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Private Equity Firms Are Wasting No Time in Calling Capital

GPs are playing defense and paying off their subscription lines of credit.

Private equity firms are increasingly paying off their subscription lines of credit and calling in commitments from investors, leaving some limited partners worried about liquidity.

General partners are building up cash reserves given the uncertain market and economic environment and to trying to mitigate the risks posed by declining cash distributions to investors, according to a new survey by Campbell Lutyens, one of the largest placement agents and advisors in private equity, private credit, and infrastructure.

“It’s a mixed picture, but there are real concerns about how subscription lines are increasing the amount of capital being called in a market where distributions are drying up and the denominator effect is looming,” according to the survey, which has not yet been released publicly. The denominator effect happens when an investor’s private equity allocation grows as a percentage of the portfolio as a result of the declining value of public markets. That leaves investors overweight private equity, often forcing them to freeze new commitments or sell stakes. 

The survey included the responses of 120 pensions, sovereign wealth funds, family offices, and other institutions.

During the global financial crisis, many private equity firms fielded calls from limited partners asking them to avoid making capital calls that would deepen their liquidity problems.

“This is a defensive move on the part of GPs to make sure they are drawing down from LPs before LPs ask them not to,” said Andrew Bentley, partner and co-head of Campbell Lutyens’ Europe private funds team. “In the global financial crisis, there were very few defaults from LPs on their commitments. But a number of LPs rang their GPs, and said, ‘please don’t draw down money, we’re already overallocated and it will make it worse for us.” He stressed, however, that this may not be the only reason for GPs’ current behavior. 

“Of course, they didn’t have to honor requests [during the GFC] not to call capital, but it puts the burden on GPs to say, ‘Do I or do I not stress my relationships?’” he said.

According to Bentley, it is is “odd” for private equity firms now to be paying off subscription lines early, when those loans are designed to delay having to call investors for capital. “The only reason I can think of is to keep the books tidy,” he said.

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Investors surveyed by Campbell Lutyens generally remained committed to their allocations. Almost half of respondents to the survey said it was “business as usual,” while 24 percent said that they are continuing with business that is underway, but not adding to the pipeline. Ten percent said they are proceeding with “re-ups,” but not making any new commitments, and 20 percent said commitments are on hold.

Co-investments and secondary transactions are the most at risk, as little can be accurately priced right now. Co-investments are directly linked to mergers and acquisitions, which have largely come to a halt, Bentley said. 

“There’s a new version of the future and these deals have to be repriced,” he said. “It would be irrational to proceed without a new price.”

Of the 20 percent of respondents who said commitments were on hold, 25 percent were insurance companies, which have been hard hit by the drop in interest rates. The lower rates are, the higher insurers’ liabilities. One respondent from a U.S. insurer said that “everything is on hold, including strategic review.” 

The survey also asked limited partners about some of the best and worst communications they had received from private equity firms during the crisis so far. One survey respondent said no one should use Covid-19 as a justification for poor performance. “Some GPs start to blame C19 to justify the poor performance of companies who were already going through difficulties,” the respondent said.

Another responded that they didn’t want to hear about the crisis being a buying opportunity. “Unless you’re Fund 1, I don’t want to hear that,” the person said.

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