Treasury Essentials

What is driving growth?

• Evolving bank/PC relationships – Many PE portfolio companies will be familiar with co-investment structures, where PC funds provide term debt and banks provide the working capital, cash management and other banking services; or even banks and PC joining together to provide term debt. More recently, banks have been establishing their own PC platforms or entering partnerships with established PC funds to strengthen co-investment capabilities^[3]. Banks are also co-investing indirectly by lending to PC funds, so-called “back-leverage” structures, in the form of NAV financing or subscription lines.
• Diversification beyond core direct lending – The deployment of PC beyond core direct lending and acquisition finance, for example, into asset-backed finance (particularly areas featuring higher-risk-adjusted yields, including aircraft and equipment leasing), infrastructure (with longer hold durations), higher risk commercial real estate and special situations, has been an increasingly hot topic. These trends have been going on for at least a year, longer in many cases. In the US, several PC funds have launched asset-based financing (ABF) or asset-based loan (ABL) strategies with dedicated funds, whilst others have partnered with or purchased ABF/ABL portfolios from other financial institutions. This is also anticipated as a growth area in Europe – with yield premiums, asset collateralisation and scalability opportunities being attractive features to a widening investor pool (see below).
• Increased lending capacity – Back-leverage structures are a tool for increasing the lending capacity of PC funds. PC funds are also starting to utilise securitisation structures and look to develop a secondary trading market as additional means of increasing liquidity and depth. Collateralised loan obligation (CLO) structures are already a well-established means of securitising bank-originated loan exposures. In the US, PC funds have started to utilise them as a means of financing their loan portfolios and the expectation is that this practice will develop in Europe (albeit more slowly due to the smaller pool of assets and greater regulatory restraints). In May, Apollo announced that it was joining forces with five banks, including JP Morgan and Goldman Sachs, to syndicate and trade investment-grade private debt on a wider scale, with the banks serving as broker-dealers – a significant step towards the development of a secondary market. There is some concern that the secondary trading of PC debt could remove some features that make the asset class attractive, in particular its focus on long term value creation, reduced value volatility risk and higher yields. However, secondary liquidity has the potential to build a more resilient market as general partners initiate secondary transactions to restructure funds, extend fund life or satisfy the liquidity of limited partners.
• Expanding investor base – Historically, PC investors were dominated by specialist investment funds and insurance firms, but PC now attracts a much broader spectrum of investor, including reinsurance firms, pensions funds, sovereign wealth funds, endowments and increasingly even family offices. PC funds have traditionally adopted closed-end structures to match the long term and illiquid nature of their assets, but the desire to open the asset class to a broader investor base has led to the launch of a number of open-ended funds that permit more flexible investment strategies. A number of PC firms have also themselves established or acquired (re)insurance vehicles, creating platforms covering buy- and sell-side interest and manufacturing fund products tailored to those vehicles’ investment demands.

Why corporate treasurers should be interested in the growth of PC

The growth of PC beyond its traditional audience, as well as the increasing depth in terms both of lending capacity and product range, offers an opportunity to treasurers looking to diversify their funding sources (whether to reinforce financial resilience or as a means of increasing competition amongst funding providers).

• “Tie-ups” between traditional banks and PC should offer treasurers greater access to joined-up, flexible, innovative funding strategies under one roof, enhancing their agility to respond to market opportunities and challenges.
• Innovations in fund structures and finance will free up capital, extend the life of funds and make more funding available for a larger and more diverse borrower base.
• A wider, more varied investor base should enable PC to support larger financings; and with different investors come varying risk appetites, allowing funds to diversify in terms of structure and the types of bespoke solutions they can offer to borrowers.
• Diversification of PC into ABL is good news for those corporate treasurers looking to leverage their accounts receivable, inventory, equipment, or real estate outside the traditional banking sphere. A wider range of providers of this type of financing should drive competition both on terms and execution capabilities as experienced in other areas of PC-provided financing.

In summary, the growth of PC could offer treasurers potential new avenues to optimise funding, support growth and enhance risk management, alongside or in collaboration with more traditional solutions.

What is a USPP?

A USPP is a private offering of notes to a select group of investors, without the need for public registration. In this way, the product is often described as a hybrid between a public bond offering and a syndicated loan.

USPPs are a form of term debt, usually (although not always) issued on a fixed-rate basis, with maturities ranging from a few years to over 30 years. The market is generally geared towards large and mid-sized corporates with investment grade profiles, although a formal public credit rating is not required.

Investors in USPPs are typically pension funds and insurance companies, although the investor base has broadened over the years. These investors tend to adopt a “buy-and-hold” strategy, seeking to invest on a long-term basis. Although a limited secondary market exists, most USPPs are held to maturity.

What are the advantages of a USPP?

USPPs offer a number of compelling well-documented benefits for corporate issuers, including:

• Longer tenor – USPPs typically offer longer maturities than traditional bank debt. While bank loans often have tenors of 3 to 5 years (perhaps with a one- or two-year extension option), USPPs can extend well beyond ten years and, in some cases, up to 30 years or more. This makes them particularly attractive for companies with medium- to long-term funding needs.
• Flexible issuance size – The USPP market accommodates a range of issuance sizes, with no minimum threshold, making it accessible to a broader range of corporates and allowing issuers to tailor the size of the issuance to meet specific strategic or operational needs. Additionally, funds can be raised in multiple currencies and tranched as necessary.
• No public credit rating required – While the USPP market is typically accessed by companies with strong credit profiles, there is no requirement for a public credit rating or stock exchange listing. Instead, the notes may be assigned a designation by the Securities Valuation Office of the National Association of Insurance Commissioners (NAIC), as required by US insurance company investors for regulatory capital purposes, which can have a significant impact on the eventual placement and pricing of the notes.
• Standardised documentation – Transactions are governed by a Note Purchase Agreement (NPA), which outlines the terms under which the investors agree to subscribe for the notes. The American College of Investment Counsel (ACIC) maintains model forms of NPAs which are used across the market as a starting point in negotiations, in the same way as the Loan Market Association’s recommended forms for syndicated loans. Non-US issuers use the “Model X Form”, of which there are two variants depending on the borrower’s credit profile and transaction complexity.

What are the key considerations for corporates entering the USPP market?

For corporates contemplating issuing a USPP for the first time, there are several important points to keep in mind. These include, but are not limited to, the following:

• Investor relationship management – USPP investors are sophisticated institutional parties, each with distinct investment objectives. Unlike syndicated bank loans, there is no facility agent appointed to act on behalf of the investor group. This means issuers must manage investor relationships directly – both at issuance and throughout the term of the notes. This dynamic becomes particularly relevant when seeking amendments or waivers.
  
  As such, proactive and ongoing engagement is essential. In the absence of ancillary business and/or frequent refinancing discussions, maintaining these relationships can require greater effort than a traditional banking relationship. This extra effort can, however, yield significant benefits as USPP investors tend to support issuers over cycles (provided engaged early) - often proving invaluable during periods of market stress compared to more transactional markets.
• Alignment with bank financing terms – The ACIC model forms contain representations and undertakings that are significantly more extensive than those found in a typical investment grade bond issuance. They are more akin to the level of terms usually seen in an LMA-based facility agreement, though a number of differences exist.
  
  To reduce the compliance burden and risks resulting from inconsistencies across financing products, many European issuers seek substantive alignment of the NPA terms with those of their existing bank facilities. Investors are generally amenable to such amendments, although they may request most favoured nation (MFN) protection as a quid pro quo to ensure they receive the benefit of any enhancements granted to other lenders. This is typically acceptable to issuers, provided the scope of the MFN clause is clearly defined and appropriately limited.
• Preserving operational flexibility – Even where alignment with bank terms is achieved, certain provisions of the NPA may not have direct equivalents in bank documentation (for example those reflecting the longer tenor of USPPs or specific investor expectations). Issuers should carefully assess the impact of these provisions and negotiate appropriate carve-outs and/or amendments to preserve operational flexibility over the life of the notes. Given the long-dated nature of USPPs and the buy-and-hold nature of many USPP investors, it is especially important to ensure that the terms do not unduly constrain the issuer’s ability to conduct its business and respond to future strategic or financial developments.
• Early redemption charges – Unlike bank loans, which typically allow voluntary prepayments at par (subject to break costs where applicable), USPPs are structured for long-term buy-and-hold investors. As a result, voluntary early redemption is generally permitted only with the payment of a “make-whole” amount – designed to compensate investors for lost yield through to maturity.
  
  The make-whole calculation can be complex and, depending on prevailing interest rates and the remaining term, potentially expensive. Issuers should factor this into their liquidity and refinancing planning, particularly if there is a possibility of early repayment.

Concluding remarks

In times of market volatility – such as those we are currently experiencing – diversification of funding sources often becomes a top priority for corporate treasurers. USPPs – a well-established and reliable financing option – offer a compelling solution, providing an alternative source of long-term debt for investment grade corporates of all sizes, execution of which is not at the mercy of potentially narrow issuance windows.

While USPPs may not be quite as advantageous today as they were during the low-interest rate era – those who secured fixed-rate USPP funding are now in a rather enviable position – they remain a viable and attractive alternative, or more often complement, to more traditional financing arrangements. As such, USPPs should not be overlooked in any well-rounded treasury strategy.