I was chatting with a guy that works on the portfolio side at my firm a while ago and he mentioned that we had ~L + 110 interest rate on our revolver for our open-ended core fund. I'm not sure if the interest rate is solely indicative of the creditworthiness of us as a firm, or if that is fairly standard for this type of fund. Also, I'm not sure what the size of this revolver could/should be. Would it be say 50% of invested equity? Less? More?
I guess just i'm curious if someone could break down 1) how revolver's work and 2) how they're sized up? I'm sure it varies depending on the profile of the fund, but I wanted to see how accretive revolvers are in a fund construct and try to model it out myself.
Appreciate any and all insights on this topic (including good websites/resources/books if there are any)
I work for a PE firm that invests through closed-end funds and we utilize a credit line facility. I don't pretend to be an expert in these types of facilities so I don't know how much that would differ from your revolver as an open-ended fund. Our credit facility is securitized by the unfunded commitments on our fund, and as we call capital from our fund investors the credit line begins to burn off. I want to say the initial commitment is something like 50% of the total unfunded commitments but I'd have to go back and look. The pricing was a bit higher than your portfolios - I think it's something like L+140. We use the facility to fund equity commitments for investments without having to call capital immediately. We probably do 70 investments in each of our fund and our fund investors would go crazy having 70 different capital calls. The other option would be to call more fund equity than you need which drags on returns. We have to pay off any oustanding credit line amount after 12 months. So, we can basically fund all our equity commitments off our credit line, and then call capital only when we need to. As you would expect, this really helps with fund carry because it reduces the amount of time that the pref is clicking away on called capital.
Interesting - this is really helpful, thank you. Is this how most revolvers work? Where you draw down when you need it, but have a 12 month payback window? I guess the way I'm thinking about it is using a credit facility as a vehicle for "synthetic" asset-level financing and utilizing it for the life of the fund.
For example, say you raise a core-fund around purchasing STNL deals with long-term WALTs (therefore low embedded going-in yields that reflect bond-like returns) and utilize fairly prudent financing at the asset-level (~40-50% LTC). If the acquisition financing is, say, a 50-75 bps wider spread in LIBOR above what your credit facility is priced at, could you add further leverage at the portfolio level (at 50% of invested equity) that bumps returns significantly?
Or am I completely out of my mind?
curious af myself
You are not out of your mind. These facilities are ostensibly for cash/liquidity management purposes, but definitely are used to help juice IRRs for the fund given their low cost,
https://www.ai-cio.com/in-focus/shop-talk/dont-fooled-inflated-private-…
"Investor beware: the annual returns touted by your private equity fund managers can easily be inflated by a few hundred basis points. Blame the proliferating use of subscription lines of credit. Years ago, fund managers with a transaction teed up would simply draw capital from backers to finance their equity investments. Immediately, the clock would start ticking on their internal rates return (IRR). Straightforward.
Today, by contrast, many fund managers first draw on low-interest credit lines provided by First Republic Bank, Silicon Valley Bank, Wells Fargo, and other bigbanks. Fund managers may not call capital from investors to replace these bridge loans for three months to a year. In some cases, the loans remain in place far longer.
“Our sense is that the use of these facilities has continued to grow and has continued to become more mainstream,” said Jennifer Choi, managing director-industry affairs at the Institutional Limited Partners Association, which has eyed the trend warily.
Indeed, a recent study by data provider Preqin found that 31% of vintage 2018 buyout funds use subscription lines of credit. That is up from 25% for vintage 2013 funds. But those figures may understate their popularity since some fund managers don’t disclose whether they use them. A source at one European pension manager said that every one of the last 30 to 40 buyout funds he’s backed over the last two years uses subscription lines of credit. His firm typically backs buyout funds of $1 billion or more in size.
Because the clock doesn’t begin on the IRR of deals until investor money is drawn, fund managers using subscription credit lines see their IRRs get an artificial boost. That’s so even as the absolute dollar returns that they produce for investors—and in turn for their beneficiaries—fall due to the interest payments.
“We’re just giving money to the banks for no good reason,” said the European pension source. “IRR isn’t a return. It’s just a comparison measure…No beneficiary can eat IRR. All the people who want cash-on-cash returns are losing out.”
The upshot for CIOs: They must be more vigilant than ever in evaluating individual fund performance to make sure they’re making apples-to-apples comparisons. They need to understand the inflationary impact of subscription credit lines on industry benchmarks. And they need to be aware of worst-case scenarios that could result in substantial losses in their private equity portfolios."
I'm curious, are you asking in the context of what's been mentioned, i.e. committments from your equity? I think you're asking if you can slap an LOC borrowing on top of a first secured loan and let it sit over time until you pay it off from somewhere else, or refi/sell the property and have proceeds to pay it down similar to a standard loan? My thought it that would be different from the unfunded committments, which is essentially acting as a liquidity bridge and changes your IRR from a timing standpoint in the example above, but not equity in.
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