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What to make of NAV loans?

October 30, 2023


NAV Financing

Extending Life Funds and Staying Liquid

with NAV Financing

Over the last 1 to 2 years, NAV (Net Asset Value) credit facilities have become a more popular topic among GPs and LPs of Private Equity funds.


NAV credit facilities have been in the market for a number of years, but there is more attention on the product offering given the current market conditions.

What market conditions are driving NAV consideration?


A few things are important to note….


  • NAV market offerings have gotten the attention of well-established Private Equity Funds. With each new deal announcement, there is a trickle-down, snowball effect in the market where more sponsors seek to learn about NAV offerings, and use cases, and replicate doing what other PE sponsors have already done.

  • The rise in interest rates and market volatility has impacted portfolio company profit margins and the ability to access higher levels of debt from traditional sources. NAV solutions can be a source of financing for portfolio investment, acquisitions, and working capital needs.

  • The recent ramp in NAV financings is driven by the growing focus on liquidity in the PE space in the current market environment, as firms seek to manage their own liquidity needs. Portfolio liquidity has taken longer for a few reasons including public market valuation pressure (not a great time for an IPO), and higher interest rates have led to an adjustment in debt capital for leveraged buyouts. Plus, macroeconomic turbulence and global geopolitical uncertainty have also negatively impacted valuations and the timing of liquidity events. Overall, the Exit/liquidity event deal volume is down.

  • Disruption in the bank Fund Finance lending segment. SVB, First Republic, and Signature Bank were all leaders in this market segment and they have been permanently disrupted. Today, new bank platforms are launching and other players are expanding. Fund Finance bank players today include SVB/First Citizens, JP Morgan Chase, Citizens Bank, Axos, Investec, and Everbank. With the disruption earlier in the year, Bank Fund Finance teams are likely to expand offerings beyond capital call lines.


What are the NAV loan use cases?


A few primary use cases include…..


  • Managing Fund liquidity;

  • Extending the Fund life by providing incremental capital for investments in portfolio companies;

  • Funding platform acquisitions within the portfolio, or supporting working capital; and

  • Buying out investment partners at the Fund level.


The bottom line is that the NAV financing market offers a critical source of liquidity for Private Equity funds and managers. Essentially, lenders provide NAV loans leveraged against unrealized investment portfolios at the Fund Level, and proceeds can be used for a wide range of investment needs and/or distributions back to investors. NAV financing allows PE firms to raise borrowings against the NAV of the assets in their funds.


NAV Market Size


In evaluating the NAV market size, we simply conducted market research, and are sharing some of the insights found from leading investors in this segment.


According to Preqin, private equity funds had around $8.3 trillion of assets under management (AUM) at the end of 2021 and an unrealized NAV of $1.6 trillion across European and North American PE firms. Extrapolating those numbers out, 17Capital (we share some insights on this fund below) has projected that the NAV financing market, which currently sits at around $100bn, could triple in size by 2025 and reach $700bn by 2030. A big factor in determining NAV market size is simply looking at the unrealized value today in Private Equity.


From Dave Philipp, partner at Crestline: “NAV lending in secondaries is expected to soar over the next decade. The market for NAV-based financings is estimated to fall between $80 billion and $100 billion today, with around $30 billion of transactions completed in 2022 alone.”


From Darren Schluter, Managing Director of the secondary advisory group at PJT Park Hill: “We estimate 20-30 percent of secondaries transactions are currently utilizing NAV financing in some format, whether that is true NAV financing or a hybrid facility, which would indicate $25 billion-$30 billion in financing per year. The growth of NAV financing is outpacing the growth of the secondaries market as these structures have increased in adoption.”


From a Q3’23 Goldman Sachs Asset Management investor survey, Subscription lines have become common for managing liquidity – 72% of GPs expect to use them in the coming year. To generate intermittent liquidity, NAV-lending and preferred equity forms of fund finance remain less used (16% each) but are being considered. Most GPs continue to see full exits via asset sales as the most likely path to liquidity in the year ahead.


NAV Advantages


NAV facilities have a high degree of customization.

Speed to close can be an advantage. Compared to a traditional secondary portfolio sale, for example, a book of 20 to 50 LP interests up for sale, an NAV deal does not require a seller, and the process can take 2 to 3 months vs. 6 to 9 months.


Avoiding selling assets in a down market is a current advantage. PE firms may not want to sell assets at a time when valuations have come down substantially. As a result, PE firms are utilizing NAV financings to support their portfolio companies and extend the holding period for these assets.


Unlocking liquidity is a key advantage. NAV facilities allow PE Funds to unlock liquidity from illiquid assets and it enables sponsors to optimize fund performance by increasing investment capacity for follow-on investments on the existing portfolio.


Loan proceeds can be used for opportunistic liquidity needs. NAV credit facilities may allow PE funds to utilize loan proceeds for dividend recapitalizations, which often isn’t permitted under a subscription-backed credit facility. A dividend recapitalization can also provide investors with an alternative to a secondary sale.


NAV Risks and Challenges


As with any asset-based credit facility, NAV Credit Facilities have issues and challenges.


One major issue is the proper valuation and calculation of NAV for inclusion in the calculation of the Borrowing Base.


Another risk factor is NAV facilities may enable PE sponsors to cherry-pick provisions from the underlying eligible portfolio of assets, as per leveraged credit agreements. This makes it more difficult to determine the NAV of a portfolio of assets.


The diversification of the underlying loan portfolio is another key consideration and risk factor in determining the LTV ratio. If diversification is high, then this may make for more favorable LTV terms with the borrower. If diversification is narrow, or there are concentration issues, then the LTV calculation may vary and be difficult to determine.


Finally (at least for this newsletter discussion), securing an equity pledge as primary collateral has unique and complex legal challenges.

 

Recommended Reading

This is a 32-page quarterly report packed with tons of insights, data, and charts. Overall: S&P noted that Higher-for-longer interest rates, the possibility of recession, and lingering inflation, suggest credit conditions for borrowers in North America will likely deteriorate.


 

Investor Spotlight


Founded in 2008, 17Capital provides preferred equity and NAV loans to top-tier private equity funds, management companies, and LPs across North America and Europe. 17Capital has raised $11 billion across six successive funds and mandates, deploying over $9 billion across over 90 investments. To date, the firm has achieved over 46 full exits.

In 2022, the firm was acquired by Oaktree to strengthen both firms in the private sector community. However, Capital17 continues to operate independently but within the Oaktree family.


According to Dana Graham at 17Capital, the firm offers the full range of NAV finance solutions across preferred equity and loan structures with the ability to apply those products across the entire private equity ecosystem, from fund to management company to LP. The firm also has deep expertise across all relevant skill sets required to make these deals work: secondaries, leverage finance, valuation and strategic advisory, and risk management.


Dane also highlighted a belief that we are still at the early stages of the adoption curve. He commented that “Take-up will continue to increase, driven by the flexibility, ease of use, and value-enhancing benefits that NAV finance offers. All in all, we believe NAV finance will become a $700 billion market by 2030, with additional upside potential.” Check out this interview: https://www.17capital.com/the-power-of-nav-finance/.


 

Chart of the Week

Despite a challenging fundraising landscape, private equity funds continued to accumulate investor capital. According to data from S&P Global Market Intelligence and Preqin, global private equity dry powder reached $2.49 trillion in mid-2023. This increase in dry powder is occurring at a time when opportunities for private equity investments seem limited, as global private equity investments fall by 53.5% year-over-year to $98.48 billion in the second quarter.



 

Economic Indicators - One More Report & Chart

The CBO published a report about the country's economic outlook forecasting for 2023 to 2025. The presentation was prepared by Richard DeKaser, CBO's Director of Macroeconomic Analysis, to Economic and Financial Counselors from the European Union. Check out the link: https://www.cbo.gov/publication/59543


See Congressional Budget Office, An Update to the Economic Outlook: 2023 to 2025 (July 2023)


Key Takeaways:

  • Real Gross Domestic Product output is projected to grow and remain positive, but too slow to prevent unemployment from rising.

  • Due to an increased slack in the economy and an end to disruptions in the supply chain, inflation is forecasted to decline.

  • A decline in interest rates is observed as inflation declines.


We view the CBO as being highly credible, however forecasts may include errors, and may not end up being correct.

 

We aim to share market insights and ideas, and some fun interests via this newsletter.


We want to build community so please touch base.




 

Disclosure

Rainmaker Securities, LLC (“RMS”) is a FINRA-registered broker-dealer and SIPC member. Find this broker-dealer and its agents on BrokerCheck. Our relationship summary can be found on the RMS website. RMS is engaged by its clients to make referrals to buyers or sellers of private securities (“Securities”). If such client closes a Securities transaction with a buyer or seller so referred, RMS is entitled to a success fee from the client. Such success fee may be in the form of cash or in warrants to purchase securities of the client or client’s affiliate. RMS or RMS representatives may hold equity in its issuer clients or in the issuers of securities purchased or sold by the parties to a transaction. This communication is confidential and is addressed only to its intended recipient. This communication does not represent an offer or solicitation to buy or sell Securities. Such an offer must be made via definitive legal documentation by the seller of securities. Investments in the Securities are speculative and involve a high degree of risk. An investor in the Securities should have little to no need for liquidity in the foreseeable future and have sufficient finances to withstand the loss of the entire investment. RMS does not recommend the purchase or sale of Securities. Potential buyers or sellers of the Securities should seek professional counsel prior to entering into any transaction.

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