Lines in the Sand – Howard Marks Memo to Oaktree Clients
In my 2016 year-end review, which went only to clients, I included a discussion of the use of subscription lines by closed-end funds in areas such as private equity, real estate, distressed debt and private credit. It’s my impression that their use has become fairly pervasive in recent years, and in response to clients’ requests and market trends, Oaktree has utilized subscription lines in some of its newer funds. That year-end note prompted some interesting and spirited discussion of lines and their merit and effect. Thus I decided to write this memo on the topic for general circulation.
How Do Subscription Lines Work?
As I wrote in the year-end review, subscription lines are bank loans extended to funds that enable them to use borrowed money, rather than LP capital, to make early investments or pay fees and expenses. While there is no universal description, I believe it’s safe to say in general that subscription lines:
are limited as a percentage of the LPs’ capital commitments. (Commitments from the most creditworthy LPs earn a 90% advance rate, and commitments from lesser credits earn lower advance rates or, in some cases, zero),
are secured by the LPs’ capital commitments, and
generally must be repaid in the early or middle part of the fund’s life(unless extended), although terms are beginning to lengthen.
The key element is that a subscription line can substitute for LP capital, but it can’t be used to allow the fund to invest more than its committed capital. That is, a $100 million fund with a subscription line might be able to buy $50 million of assets without calling LP capital, but it still can’t invest more than $100 million in total (other than by recycling proceeds from liquidated investments). The bottom line is that essentially all subscription line financing does is defer the calling of LP capital.
So the starting point for this discussion is the fact that these lines lever LP capital but do not lever funds in the sense of allowing funds to invest more than their committed capital.Fund-level debt that allows funds to invest more than their committed capital is different from subscription lines and not my subject here.
Read rest of the memo here