Fund Finance - Is your Facility Agreement In Good Health?

In these testing times lenders cannot rely on that much cherished mantra of the fund finance community that there has never been a default on a drawdown bridge facility. Robust covenants and proactive monitoring of covenant compliance are the best ways of ensuring facility agreements remain fit-for-purpose. Alan Fulton and Colin Lawrie drawn upon two decades of fund finance experience to identify 10 key stress points in typical funds which lenders must address.

1. Asset coverage – valuation is extremely difficult in the current circumstances but for facilities in part underpinned on underlying asset values it remains vital for lenders to keep on top of valuation. Even where the facility is reliant on LP commitments rather than asset values, we know from the Liquidity Crisis that a significant drop in valuation can cascade into investor rebellion and threatened default.
2. Carry valuation – it is not just LPs who behave differently when asset values fall, if management teams find their carry underwater there will be difficult discussions with LPs over re-basing carry and indeed within management teams as to vesting of carry to ensure key personnel are motivated and, ultimately, retained. Most facility agreements will ensure that lenders are copied in to formal communications to LPs on these matters but think about how, as a lender, you ensure you understand what is informally being discussed.
3. Diversification limits- while there will be a tendency on valuation to let matters ‘ride’ at least in the short term, it is important to note that in many funds valuation is not just a function of LP reporting it will also, through diversification criteria in the investment policy, have a bearing on the investments a fund can make and, in turn, what it can borrow to fund. So challenge what assumptions as to valuation the GP has made in reaching any conclusion that a proposed investment is within the investment policy.
4. Sovereign immunity – these are extraordinary times and we have already seen states take exceptional measure to protect their national ‘health’ often at the cost of international reputation and obligation, will they do the same to protect their national ‘wealth’ and cite sovereign immunity to avoid drawdown obligations. Do you have sovereign immune LPs in your borrower base?
5. LP default – all facilities will have mechanisms to react to actual LP defaults where the borrowing base is significantly eroded but, as a lender, should you be proactively monitoring the quality of the investor base?
6. LP Transfers – we expect to see increased levels of secondary transactions as many investors actively manage risk across their portfolios - many facilities will not allow a lender to object to a proposed LP transfer and rely instead on the borrowing base covenant, has the time come when that needs to become the exception rather than the rule to avoid the stable door swinging after the horse has bolted?
7. Default remedies – almost all funds will present the GP with a range of (often draconian) remedies against a defaulting LP including ultimately forfeiting their interest and ejecting them from the fund. Do not assume that GP and lender interests will always be aligned when the GP makes decisions about how to apply those remedies. At the very least, require the GP to consult with the lender before taking action.
8. MFN ‘risk’ – faced with distressed investors Managers may be tempted to grant concessions (e.g. more time-to-pay following initial drawdown default) but it should be borne in mind that the impact of many most favoured nations provisions will be to ensure that what goes for one investor often applies to all.
9. Key Person provisions – many LPAs will suspend drawdowns for new investments if key GP personnel are not available to manage the fund. Does your facility agreement trigger a corresponding draw-stop in such circumstances?
10. Talking beats worrying every time – if you have concerns over a borrower/facility engage with the borrower and with us.