Subscription Credit Facilities: A Comparison of Borrowing Base Structures By Kiel Bowen, Todd N. Bundrant, Mark C. Dempsey and Christopher N. Ellis 1 Subscription credit facilities, which are lines of Calculation of the Borrowing Base: A credit in favor of private equity and similar subscription credit facility borrowing base is investment funds primarily secured by the usually calculated by taking (x) uncalled capital commitments of the fund’s investors, capital of each Eligible Investor multiplied are most commonly structured using a by (y) the Advance Rate with respect to such borrowing base structure similar to other Eligible Investor and (z) subtracting any types of asset-backed loans. Many factors will haircuts related to Concentration Limits dictate the best borrowing structure for a and/or Borrowing Base Deductions. fund, the most important of which are the Eligible Investors: The uncalled capital make-up of the fund’s investor pool and commitments of some investors will be where the fund is in its life cycle (raising included in the calculation of the borrowing capital, harvesting investments, etc.). base (“Eligible Investors”) and the uncalled Historically, each market lender has been tied capital commitments of other Investors will to a single borrowing base philosophy that not be (“Excluded Investors”). Determining keyed squarely into its unique credit and which investors will and will not be included underwriting requirements. As industry varies greatly in the different market competition has continued to grow, banks approaches to structuring a borrowing base. have realized that a one-size-fits-all approach Typically, both an investor’s may not be the best long-term approach in creditworthiness and its investor the market. Accordingly, many lenders have documentation (e.g., the existence of a adjusted their credit and underwriting policies problematic side letter provision) will be the to permit more flexibility in structuring key factors in determining if an investor will borrowing bases to better fit a particular be included or excluded from the borrowing fund’s investor pool. Sometimes this has been base. As described below, some borrowing accomplished by adjusting the borrowing base approaches use bright-line categories base inclusion criteria, advance rates or of Eligible Investors, meaning the inclusion concentration limits, while other times, it is process, approval rights, and requirements accomplished by taking a completely different for these categories are explicitly set forth in approach to structuring the borrowing bases. the loan documentation, while other approaches employ more relaxed standards. Prior to discussing the differences between It is important to note, that even though the various borrowing base structures, it is Excluded Investors do not contribute to the helpful to first outline the common tenants of calculation of the Borrowing Base, their the various borrowing base structures: uncalled capital is collateral and, similar to Concentration Limits provide over- other asset-backed lending structures, collateralization. provides the lender with “over- Borrowing Base Deductions: Some lenders collateralization.” may also include deductions from the Exclusion Events: Upon the occurrence of borrowing base that limit the amount certain negative events, Eligible Investors available under the facility. For instance, will automatically be excluded from the recourse debt outside of the facility is borrowing base and become Excluded commonly deducted from the borrowing Investors. Standard exclusion events base on a dollar-for-dollar basis. This include, among others: (a) an investor elects concept is premised on the lender’s to stop funding its commitment or such understanding that all debt (and not just investor repudiates or challenges the their borrowings) should be covered by the enforceability of its commitment; (b) an borrowing base. investor fails to fund its capital contribution With the above background, there are three when due; (c) an investor defaults in any standard borrowing base approaches representation or warranty made in any common in the US subscription facility market: fund document; (d) rated investors fail to (1) a borrowing base of only highly-rated satisfy the applicable requirement (or any included investors with a high advance rate other inclusion standard) or unrated (the “Included Investor Model” or “II Model”); investors have a significant drop in net (2) a two-tier approach, which provides for worth; (e) an investor transfers its interest or both highly-rated included investors with a otherwise ceases to be an investor or high advance rate and a designated investor requests a withdrawal from the fund; and class, where the latter has a lower advance (f) bankruptcy of an investor. rate (the “Included/Designated Model” or the Advance Rates: This is the percentage of “II/DI Model”); and (3) a flat advance rate uncalled capital commitments of each across all (or most) investors (the “Flat Eligible Investor that will be used in the Advance Rate Model”), which may also be calculation of the borrowing base. It is structured as a coverage ratio (the “Coverage typically less than 100% to provide Ratio Model”). additional over-collateralization. Below we explore these traditional structures Concentration Limits: In order to provide and then discuss how these structures are greater risk diversification, concentration evolving to address increased competition limits are often included in subscription and the particular needs of fund borrowers. credit facilities. Concentration limits are restrictions on how much borrowing base A. Included Investor Model credit will be given to any particular In the traditional Included Investor Model, investor’s uncalled capital commitments— only highly-rated investors that meet a often calculated as a percentage of an pre-defined set of criteria (e.g., a minimum individual investor’s uncalled capital credit rating (typically set at BBB+) and, commitment against the total amount of all with respect to pensions, a minimum uncalled capital commitments or all Eligible “funding ratio” (often 90%) or, in some Investor uncalled capital commitments. cases, minimum assets (typically Additionally, aggregate investor class $1 billion)) will be designated Eligible concentration limits might be included. Like Investors (“Rated Included Investors”). For Excluded Investors and Advance Rates, these investors, typically the only approval 2 Mayer Brown | Subscription Credit Facilities: A Comparison of Borrowing Base Structures right is in favor of the administrative agent creditworthiness to include in the (and not any facility lenders). Other non- borrowing base (these investors are rated investors that, in the determination commonly referred to as “Designated of all lenders, would be rated investment- Investors”). The inclusion of any grade if they had a rating (“Non-Rated Designated Investors typically requires all Included Investors”) will also usually be lender consent and has historically Eligible Investors in an II Model. required some evidence of credit- The Advance Rate for all Eligible Investors worthiness or credit support, such as in an II Model is typically set between 80% publicly available financial information or and 100%2 and Concentration Limits have evidence of a strong relationship with a historically been determined by a static creditworthy parent. grid ranging from 5-15%, in each case Advance Rates and Concentration Limits dependent on the Eligible Investor’s rating with respect to Included Investors usually or classification as a Non-Rated Included mirror the Advance Rates and Investor. Non-Rated Included Investors Concentration Limits typically used in the (and sometimes lower-rated Rated II Model. The Advance Rate for Designated Included Investors) are usually also subject Investors is typically set at either 60% or to an aggregate Concentration Limit. 65%. Additionally, Designated Investors Since the borrowing base only includes are usually subject to both individual and uncalled capital commitments of aggregate Concentration Limits. We often investment-grade investors, lenders see a 5% individual Concentration Limit typically offer favorable pricing and looser and an aggregate Concentration Limit of terms compared to other borrowing base 35% with respect to Designated Investors. structures. Funds that use the II Model The II/DI approach is currently the most usually have a diversified class of highly commonly used in the syndicated market. rated investors and use subscription This approach is often used by funds that facilities mostly for bridging purposes— need larger credit facilities with a and not long-term leverage. These funds borrowing base than a traditional II Model typically don’t require high overall or Flat Advance Rate Model approach effective advance rates against the entire would be unlikely to support over the life investor pool because they regularly repay of the fund, and usually offers the highest borrowings and prefer the less expensive overall effective advance rate. To account pricing and looser terms that the II Model for the fact that lower-rated investors are provides. included in the borrowing base, pricing B. Included/Designated Model may be higher than facilities employing the II Model and these facilities may be The Included/Designated Model builds off tighter on other terms and reporting the II Model’s technology. In addition to requirements than the other models. classifying Rated Included Investors