if a $100 million fund uses 100 percent debt financing for the first two years and realises $200 million at the end of year six, the credit line offers an IRR boost of 300 basis points and negatively affects multiple on invested capital by 0.12 turns, compared with not using any facility.
According to a poll at PEI‘s CFOs and COOs Forum in January, 34 percent of respondents have subscription credit lines with a term length of 180 days, while 31 percent have 265 days or longer.