December 3, 2019 – Since launching Fund Finance Partners (“FFP”) this Summer, we’ve been approached by all types of asset managers and fund sponsors with questions or requests for assistance with numerous issues. Some are classic (like placing a subscription line for a new fund) and some are unique (developing products for completely new investment strategies). One product that FFP has been offering to clients quite frequently is the “Umbrella Facility”. In fact, since FFP’s launch, we’ve received more inquiries for potential Umbrella Facility financings than any other type of fund financing. Umbrella Facilities are an aggregation of multiple subscription-backed credit lines, for the same asset manager, benefiting multiple investment vehicles, under one set of documents, in a single transaction. We have been directly involved in the evolution of these facilities for well over a decade. Given their resurgence and the frequency with which we’re contacted by asset managers looking for a financing solution like an Umbrella Facility, we are publishing this white paper to summarize their structure, identify their pros and cons and proffer an explanation as to why the demand for Umbrella Facilities has recently spiked.
Structure
Umbrella Facilities are designed to simplify subscription-backed credit facility documentation and utilization, reduce execution timelines, lower transaction costs, and achieve pricing advantages by essentially becoming a larger borrower. In our experience, when executed correctly, they are successful in doing so. The essence of the Umbrella Facility is the gathering of multiple subscription-backed lines of credit under one credit agreement (and a single set of ancillary documents). Each investment vehicle managed by the asset management firm (inclusive of any parallel funds, SPVs, AIVs, SMAs, qualified borrowers, etc.) that has or is seeking a subscription facility obtains an extension of credit, evidenced by its own tranche of the master Umbrella Facility. For example, “Investment Partners Fund I” and related fund vehicles have one tranche, “Investment Partners Fund II” with its own independent fund structure, investors and maturity has its own tranche, and so on. The number of tranches should be limitless, and a sponsor should be able to perpetually add tranches for any newly created fund, co-investment, or SMA vehicle.
Sounds too good to be true? It’s not, and over the decade that Umbrella Facilities have matured, the details have evolved. For starters, each tranche is severally liable for its own obligations. A default under one tranche should not jeopardize your autonomy to call or not call capital in investment vehicles financed in other tranches. Each tranche has its own borrowing base, and the tranches are not cross-collateralized or cross-defaulted. The tranches are typically governed by a uniform set of loan documents, although there may be a variation or two in the covenant or representation packages, depending on a particular fund’s constituent documents.
Finally, though these are often bilateral financings, with the same bank administering each of the tranches, they don’t have to be. Due to the separate, distinct nature of the tranches, there can be different lenders for each. With a correctly executed Umbrella Facility, a sponsor and its investors benefit from the streamlined documentation, reduced pricing and administrative simplicity, while avoiding any cross-collateralization or cross-default risk. Consider the following advantages and possible disadvantages to Umbrella Facilities. Like any good advisory firm would, we have of course proffered mitigants to the possible disadvantages.
Advantages
- Lower pricing. Consolidating multiple subscription facilities increases a sponsor’s negotiating leverage with a lender. Instead of being a $150 million borrower at four financial institutions, you’re a $600 million borrower at one. FFP has observed meaningful improvements in upfront pricing, spread and fees. In an instant, your firm is exponentially more important to the Umbrella Facility’s agent. Your Umbrella Facilities will be viewed by the agent lender as one transaction, and larger borrowers have access to lower pricing grids.
- Unused fee savings. FFP has experience in obtaining Umbrella Facilities that provide for a lender commitment that can be shared across the fund tranches at the fund sponsor’s discretion. This can significantly reduce unused fees by permitting allocation of the commitment to the tranches where it is most needed. For instance, the sponsor can move a portion of the commitment from an older vintage fund tranche to a newer fund tranche, so long as there is borrowing base availability, of course. This valuable feature is not yet universal in the market but FFP has successfully guided financial institutions to provide the shared commitment.
- Significant time savings. Negotiating one document that supports an infinitely expandable number of facilities (or tranches) for any number of investment vehicles saves your professionals’ time with every new investment vehicle your firm onboards. Notwithstanding the number of tranches, the borrower is merely responsible for monitoring one familiar set of covenants, reps, exclusion events and reporting, as opposed to being forced to administer a potentially infinite number of unique loan documents with distinct covenants, reps and required deliverables. Finally, it’s much easier to manage borrowings, payments, letters of credit, etc. with a single agent as opposed to multiple banks with unique cash and credit management processes. All asset management firms seek economies of scale. The Umbrella Facility is an efficient route to realizing those economies of scale.
- Lower legal costs. Streamlining documentation slashes legal costs by roughly 70% per each additional tranche. A simple joinder and a few duplicated deliverables are all that is required to obtain leverage for each new investment vehicle.
- Avoid default and cross-default risk. Contrary to conventional wisdom, Umbrella Facilities do not present contagion risk. An issue specific to “Investment Partners Fund I” does not impact “Investment Partners Fund II”’s ability to borrow under the Umbrella Facility. Defaults to tranches are tranche-specific.
- Optionality. If structured properly, there should be no requirement that fund sponsors be required to add new vehicles to the Umbrella Facility.
Disadvantages
- Lender concentration. Though completely unprecedented, a lender default would cause significant problems. For that reason, most fund sponsors only mandate the most active, leading, well-rated, money center banks to lead their Umbrella Facility. It is imperative that fund sponsors have confidence in their Umbrella Facility provider.
- Upfront investment. Depending on how many investment vehicles a sponsor covers with its Umbrella Facility, the initial outlay of time and legal cost is likely more than a typical subscription facility. The marginal cost is significantly less than the sum total of time and capital required by individual financings and should be appropriately mitigated by apportioning the upfront costs among the initial investment vehicle borrowers, pro-rata. Further, future investment vehicle borrowers under the Umbrella Facility should be apportioned pro-rata costs, curing some of the initial borrowers’ outlay. Fund Finance Partners has advised sponsors on these apportionment issues and can efficiently solve for them with new Umbrella Facility users.
- Lender sophistication is critical. If structured correctly, the Umbrella Facility should not permit inter-tranche cross-defaults. Unfortunately, certain banks still offer Umbrella Facilities without appreciating the criticality of cross-default avoidance for the sponsor, and reject comments eliminating that unacceptable risk. FFP principals have experience in both successfully challenging lender resistance to cross-default avoidance, which has opened the door for thoughtful sponsors eager to utilize Umbrella Facilities to reduce their transaction costs without sacrificing sacred rights.
- Sponsor innovation sometimes outpaces lenders. Sophisticated sponsors offer innovative, bespoke products to their investors, and some of those structures outpace the degree of sophistication of your Umbrella Facility agent. Though stand-alone financing for those structures is a solution, FFP has demonstrated its ability to work with all parties to accommodate as much flexibility as possible in the Umbrella Facility documents.
Conclusion
Umbrella Facilities have existed in one format or another for fifteen years, but they’ve only recently been widely accepted, given the fund sponsor and Umbrella Facility lenders’ recent connection on important points. Fund sponsors need to demonstrate reduced costs to their investors, and Umbrella Facilities accomplish that. Likewise, lenders have improved their execution capability, as evidenced by their willingness to separate the facility tranches. Experienced, sophisticated lenders have embraced these and other types of reasonable accommodations, leading to further product penetration and sponsor satisfaction. There is no doubt that sponsors still must be protected from residual underwriting or structuring shortcomings, but with the proper guidance and transaction oversight, they should be able to find a lender that can provide them with an Umbrella Facility to meet each of their investment vehicles’ financing needs.
Considerations of transaction time, energy and cost have now reached an inflection point where innovative, thoughtful sponsors see the Umbrella Facility as a solution to finally halt the annual human and financial capital cost burden of their many subscription lines. FFP is now in the market on behalf of two sophisticated fund sponsors seeking this solution, and we are happy to report that the Umbrella Facility is now ripe for effective utilization.
New Umbrella Facilities weren’t closing during the great recession, and we can’t imagine that changing during the next downturn. As you’re aware, we’ve been in the “seventh inning” of this unprecedented expansionary cycle for many years (or innings). When the market does correct, confident access to reliable debt capital will be extremely important.
Umbrella Facilities simplify loan administration and documentation, while demonstrating real savings to investors, showing them that you continue to be opportunistic when it comes to locating efficient debt capital solutions and applying an asset manager’s expertise to maximize fund returns and efficiency metrics. FFP has the experience, knowledge, contacts and resources to add your asset management firm to the short, but distinguished, roster of fund sponsors utilizing this state-of-the-art solution.