Staying abreast of financing developments is of ongoing importance to private equity funds. On March 26, 2019, Thomas Smith of the firm's London office participated in the NAV and Hybrid Facilities Panel at the Global Fund Finance Symposium, along with Steve Colombo (Goldman Sachs Asset Management), Vicky Du (Standard Chartered Bank), Brian Goodwin (J.P. Morgan Asset Management), Katie McMenamin (Travers Smith) and Adam Summers (Fried, Frank, Harris, Shriver & Jacobson). Below are the key highlights of the discussion.
NAV facilities mean different things to different people. There really is no “one size fits all.” To cite just a few common uses of NAV facilities:
- A credit fund may employ a levered investment strategy from its inception.
- A secondaries fund may effect a dividend recap using a NAV facility.
- A private equity fund may re-lever a concentrated pool of its investments.
- An open-ended infrastructure fund may rely on its NAV facility rather than its limited uncalled capital in light of its open-ended strategy.
The fundraising climate remains generally positive. There remains an abundance of liquidity in the market for sponsors to invest. This material liquidity is one cause for the increase in asset prices. In this pricing environment, leverage can help funds maximize returns from their investments.
The liquidity of underlying investments is key to NAV facilities. Lenders generally prefer to lend against liquid assets. As a result, the relatively liquid assets held by credit funds and secondaries funds facilitate a NAV lender’s credit analysis. In contrast, private equity investments are much less liquid and therefore find fewer willing lenders, although that lender market is growing.
The availability of financing may require third-party consents. The specific requirements will depend on the fund structure, the security package and the nature of underlying investments. For example, a secondaries fund effecting a dividend recap will need to consider whether it must obtain GP consents to transfer underlying investments under a new SPV, to give security over that SPV and to authorize the lender to ultimately enforce security. Expect lenders to conduct diligence on the underlying assets to understand the applicable consent requirements.
Lender security requirements will inform NAV facility structuring. Any sponsor wanting to raise a NAV facility should consider a lender’s potential security package when setting up its fund investment structure. Lenders may ask to take security as close to the assets as possible, although ultimately this is a negotiation point to be informed by a cost-benefit analysis and the required consents discussed above. Lenders may require at least a share pledge over holdco SPVs below fund level which hold the assets. Lender requirements will vary across lenders, structures and investment strategies.
Asset valuations are crucial to any NAV facility. Many types of assets, including private equity investments, secondaries investments and infrastructure investments, are difficult to value other than by the sponsor. In many NAV facilities, lenders will therefore accept the sponsor valuation of underlying assets by reference to sponsor financial statements prepared for their limited partners, provided the sponsor includes an appropriate valuation methodology. The valuation of credit fund assets, which is heavily negotiated between sponsor and lender, are an exception, however. Credit fund sponsors may be prepared to accept that broadly traded loans can be valued by reference to quotes of dealers in the market. However, those sponsors will prefer to use their own valuation method for any loan asset which is not valued by reference to an objective mark.
NAV facility amortization matters to both sponsors and lenders. A balance must be struck between the strategy of the sponsor, on the one hand, and the need for the lender to de-risk and ensure repayment of the loan at maturity, on the other hand. Certain NAV facilities will amortize sharply, while others will not amortize at all. For example, a credit fund using a levered fund strategy from its inception may not find it acceptable for its NAV facility to amortize before the end of the investment period because any earlier amortization would impact its levered investment strategy. In contrast, a secondaries fund seeking to return capital to its investors by levering its existing portfolio towards the end of its investment period may be more willing to accept amortization of its NAV facility in parallel with its investment sell-down strategy.
NAV facilities may seek to borrow against all or a specified subset of fund assets. Some sponsors may wish to borrow against the NAV of all investments in the fund. Other sponsors may wish to lever specific assets. This question is most keenly negotiated by credit funds, who will prefer that assets acquired after the NAV facility is put in place be automatically included in the facility borrowing base (subject to meeting pre-agreed eligibility criteria). Certain lenders are comfortable with this approach, whereas others will require a veto right over inclusion of future assets in the borrowing base.
Hybrid facilities combine NAV and subscription line elements. < In offering a NAV facility, lenders look to the underlying assets of the sponsor for their credit support, while subscription-line lenders look to the uncalled capital of the fund’s limited partners. A hybrid facility combines the two types, allowing a sponsor to put in place a single facility with both a subscription-line element and a NAV element.
Credit funds have the option to raise a hybrid facility or split NAV and capital call facilities. Credit funds may be presented with the option either to put in place a hybrid facility or raise split NAV and capital call facilities. There are reasons for pursuing each option. Sponsors preferring to split their facilities may find a wider group of willing lenders and may gain cheaper pricing overall. They may also gain the benefit of less fund-level regulation, as only the subscription line covenants will apply to the main fund entity. On the other hand, sponsors preferring a hybrid facility only have to deal with one lender and one facility (although there may be multiple points of contact at that one lender, insofar as putting in place a hybrid facility may require collaboration between different sections of a lender). Importantly, sponsors of hybrid facilities may also be able to ramp up their levered investments at the start of the life of the fund by relying on the uncalled capital credit at the time when the fund holds no or very few underlying investments.
These are only a few of the numerous aspects of NAV and hybrid facilities addressed during the panel discussion. Please contact us to further discuss these facilities.