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.