“Banks and private credit are creating a collaborative network, where you’re able to leverage the infrastructure and the client base of a bank and the ingenuity and capital of a private credit manager,” said Kevin Alexander, partner in the Ares Alternative Credit strategy.

A forward flow structure involves an investor committing to buy assets that meet certain defined eligibility criteria as they are originated, and is a common way for investors to fund consumer lending platforms, especially lightly-capitalised institutions keen to grow quickly — the institution which writes the loan can sell it on immediately.

In the Ares-Investec deal, Ares is available to buy the bulk of any eligible subscription line loans, with Investec retaining a small vertical strip in the exposures to align its economic interest and meet regulatory obligations.

“We’ve been able to provide Investec access to capital that can help them continue to originate and invest in the same quality of transactions,” said Richard Sehayek, managing director in the Ares Alternative Credit strategy. “It essentially gives them a committed partner for these facilities”.

Ares will then seek leverage on the sub lines portfolio, looking to raise senior and mezz finance from banks and insurers through a private syndication process.

Forward flows in other asset classes can prove challenging when market pricing moves rapidly. In the UK mortgage market turmoil of 2022, several facilities either stopped purchasing assets entirely or had to continue buying assets at non-market rates. Subscription lines are floating rate, partly mitigating this risk and solving for rates moves, while the vehicle also has an average spread requirement; if sub line pricing drops too low it will stop buying.

Sub focus

Subscription lines are loans to private funds, backed by the commitments from fund limited partners. Most of them are to private equity funds but they can in principle be used for any fund structure with institutional LPs.

While the loan is to a fund (essentially a basket of highly levered portfolio company equity), the credit risk is to institutional LPs such as pension funds or sovereign wealth, since the purpose of the sub line is to allow the fund to buy assets immediately, then call down the LP commitments at its leisure.

This gives rise to a mismatch between the tough capital treatment of the loans and the relatively benign credit risk. No public default rate data is available in this private market, but the only public securitisation of subscription lines to date achieved a 95% advance rate, with the 90-95% tranche double-A rated.

Fitch Ratings, in its primer on securitisation of subscription finance facilities (another name for sub lines), says that the most publicised default in subscription lines related to GP fraud, rather than a problem with the LP exposures.

“In the most publicized instance of [subscription finance facilities defaults, multiple SFFs extended to different funds managed by the same manager defaulted when LPs did not fund obligations due to concerns surrounding the manager. While this instance was driven by manager fraud-related issues and is not expected to be a common occurrence, it illustrates the potential for idiosyncratic increased correlations of LP performance.”

Elsewhere, Fitch cited Abraaj Group and JES Global Capital as high-profile examples of issues with subscription lines, though it noted that lenders recovered 100% on one Abraaj facility and 70-100% on a second. See here for a further discussion on these highly idiosyncratic situations and their implications for fund finance.

Given the high capital requirements, sub lines may be priced at levels which aren’t terribly attractive for a bank looking to maximise return on risk-weighted assets. Private equity firms are generally excellent clients for investment banks, paying extensive fees in M&A and leveraged finance, and offering a sub line can be an excellent way for an investment bank to build up a PE fund relationship — so the facility itself might be a loss-leader for a regulated institution.

However, these facilities might still be attractive for capital providers outside the banking system, especially if a portfolio of sub lines can obtain external leverage, as in this case.

While banks want to lend to PE funds, the raw demand for fund finance is still outstripping its supply. The collapse of Credit Suisse, a major fund finance bank, removed one major lender from the sector while the crisis in the US regional banking sector further reduced supply.

Ares has been able to step in the gap in more ways than one — Sehayek, who ran this deal for Ares, was formerly head of fund finance origination at the Swiss lender.

Solving securitisation

This private transaction comes hot on the heels of the first public capital call asset-backed deal to hit the market, the Goldman Sachs-sponsored Capital Street Master Trust 2024-1, which had Blackstone in the equity.

One generic issue with subscription lines is that they are usually revolving exposures — a fund might draw on its sub line to make a portco investment, and then pay it down as soon as the LPs fill their commitments. It’s like a credit card for a PE fund, and although usually structured as a revolving credit facility, term deals are possible.

This is a challenge to structure into a securitisation, and a challenge for credit funds looking to enter the market, since they generally prefer drawn term debt exposures.

In Capital Street, as in the Ares-Investec deal, the solution is to make the pool itself revolving (the Capital Street deal uses a master issuer structure). If a subscription line loan pays down, another eligible asset can be added to the pool to maintain its size. There’s also a notice period for repayment of a drawn subscription line, unlike consumer assets like credit cards, making it easier to manage the portfolio size.

Subscription lines are loans, so could come with transferability restrictions, but their documentation generally allows for syndication. In the Ares-Investec structure, the SPV will be the lender of record, and this has been agreed with the general partners who are borrowing the sub lines.

While some of these sponsors may ultimately compete with Ares’ private equity division, that’s not seen as a major obstacle — Ares and all of its alternative asset management competitors frequently back each others’ deals, providing unitranches or other private credit lines, and Ares and other credit funds have been increasingly active in ordinary fund finance syndications.

“The market has moved a lot in the last 18 months, and I think that sponsors are more aware of our capabilities across fund finance and other solutions that can provide important flexibility,” said Sehayek.

While cash securitisations in public and private are one way to derisk subscription line portfolios, lots of banks have opted for synthetic structures. Subscription lines have been one of the most popular asset classes in the SRT market, especially in the US. In these structures, the sub lines never leave the bank’s balance sheet, but a bank obtains a guarantee or CDS protection on the risk of the portfolio, cutting the capital costs of holding the exposures.

In these deals, as in the Ares-Investec transaction, the bank retains the servicing of the loans and the relationships associated.

Ares has bought synthetic sub line deals as well as agreeing the partnership, and has ambitions to do more in the evolving area. It published a White Paper called the Future of Fund Finance.

“We’re having conversations with other banks about different types of structures that could meet their capital needs,” said Sehayek. “The key difference with this structure is it’s really about continuing to grow the business in partnership.”

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