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In the past few years we have seen a resurgence of the use of portable alpha strategies tied to hedge fund investments (and the financing arrangements that accompany them), a trend that this old-timer last encountered more than 15 years ago prior to the global financial crisis.
The market for financing pools of interests in private equity funds and private credit funds continues to sizzle, with new lenders joining the market and competition on pricing leading to a tightening of spreads for the most sought after deals. We are regularly having conversations with business principals, risk officers and internal lawyers at new and existing lenders looking to better understand this market. How to underwrite secondaries is a particular focus for new lenders, and is a topic we covered at yesterday’s Fund Finance Association University 2.0.
As most Fund Finance Friday readers probably already know, over the summer, the Institutional Limited Partners Association issued guidance for Limited Partners and General Partners around the use of Net Asset Value based financing facilities by private equity funds. ILPA issued the Guidance to identify potential issues relevant to LPs regarding the use of NAV facilities, including (i) transparency around their use, (ii) the level of engagement by GPs with LPs to solicit LP feedback and/or consent, and (iii) how the impact of NAV-based facilities is reported. Fund Finance Friday previously summarized the Guidance when it first came out here. However, now that there has been ample time to digest, we wanted to take the opportunity to recap some of the events leading up to the Guidance, to provide insight as to the market’s reaction to it, and to highlight some practical considerations for market participants to consider in implementing its recommendations.
We have recently seen a notable uptick in the usage of equity commitment letters (ECLs) in fund finance transactions and have been spending an increasing amount of time discussing their merits with our clients’ credit teams. So, even though Fund Finance Friday has done overviews of various types of credit support in the past, we thought it was time for a refresh on ECLs, how they are deployed in fund finance transactions and what lenders should look for when relying on them as credit support.
NAV loans are getting constant coverage in the press now. For those of us that spent years trying to direct focus to the potential of NAV lending, this is a welcome development. Admittedly, not all of the coverage is positive. It seems that there is a new article out every week with a negative take on NAV. As a result, we’ve been receiving a lot of calls from clients asking questions about the status and trajectory of the NAV loan market. We welcome the attention, positive and negative. A discussion on the merits of NAV lending is warranted, and the positives will, over time, win out over perceived negatives. In the meantime, we continue to see robust NAV loan activity, and we remain unequivocally bullish on this segment of the fund finance market. Let’s recount some of the reasons why:
It’s not unusual for new products to come under scrutiny in their ‘growing up’ phase, but some concerns around NAV loans may be misplaced.
(This article originally appeared in Private Equity International. You can view the article here.)
It’s already been two weeks since we wrapped up the Cadwalader Finance Forum in Charlotte, which featured a panel on “New Approaches in the NAV and Secondary Market.” The panelists provided attendees with an entertaining and very educational discussion explaining what exactly is NAV finance (see summary of panel discussion here). Given the packed crowd for the panel and the general buzz at the conference, it should be obvious to even the casual observer that interest in NAV finance is at an all-time high (which is saying something since it has consistently been one of the hot topics at industry conferences in recent years). So, as we enter the home stretch of 2023, we wanted to reflect this week on the state of the U.S. NAV finance market and provide some thoughts on trends we are observing and what we are hearing in the market as we get ready to wrap up what has been a dynamic year.
It has been a common refrain in the fund finance industry that “hybrid” loan facilities (i.e., loans underwritten on the basis of both a fund’s investor capital commitments and its investment portfolio) are constantly talked about, but are (at least in the PE buy-out space) seldom seen. An internet search returns a bounty of articles citing such facilities as a “cradle to grave” financing solution. Marketing teams crank out glossy presentations touting capabilities to execute such facilities. And conference agendas schedule panels to discuss the nuances of hybrid collateral structures. But the market consensus year after year has been that the number of hybrid deals actually executed has been . . . underwhelming.
In the private equity secondaries market, financing is often used to facilitate the purchase of portfolios of interests in private equity funds. These transactions require lenders to underwrite the value of assets that the borrower does not yet own, which gives rise to a specific set of challenges for the lenders. Here we discuss some of those challenges and the steps lenders can take to get comfortable making such loans.
We continue to see significant interest in NAV financing products in both the U.S. and European markets, which is reflected in double digit year-over-year growth in our deal activity for these facilities to date. As compared to years past, there has been a noticeable uptick in new lenders willing to provide NAV financing (including both banks and private lenders). In mid-2020, at the outset of the pandemic, the spike in interest in NAV lending from sponsors was anecdotally explained by (i) sponsors being hesitant to call capital from LPs during the uncertainty of the pandemic and (ii) the inability of private equity-backed companies to obtain affordable financing during the disruptions caused by COVID shutdowns. Nonetheless, as these pandemic effects continue to fade and we shift to a very different macroeconomic environment, the demand for NAV lending remains strong. Here is a high-level summary of some of the key features of NAV loans, many of which are the focus of our conversations with clients.