The Spectrum of Loan Portfolio Backleverage Options: A Primer for Private Credit Funds

Executive Summary

There is a spectrum of potential financing structures for a private credit fund (a “Credit Fund”) to obtain liquidity, including at various levels in the fund structure, such as at the fund level or by incurring debt to lever a particular loan asset or an entire loan portfolio. Each type of financing possesses distinct characteristics and may be used to accomplish different objectives. Understanding the different financing options—and how and when a Credit Fund may pursue a particular financing structure—is important for a Credit Fund to thoughtfully consider its liquidity strategy (including, potentially, the use of different liquidity options at discrete points in its life cycle, or for different assets).

This Legal Update is a primer on an array of liquidity structures that a Credit Fund may find beneficial—including subscription credit facilities, note-on-note financings, total return swap (TRS) transactions, single-asset backleverage facilities, repurchase facilities, “CLO-lite” or SPV warehouse facilities, collateralized loan obligation (CLO) transactions, and hybrid facilities—and explores some key features and differences and when each may be a relevant option for a Credit Fund.

Background on Private Credit

Following the global financial crisis of 2007-2009, the private credit industry significantly grew in size and prominence. By the end of 2023, this asset class accounted for more than $1.7 trillion in global assets under management (AUM), and is projected to balloon to ~$3 trillion by the end of 2028.

The life of a Credit Fund, like other types of private investment funds, begins with fundraising. Once investors close into a Credit Fund, the Credit Fund uses that pool of capital and, in most cases, leverage to build a portfolio of loan assets. The type of loans that a Credit Fund extends depends on its investment strategy and objectives (e.g., direct lending, real estate, mezzanine, infrastructure, venture, dislocation/special opportunities, or distressed).

A Credit Fund may seek to use leverage in pursuit of various goals: to optimize efficient capital deployment, increase investment capacity, enhance internal returns, and ensure it has a rapid and reliable source of liquidity to fulfill its obligations to its loan portfolio. Use of borrowed money to invest in loans permits a Credit Fund to invest in a larger portfolio of loans and, under some financing structures, provides it with greater flexibility to adjust its loan portfolio in light of market conditions.

The liquidity option that will best suit a Credit Fund will depend on the answers to some key questions, including: (1) where is it in its life cycle (e.g., does it have a meaningful amount of uncalled capital commitments from its investors left and/or has it built up its loan portfolio yet, and if so, how many loans and what type of loans does the portfolio include); (2) what are the Credit Fund’s investment and return objectives; (3) are there pertinent restrictions in its constituent documents or under the loan documentation for its underlying loan assets; (4) would it be ideal for the obligor to be the Credit Fund itself or a special purpose vehicle (SPV) wholly owned by the Credit Fund; and (5) what financing arrangement will provide it with the most favorable economic terms as compared to those of the underlying loan asset(s) (so that the Credit Fund can arbitrage and borrow at a low enough rate that the cost of capital will not exceed the rate at which it itself lends). In some cases, the financing products explored in this Legal Update are not mutually exclusive; a Credit Fund may be able to implement them concurrently (e.g., a Credit Fund could have both a subscription credit facility and a CLO-lite facility in place at the same time) or in succession.

Notably, there is mixed terminology used in the market to describe some types of backleverage structures. Sometimes, the same term is used to describe different types of facilities, or the same type of facility is given multiple names. In addition, it is not unusual for some of these products to be managed by different desks at a lender. So, it is crucial for Credit Funds and their leverage providers to ensure they are on the same page as they explore potential liquidity options.

A Range of Financing Products for Credit Funds

Credit Funds can incur leverage at various levels in the fund structure, including at the fund level or by incurring debt to lever a particular loan asset or an entire loan portfolio.

A. FUND-LEVEL LEVERAGE

I. Subscription Credit Facilities

• Loan Parties: Credit Fund, as borrower, and its general partner, as a pledgor
• Collateral: Capital commitments of the Credit Fund’s investors, an account into which the investors’ capital contributions are required to be funded, and the right to receive and enforce those commitments and contributions
• Availability: Lesser of (1) a stated facility size, and (2) a borrowing base tied to the investors’ uncalled capital commitments, subject to eligibility requirements (with advance rates based on the credit quality of the relevant investors), concentration limits (if applicable, depending on the makeup of the investor base), and investor exclusion events
• Tenor / Type: One to two years (but commonly subject to renewals); revolving credit facility
• Typical Purpose: Bridge timing gap between issuing capital calls to the investors and making investments
• Diligence Focus: Credit Fund’s constituent documents and the underlying investors and their creditworthiness, including review of their subscription agreements and side letters

Subscription credit facilities are one tool commonly found in a Credit Fund’s liquidity toolkit. A Credit Fund uses this type of facility at the beginning to middle stages of its life cycle, when the Credit Fund has completed an initial round of fundraising and most of the capital commitments of its investors remain uncalled. A Credit Fund does not need to hold many (or even any) investments yet, as investments are not part of the collateral package (see above). A Credit Fund may draw under the facility to ramp up its loan portfolio and for other working capital purposes. At a later date, the Credit Fund would call capital from its investors to repay its borrowings under the subscription credit facility.

This type of financing offers a Credit Fund several key benefits. First, it provides a reliable source of, and quick access to, capital for a Credit Fund to originate and manage loan assets. The ability to borrow on short notice (often on a same-day to three-business day basis), in contrast to the typical 10-business day lead time permitted to investors to fund in response to capital calls, allows a Credit Fund to nimbly realize on time-sensitive investment opportunities. Second, use of a subscription credit facility offers administrative ease to Credit Funds and investors alike, as a Credit Fund can draw under the facility to make multiple investments, then consolidate capital calls to repay the related borrowings (instead of issuing separate, smaller capital calls for each investment). Third, the pricing for this type of facility is relatively low and both the structure and loan documentation for the facility are relatively simple (as compared to some of the other financing products described below).

The following sections discuss financing tools that require a Credit Fund to hold at least some assets. Accordingly, they are often put in place later in a Credit Fund’s life cycle (either as a replacement of, or supplement to, a subscription credit facility, when the subscription credit facility’s borrowing base has decreased and the number / value of the Credit Fund’s loan assets have increased).

B. LEVERAGE BASED ON A PARTICULAR ASSET

There are a few financing products available to a Credit Fund that are based on the value of a single asset (or a few assets) from its loan portfolio, including note-on-note financings, TRS transactions, single-asset backleverage facilities, and repurchase facilities.

I. Note-on-Note Financings

• Borrower: Credit Fund or a subsidiary
• Collateral: A specific loan asset owned by the Borrower
• Availability: An advance rate (typically, 60-80%) is applied to the amount of the underlying loan asset
• Tenor / Type: Must fall within the maturity of the underlying loan; term loan format
• Typical Purpose: Provides an additional and readily available source of capital for a Credit Fund to enter into and maintain the underlying loan asset; increases the Credit Fund’s yield on the underlying loan asset
• Diligence Focus: Credit Fund’s track record and the credit/performance of the specific underlying loan

In note-on-note financing, a Credit Fund (or its subsidiary, as applicable), as borrower, pledges one of its loan assets to the note-on-note lender (often, a bank). The note-on-note financing is senior and priced with a lower interest rate than the underlying loan asset’s interest rate (note: a Credit Fund typically demands higher yields from its borrowers than does a bank), thereby increasing the Credit Fund’s margin. The note-on-note financing is typically subject to a tighter, lower LTV ratio than the LTV required under the underlying loan asset.

If the underlying obligor fails to repay the underlying loan, the Credit Fund, as borrower, remains obligated to repay the note-on-note lender. If the Credit Fund defaults on the note-on-note financing, the note-on-note lender could step into the shoes of the Credit Fund vis-à-vis the underlying loan asset.

A key benefit of this type of financing is its straightforward execution.

II. Total Return Swap (TRS) Transactions

• Transaction Party: Credit Fund or a subsidiary
• Collateral: Cash collateral
• Availability / Notional Amount: Set as the face amount of the applicable underlying loan asset
• Tenor / Type: One to three years; swaps / term
• Typical Purpose: Leverage on a single loan asset or a small group of loan assets
• Diligence Focus: The value and credit/performance of the underlying loan asset

A TRS transaction is a bilateral derivatives transaction involving a total return payer (usually, a bank or dealer) and a total return receiver (e.g., a Credit Fund). The transactions are documented under the form ISDA Master Agreement and related ISDA documentation.

If a Credit Fund intends to use a TRS transaction in order to obtain leverage on an underlying loan, the Credit Fund would typically assign the underlying loan (or sell a participation interest in it) to the total return payer concurrently with entering into the TRS transaction. The economics of this type of TRS transaction would typically work as follows: (1) a notional amount would be established under the TRS transaction that would track the exposure under the underlying loan that was assigned or participated to the total return payer; (2) the total return payer would be required to make ongoing payments to the Credit Fund (solely to the extent such payments were received by the total return payer under the underlying loan) that would be based on the notional amount, but would be calculated using the interest rates and spread set forth in the underlying loan agreement; and (3) the Credit Fund would be required to make ongoing payments to the total return payer representing the economic consideration due to the total return payer (i.e., interest plus spread) for providing the TRS transaction. The TRS transaction would contain negotiated early termination rights that would give the total return payer and/or the Credit Fund the right to close out the TRS transaction in certain situations by having the Credit Fund re-acquire the underlying loan from the total return payer or cash settle. The early termination rights granted in favor of the total return payer under the TRS transaction would, for the most part, be similar to events of default in a credit facility (e.g., a failure by a loan party to make a payment, covenant breach by a loan party, bankruptcy event with respect to a loan party, etc.). The Credit Fund may also have the right to close out the TRS transaction at any time or in certain situations (e.g., a voting discrepancy for an amendment on the underlying loan, or upon the occurrence of a default or event of default on the underlying loan).

Some benefits of this type of financing are that it provides an alternative for a Credit Fund to obtain leverage on a single loan asset or small group of loan assets and, due to the use of the form ISDA Master Agreement and related documentation, it also has the potential to be easier to implement from a documentation standpoint than certain other types of financings.

III. Single-Asset NAV Lines / Backleverage Facilities

• Borrower: Often, a bankruptcy-remote SPV of the Credit Fund that originates, or is assigned, the relevant underlying loan asset
• Collateral: All-assets pledge from the Borrower (with the key assets being (1) its ownership interests in the underlying loan asset, and (2) an account of the Borrower into which principal, interest, and other payments paid to the Borrower under the loan asset are required to be funded); may include a pledge by the Credit Fund of 100% of the equity it owns in the Borrower, or other credit support
• Availability: Lesser of (1) a stated facility size, and (2) the result of a pre-negotiated advance rate multiplied by the outstanding principal balance of the underlying loan asset
• Tenor / Type: Three to five years (but in any event, the maturity date will be within the underlying loan’s remaining tenor); term loan or revolving line of credit
• Typical Purpose: Generate enhanced returns; readily available source of capital to fulfill timing and liquidity obligations under the underlying loan asset
• Diligence Focus: The underlying loan asset’s performance, credit metrics and related loan documentation

A single-asset backleverage facility shares features with a net asset value facility and a CLO-lite facility. Importantly, unlike a CLO-lite facility, the collateral for this type of facility is a single underlying loan (or, perhaps, a few related loans), rather than a large loan portfolio. Accordingly, the extensive list of eligibility criteria, concentration limits, and exclusion events commonly found in a CLO-lite facility (described below) drop away, along with, potentially, the revaluation events.

The key characteristics of a single-asset backleverage facility vary throughout the market and can be tailored to the parties’ needs. For instance, the facility’s life may or may not be split between a draw/reinvestment period and amortization period. In some cases, there may be a regular (e.g., quarterly or monthly) payment waterfall, whereby cash flows from the underlying loan asset (which are required to be directed to the backleverage facility’s collateral account) are applied to repay the backleverage facility. Alternatively, the parties may agree for principal to not be due until the maturity date (subject to any mandatory prepayment events or exercise of remedies upon an event of default).

A main benefit of this financing product is its flexibility and ability to sync up various key terms (such as maturity and payment dates) for the backleverage facility to the specific loan asset that is being levered.

IV. Repurchase Facilities (a.k.a., “Repo Lines”)

• Seller: Typically, a bankruptcy-remote subsidiary of a Credit Fund that holds one or more loan assets; a repo seller is akin to a borrower in a standard lending arrangement
• Collateral / Credit Support: Seller’s ownership interests in the underlying loan asset(s); there may also be a limited guaranty and/or keepwell from the Credit Fund
• Availability: An advance rate is applied to the value of the underlying loan asset(s)
• Tenor / Type: One year or less (if relying on the bankruptcy safe harbors referred to below); technically, a sale, but similar to a term loan
• Typical Purpose: Temporary financing of a loan asset until an exit strategy (such as pooling into a securitization) can be pursued; optimize investment returns
• Diligence Focus: The performance, credit metrics and related loan documentation for the underlying loan asset(s); the credit metrics of the party providing a limited guaranty and/or keepwell (if applicable)

A repurchase facility is a type of financing arrangement in which a subsidiary of a Credit Fund, as repo seller (akin to a borrower in a standard credit facility), enters into an agreement with a repo buyer (i.e., a backleverage provider acting similarly to a lender in a standard credit facility). The repo buyer provides liquidity to the repo seller by temporarily “purchasing” one or more loan asset(s) for a cash “purchase price”, with an obligation of the repo seller to “repurchase” the same loan asset(s) on a specified future date at an agreed price. The repo buyer also receives a rate of return, which is typically described as the “price differential” and, similar to interest on a loan, is payable periodically prior to or upon repurchase of the underlying loan asset(s) by the repo seller. This type of facility is documented by a repurchase agreement, which usually contains a similar set of representations and warranties, covenants, and events of default as found in a secured credit agreement.

Some repurchase facilities may be structured to benefit from certain bankruptcy safe harbors (particularly, where the underlying loan assets are mortgage loans). To qualify for certain US Bankruptcy Code protections, a repurchase facility’s underlying asset(s) must be (a) a security, mortgage loan, or an interest therein, and (b) sold with an automatic obligation to resell such asset within one year.¹ If the repurchase facility satisfies these criteria, then its repurchase agreement will be a “protected contract” under the US Bankruptcy Code. Accordingly, if a repo seller becomes the subject of a bankruptcy case, the repo buyer would receive preferential safe harbor protections, allowing it to terminate the contract and exercise the contractually agreed upon rights of liquidation, termination, and acceleration, free from the automatic stay and certain other significant restrictions of the US Bankruptcy Code. The repurchase facility would not be included in the repo seller’s bankruptcy estate. The bankruptcy protections afforded to qualifying repurchase facilities are a noteworthy benefit for backleverage providers that are not provided by the other types of lending arrangements described in this article. Note, however, that not all repurchase facilities benefit from these bankruptcy protections; for instance, there are many repurchase facilities for which commercial loans are the underlying collateral and, accordingly, these bankruptcy safe harbors do not apply.

Given the benefits enjoyed by backleverage providers as repo buyers under repurchase facilities (including bankruptcy protections afforded to them for repurchase agreements that qualify as protected contracts under the US Bankruptcy Code, better regulatory capital treatment, and the fact that a repurchase agreement is treated as a loan for accounting and tax purposes), Credit Funds may, in turn, benefit from better pricing and other favorable economic terms for repurchase facilities as compared to other asset-level lending arrangements.

C. PORTFOLIO-WIDE LEVERAGE

Financing tools that a Credit Fund may use to obtain leverage based on the value of a large underlying loan portfolio include CLO-lite facilities and CLO transactions.

I. CLO-Lite Facilities (a.k.a., Warehouse Facilities, “SPV Drop-Down” Facilities, or ABL Private Credit Facilities)

• Borrower: A bankruptcy-remote SPV wholly owned by the Credit Fund, to which the Credit Fund’s loan portfolio (or a subset thereof) is sold, so that the SPV becomes the lender of record on the underlying loans
• Collateral: All-assets pledge from the Borrower (with the key assets being (1) its ownership interests in its portfolio of loan assets, and (2) blocked collection accounts of the Borrower into which principal, interest, and other payments paid to the Borrower from the loan portfolio are required to be funded); may include a pledge by the Credit Fund of 100% of the equity it owns in the Borrower
• Availability: Lesser of (1) a stated facility size and (2) a borrowing base tied to the characteristics of the underlying loan portfolio
• Tenor / Type: Typical term of three to seven years, including a draw/reinvestment period of two to four years, followed by an amortization period of one to three years; often a revolving line of credit
• Typical Purpose: Continued revolving liquidity option for early- or later-stage fund; additional source of capital to facilitate Credit Fund’s funding obligations to its loan assets and acquisition of additional (or larger) loans; used to optimize the Credit Fund’s deployment strategy and potentially generate higher returns
• Diligence Focus: The underlying loan assets’ performance, credit metrics and related loan documentation; the Credit Fund’s and SPV’s ownership of the underlying loans and the ability to transfer their rights under the underlying loans

A Credit Fund uses a CLO-lite facility as a method of borrowing against a revolving pool of loans, applying cash flows from the underlying loans (e.g., principal, interest, and fee streams) to service and ultimately repay the CLO-lite facility.

The borrower is a bankruptcy-remote SPV in which a revolving pool of loans is isolated. The Credit Fund (or an affiliate) typically serves as the collateral manager and is responsible for servicing, administering, and managing the borrower’s underlying loan portfolio. Recourse under the facility extends only to the SPV’s assets; there is typically no recourse to the Credit Fund other than customary indemnification and repurchase obligations.

Cash flows from the underlying loan assets are required to be funded to the borrower’s collection accounts. Amounts in the collection accounts then flow through regular (e.g., quarterly or monthly) waterfalls; separate waterfalls apply to interest collections (pre-Event of Default), principal collections (pre-Event of Default), and all collections (post-Event of Default).

During the facility’s reinvestment period, the borrower can borrow and/or use principal collections from the underlying loan assets to acquire new loan assets (subject to certain conditions, including borrowing base compliance). The ability to actively add to and (subject to limitations), substitute the loan portfolio during this time permits the collateral manager to strategically capitalize on market opportunities.

Various elements come into play in the facility’s borrowing base calculations, including:

• Tailored advance rates for particular types of assets, which are applied to the outstanding principal balance of the eligible loan assets;
• A lengthy list of eligibility criteria tied to various legal and economic conditions (e.g., it must be a performing loan, require regular cash interest pay (potentially, with some PIK allowance), have a max remaining term to maturity of 6-7 years, permitted jurisdictions for obligor domicile or governing law of underlying loan documents, permitted currencies, and type of loan (e.g., first lien loans, first lien last out loans, etc.)); the CLO-lite lender may also have an approval right over inclusion of loans in the borrowing base, even if they satisfy the enumerated eligibility criteria;
• Excess concentration limits (e.g., tied to single obligor, industry, or geography); and
• Revaluation events or exclusion events, which give the CLO-lite lender the ability to either assign a lower value to an underlying loan asset if certain adverse events occur with respect to such asset (e.g., an increase in leverage, release of collateral or a guarantor, or a default) or remove the asset from the borrowing base altogether.

These components are intended to control the underlying loan portfolio’s composition, provide overcollateralization, and protect the CLO-lite lender from deterioration in the value of the underlying loan assets. The facility may also include financial covenants (e.g., minimum AUM test tied to the Credit Fund’s investment advisor) a collateral quality feats intended to track the strength of the CLO facility and underlying loan portfolio.

A CLO-lite lender will typically require delivery of copies of the loan documentation for the underlying loan assets to a third-party custodian. Relatedly, the facility may include restrictions on the borrower’s ability to agree to material amendments or other modifications of the underlying loan documentation (or else it could trigger a revaluation event).

Given the underwrite of a large pool of loans and the complexity of tailoring the borrowing base to the specific loan portfolio (including future loans to be acquired during the reinvestment period), a significant amount of upfront work and coordination by the parties is required to put this type of facility into place. However, benefits include having a reliable source of liquidity to turn to, scalability, and seasoning for a CLO transaction.

II. CLO Transactions

• Issuer: A bankruptcy-remote SPV established by the CLO manager and whose assets consist primarily of commercial loans
• Collateral: Large, diverse pool of underlying loans and collection accounts
• Proceeds: Generated from Issuer’s sale of CLO tranches (debt and equity)
• Tenor / Type: Total legal term of 11-13 years, including a three-to-five-year reinvestment period (which may be preceded by a three-to-six-month ramp-up period), followed by an amortization period; combination of term debt and equity
• Typical Purpose: Fund the origination of loans; generate returns via arbitrage (capture the excess between the CLO portfolio assets as compared to the cost of servicing the debt); efficiently raise the CLO manager’s AUM; optimize returns through ability to strategically and actively trade assets during a reinvestment period
• Diligence Focus: CLO manager’s track record, structural features of the CLO transaction, and credit and performance metrics of the underlying loan portfolio

A CLO is a securitization of a large, diversified portfolio of loans (e.g., 150-400+ loans). A Credit Fund may transfer its loan portfolio (or a subset thereof) to the SPV issuer and/or the SPV issuer may directly originate or acquire loans. To finance the acquisition of the loan portfolio from the Credit Fund (or third parties, as relevant), the SPV uses capital raised from an issuance and sale of securities collateralized by its underlying loan portfolio to investors. Banks, other institutional investors, and insurance companies have historically been the primary investors in CLOs, although other types of investors have increasingly become involved in the CLO market.

The capital stack for a CLO transaction is multi-layered, comprising a series of debt tranches (with various credit ratings, which may range from AAA through B) and an unrated equity tranche at the bottom of the stack. The debt tranches are ranked in terms of subordination and priority, with varying risk and return profiles.

CLO transactions bear a number of similarities to CLO-lite facilities. For instance, the life of a CLO transaction includes a few phases: it may begin with a short ramp-up period during which the CLO issuer buys additional loan assets to grow its loan portfolio and coverage tests may not yet apply. A reinvestment period follows, during which the collateral manager (which services and manages the loan portfolio on behalf of the CLO issuer) actively trades the loans in the portfolio, buying and selling them. During this period, the CLO manager can use principal proceeds from the underlying loan portfolio to purchase new loan assets, so long as the relevant coverage tests and other conditions are satisfied. The final stage of the CLO transaction is an amortization period, during which cash flows from the underlying loan assets are used to pay down the CLO tranches in order of seniority of the capital stack.

Similarly, cash flows from the underlying CLO collateral are run through regular (e.g., quarterly or monthly) waterfalls, with a separate waterfall for collections of interest vs. principal payments from the underlying loan portfolio. In terms of payments to the CLO investors, the general rule is for cash flows from the underlying loan portfolio to be paid first to the CLO debt holders (in order of seniority), with the residual going to the equity tranche. Losses on the underlying assets follow the opposite order, starting with the equity tranche and working their way up to the most-senior debt tranche. A CLO transaction features various structural protections including collateral concentration limits (similar to those applicable in a CLO-lite facility) and a series of coverage tests designed to protect the CLO investors, such as an interest coverage test and an overcollateralization test (i.e., the outstanding principal value of the underlying loan assets must exceed the outstanding principal of the CLO debt). If a test fails, cash flows are diverted to the senior CLO notes until the test is in compliance, instead of flowing further down the waterfall. During the reinvestment period, CLO noteholders will typically not receive principal payments (unless a coverage test fails) but will receive interest payments derived from interest proceeds generated from the underlying loan portfolio.

As the CLO securities are collateralized by the underlying loan portfolio, if there is an event of default, the trustee (i.e., an entity whose predominant role is to represent the CLO investors and hold a security interest for their benefit) can take control of the underlying loan assets and the CLO issuer’s accounts.

Benefits of CLO transactions include a low cost of financing, significant scale, and a term capital solution.

D. MULTI-LEVEL LEVERAGE

Market participants may also pull features from various financing products (including those mentioned above) and piece the puzzle together to create a hybrid structure tailored to a Credit Fund’s unique characteristics and objectives, as well as what it can offer as collateral.

I. Hybrid Facilities

• Loan Parties: Credit Fund, as borrower (or guarantor, if an SPV is the borrower), and its general partner, as a pledgor (if the facility includes subscription line collateral)
• Collateral: Varies (see below)
• Availability: Lesser of (1) a stated facility size, and (2) a borrowing base (see below)
• Tenor / Type: Two to five years; revolving and term features
• Typical Purpose: Bridge timing gap between issuing capital calls to the investors and making investments; support the Credit Fund’s portfolio construction and provide additional capital to make investments; provide a continuous/seamless source of liquidity
• Diligence Focus: May depend on the exact composition of the borrowing base and collateral package. However, likely includes the same type of diligence required for subscription credit facilities and a smaller-scale version of the asset-level diligence required for CLO-lite facilities

Hybrid facilities are vastly customizable. “Hybrid” can refer to the facility’s borrowing base, covenant package, and/or its collateral. The borrowing base model may be a blend of both the unfunded capital commitments of the Credit Fund’s investors (like traditional subscription credit facilities) and the value of some or all of its underlying loan portfolio (akin to the asset-based financing structures discussed above). Alternatively, the borrowing base may focus solely on one of those two components. Another possibility is to include a trigger event that causes the borrowing base to toggle from calculation solely off of the unfunded capital commitments of the Credit Fund’s investors to calculation solely off of the asset value. To the extent the borrowing base is linked to the underlying loan portfolio, the credit agreement would include some baseline eligibility criteria (similar to, but less fulsome than, the eligibility criteria found in a CLO-lite facility) tied to factors such as whether the underlying loans are performing, the status of the underlying obligor, etc. Hybrid facilities will also likely include financial or maintenance covenants, although there may be a ramp-up period before those covenants are “turned on.”

By taking advantage of the potential blend of borrowing base characteristics and types of collateral, hybrid facilities can be useful to fulfill a Credit Fund’s liquidity needs throughout a longer portion of its life cycle. Credit Funds commonly pursue this type of financing once they have matured beyond their investment or commitment period and have meaningful investment portfolio value; however, this financing tool can also be used from the outset in place of an early-stage subscription credit facility. The ability to continuously use a single facility through more stages of a Credit Fund’s life cycle can reduce administrative burden and costs and provide the Credit Fund with a seamless and reliable source of liquidity. Moreover, a hybrid facility can be a good option for a Credit Fund with a challenging investor base that would not provide a sufficient borrowing base in a pure subscription facility; a blended borrowing base under a hybrid facility could provide better liquidity, with the value of the underlying loan portfolio giving a boost to the borrowing base.

Key Takeaways

As the private credit asset class continues to grow, backleverage options have become a hot topic. Understanding the spectrum of financing structures available in the fund finance market to a Credit Fund and thoughtfully choosing which one(s) may best suit its unique needs will be important to optimize capital deployment and make the best use of leverage. Credit Funds can use leverage to enhance their underlying loan portfolio, make additional acquisitions, fulfill general working capital needs, arbitrage, and strategically capitalize on investment opportunities, maximizing fund performance. The characteristics of the financing options range widely, including from short-term to longer-term, early-life to late-life (or continuous through multiple stages of the life cycle), single-asset to a large pool of assets, and whether the Credit Fund or an SPV is the obligor, and whether they fall into the purview of traditional bank financing, derivatives, or structured finance products. Subscription credit facilities, note-on-note financings, TRS transactions, single-asset backleverage facilities, repurchase facilities, CLO-lite or SPV warehouse facilities, CLO transactions, and hybrid facilities are all viable and valuable financing solutions for Credit Funds to consider.

¹ If a longer duration is necessary, the parties may consider exploring the use of a securities contract framework instead.