PE Tech Report


Like this article?

Sign up to our free newsletter

Larger GPs to test limits of NAV-based lending

Fund financing – which includes subscription lines of credit and NAV-based loans – is set to grow even as capital markets slow. A measured approach is advised…

In a slower credit market, there is one form of debt financing that tends to accelerate among private equity funds. 

Fund finance – which allows GPs to raise loans at fund rather than asset-level – has been around for years but spiked during the onset of the Covid-19 pandemic when sponsors were unable to raise debt for their portfolio companies and unwilling to make capital calls on their LPs. 

With the cost of acquisition debt rising and a more uncertain dealmaking environment emerging, NAV-based loan requests in particular are picking up again and, according to people with knowledge of plans, many of the top tier private equity firms are investigating how they can use the structure to boost liquidity. 

“There’s been a big increase generally over the last couple of years,” says David Wilson at 17Capital. “As more managers are aware of it, we’ve seen an increase again over the last few weeks on the back of what’s happening in the world right now.”

17Capital announced final close of its 17Capital Credit Fund in April, raising EUR2.6 billion to provide NAV loans to high-performing private equity managers in Europe and North America and is planning to launch a second larger fund. Ares, Apollo and Pemberton are among a growing list of credit fund managers deploying NAV-based lending, either formally or informally, but they are yet to raise dedicated funds to do so, according to Mergermarket in October. A survey by Private Equity Wire in October found that more than 60% of GPs will continue or increase their use of fund finance in the current macro environment.

As fund finance is largely decoupled from pricing in the capital markets, lenders also remain bullish, according to US law firm Cadwalader, a leading adviser in the area which sees NAV-based lending as the “Swiss Army knife” of fund finance. It saw a 17% increase in fund finance originations during H1 this year and says that 86% of decision-makers are holding steady or increasing their exposure in 2023.

Banks have traditionally used another form of fund finance known as subscription lines of credit – raised by GPs on pledged commitments by LPs, rather than fund NAV – to build closer ties with private equity firms. Demand for capital call lending has increased due to the significant amount of dry powder at private equity and venture capital firms, wrote Moody’s in June. While short term lending to these funds remains a small percentage of total US banks total loan portfolios, some banks are rapidly growing their capital call commitments

Despite a massive pullback here from one of the major providers Citigroup, reported by the Financial Times in September, sufficient appetite remains from lenders despite recent volatility. According to Moody’s, other US banks are growing capital call commitments and more are poised to enter the arena.

“I wouldn’t look too much into [Citi],” says a partner at a European private equity fund, “subscription lines are something that is practical, not harmful, and there is no systemic risk [from them being used or increasing].”

The same may not be true of NAV-loans as they grow in size and number, the partner adds. 

“You need to be careful and sensible here. You need to stress test your cases. And you can’t just take whatever people are handing you – you need to do your homework before engaging in these products,” says the partner. “For NAV-based lending, you need a good [credit] cycle or two to really see how it’s going to react.”

Some LPs have also been less keen on NAV-based loans if they are not written into the Limited Partnership Agreement. With fund NAVs being revised downwards following this year’s fall in the public markets, the risk appetite here could shift quickly. 

“We are very careful to negotiate upfront where the leverage is at the fund level, and we’re fine with that for six to 12 months,” says a senior level source at a large US-based private equity fund. “We’ve had situations with fund leverage where a deal went south and then you’re on the hook for a capital call.”

In their current form, the NAV-based loan structure makes sense for private equity funds and their increased use looks likely through 2023, by established top-tier managers at least. NAV-based loans are subordinated to the financing in the underlying fund assets but benefit from risk diversification across the whole portfolio. This means lenders are taking ‘manager risk’, rather than asset risk, says Wilson, meaning lenders will favour larger and more diverse managers as the structure evolves.

For now, the gearing of most NAV-based finance remains conservative, at between 10% and 20% loan-to-value, which makes it attractive to lenders, but the interest of larger private equity funds will test capacity further. Wilson says he has seen a request from private equity funds of $20bn in size seeking to raise 20% LTV, which would equate to a $4bn NAV-based loan. “Doing this in one transaction becomes a bit of stretch,” he says, “but there is good and increasing interest from co-investors, and capacity is growing all the time.”

Like this article? Sign up to our free newsletter