Debt fund quoting 9-10% net to LPs on loans that coupon at 10.5%. Where's the money coming from?

Question

Working through a first-time debt fund from a shop that's been doing equity deals for years. Loans are bridge, first position, quoted at SOFR plus 450 to 500 with floors, so call it 10 to 10.5% coupon, one to two points at origination. Fund terms are 1.5% management fee, 20% carry over a 7% pref.

The marketing deck says target net to LP of 9 to 10%. I can't make that arithmetic close. Take a 10.5% gross coupon, subtract 1.5% of fees, subtract fund expenses, and you're at 8.5% or so before any carry, and any loan that stops paying takes a bite out of that. So either the origination points are flowing to the fund rather than the manager, or the whole thing is levered on a warehouse line and the spread is doing the work. I suspect the second. If that's right, the return isn't really a credit return, it's a levered credit return, and I'd like to understand what breaks first when it does break.

Rena Expert · Accepted Answer

Levered credit is almost certainly the answer, and the deck should say so. The usual construction is a warehouse or repo facility at something like SOFR plus 200 to 275 advancing 65% to 75% against each loan. Borrow at 6.5% against a 10.5% asset at 70% advance and the return on the fund's equity slice moves from roughly 10.5% to somewhere in the mid teens gross, before fees and losses. That gap is what funds a 9 to 10% net target and a 20% carry on top.

Origination points can go either way and the LPA decides it. Points retained by the manager are effectively a second fee stream and should be disclosed alongside the 1.5%. Points contributed to the fund improve LP yield and shorten the effective duration on a two-year loan meaningfully. Ask for the actual language, not the summary.

What breaks first is the facility, not the loans. Warehouse lines carry margin calls tied to lender-determined collateral value and mark-to-market provisions, so a borrower going non-performing can trigger a repurchase demand or a haircut increase while the loan itself is still recoverable in full. That forces the fund to post cash at the worst possible moment, which is where capital calls get made into a stressed market and where LP defaults cluster. Ask whether the facility is recourse to the fund, what the advance rate reset triggers are, and whether there's a single lender or two.

One more thing to check on a first-time debt fund from an equity shop. PIK and default interest accrue into reported returns without cash arriving, so a fund can show a 10% accrual rate while collecting very little. Ask for cash-on-cash distributions versus accrued yield, separately stated.

hannah_west29 · Answer

Ran the numbers your way. $50M equity, 70% advance gets you to roughly $166M of loans, so $116M borrowed. Gross interest at 10.25% is $17M, facility cost at 6.5% is $7.5M, leaves $9.5M on $50M, so 19% gross. Take 1.5% on assets and you're chewing $2.5M if the fee base is total assets rather than equity. That fee base question is worth more than the carry question.

wendy_park48 · Answer

ledger's last sentence is the one I'd chase. I've read debt fund LPAs where the management fee is computed on gross asset value including levered assets, which nearly doubles the effective fee on invested equity. Also look at whether the pref is compounding, and whether it's a true pref or a return hurdle measured on an IRR basis. A 7% IRR hurdle on a fund that distributes monthly is easier to clear than a 7% compounding pref, and the deck will call both of them a pref.

marcus_hale41 · Answer

Recourse is the question I'd lead with. If the warehouse provider has recourse to fund assets rather than just the pledged loans, one bad borrower can reach across the portfolio. I'd also want to know the lender's name and whether the facility has been renewed at least once, because a facility that matures before the fund's loans do is a mismatch nobody prices until renewal season.

ehernandez74 · Answer

Naive question. In a bad year, does the LP just get a lower coupon, or can the levered structure actually take principal? I've been assuming first position bridge debt was the safer end of this.

dmitri_v6 · Answer

anchor, leverage means the equity slice absorbs losses first, so yes, principal is reachable. At a 70% advance rate a 30% loss of collateral value wipes the equity in that loan entirely. Vellum, one thing to add to your list: whether the manager can put a loan on non-accrual and how that decision gets made. If the GP controls when a loan stops accruing, the GP controls the reported yield, and the carry gets calculated off numbers they set.

Debt fund quoting 9-10% net to LPs on loans that coupon at 10.5%. Where's the money coming from?

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