The use of so-called subscription lines the bank
loans that private equity, real estate, distressed debt, and
private credit funds sometimes use to postpone calling
investors capital are on the rise. And they may
pose systemic risks in the event of a market downturn,
according to Howard Marks.
The co-chairman of Oaktree Capital Group, who has been
writing his widely-read memos since 1990, writes that these bank loans have become a
popular way for funds to make early investments or even pay
fees and expenses without calling investors capital.
Typically, investors commit a certain amount of money to a private equity fund, and the fund manager
draws down those commitments over time as it makes investments.
Bank loans are not the same as leverage, which would allow a
private equity fund to actually invest more than what it raises
Funds are increasingly using bank loans, in part because big
investors want higher reported internal rates of return, or IRR
the performance measure for these types of closed-end
funds as well as fewer drawdowns of their capital.
Private equity and other funds, for their part, want a way to
enhance returns as well as lower the hurdle to receive
incentive fees. Bank loans allow them to do this. But Marks argues that bank loans can muddy
performance records along with investors ability
to discern whether a fund manager is skilled in picking
More worrying for Marks, however, is the risks that bank
loans may pose to investors. First, bank loans do result in
funds making fewer calls on investors capital, but each
of those eventual calls will be larger in the end. During a
market rout, investors may be less likely to make good on
commitments if theyre experiencing problems in other
areas of their portfolios. If a private equity fund
doesnt have access to all of the money it is due, it
could default on the loans or not be able to jump on attractive
deals. In addition, if a number of investors dont make
their capital calls, a fund might not be able to repay its bank
loans as well.
Could this mean that failures by some LPs would
increase the likelihood of failures by others? asks Marks
in the memo. In the extreme, if defaults on lines are
widespread, could lines become a source of significant risk to
Marks argues that the bank loans do give funds flexibility
in making capital calls and to quickly jump on investment
opportunities. He adds that by postponing capital calls, a fund
can also make their early returns as well as longer-term
returns look better than they would have otherwise.
All other things being equal, the funds lifetime
IRR will remain higher than it otherwise would have been, since
the impact of using will taper off but not reverse, he
writes. Still, Marks says that some of Oaktrees newer
funds have started using subscription lines in response to
requests from clients.