Fitch Ratings says it expects direct lending through funds to gain momentum as European bank deleveraging continues to drive corporate disintermediation.
Fitch expects assets such as properties or corporate loans to be increasingly financed via funds, which will often have recourse to debt to increase returns for junior/equity investors, typically pension funds or insurers.
In this context, the agency has recently come across several transactions aimed at providing financing to funds. Funds with financing (or senior share classes) are typically limited partnerships, closed end funds or lightly regulated vehicles invested in private equity (corporate and projects), loans, bonds and properties.
While in many ways similar to structured finance products such as CLOs, these funds differ in several ways, including having a different legal structure, greater flexibility over their holdings and different financing sources.
Financing can serve different purposes including as working capital, a bridge between investments and capital calls or purely for leverage, which is generally limited to 50% of the total portfolio value. It can also take different forms such as a revolving loan facility, a term loan facility, debt or senior shares.
With a two tranche liability structure, funds have two investment profiles: one higher return and one senior and secured. Fund debt and senior shares are sold to investors, while loans are currently kept on bank’s balance sheet. However, in the future, they could be syndicated and also sold to real investors.
This financing can be rated, for internal capital calculation or investors’ purposes. The rating evaluation would focus on 1) the fund structure (incorporation, segregation of assets, bankruptcy remoteness, governance, third parties); 2) the asset manager (people, process, procedures); 3) the recourse of the lenders/debt holders to the assets or equity investors; 4) the priority of payments; 5) the regulatory or contractual limits and covenants (such as country or sector concentration, NAV deviation, minimum rating, occupancy rate); 6) the capacity of the assets to service the debt; 7) any market risk due to early liquidation of the portfolio.
Fitch expects to shortly publish a report detailing rating considerations for rating loans to funds or debt/senior shares issued by funds.
