Net Asset Value (NAV) loans have been making headlines in recent years.
With eye-popping increases of 30-50% in deal volumes in recent years, it is no surprise that it has attracted mainstream attention and new lenders.
However, completed deals – and ticket sizes – remain relatively small. We wanted to take a look at what we really know about NAV loans and its outlook.
What is it
A NAV loan is secured against the value of the underlying portfolio and the cashflow and distributions that flow from a portfolio.
As such they are generally secured against an SPV which owns the assets.
Generally these are complementary to capital calls which are likely to be used in the early stages of a fund, whereas NAV really suits the later stage of a fund where investor capital has already been utilized. Hybrid facilities may be secured against both portfolio companies and investor commitments, where a fund may be looking for longer term financing from the fund’s inception.
NAV facilities are generally structured as a term loan, which will vary depending upon the stage of the fund and its need. If the facility is designed to bridge a particular event, the tenor can be very short. However, it is more likely to be in the range of 3-5 years.
As the whole premise of the facility is the net asset value of the fund, the loan to value is a key factor. LTV ratios can range from 10% to as high as 60% for well diversified portfolios.
LTV “grids” determine whether this impacts an increase in the facility or a decrease in the interest rate.
In terms of security, there are undoubtedly challenges with potential conflict between individual company debt and portfolio level debt.
Security typically comes in the form of a pledge of the SPV holding the asset and possibly the bank accounts.
However, there may be nuances depending upon the underlying assets, the purpose of the facility and the LTV. Stronger, well diversified portfolios may be able to negotiate carve outs from the bank sweeps – which are often tighter in NAV loans than other facilities.
Where next for NAV
To understand the future of NAV lending, it is worthwhile looking back at how this market has developed.
Historically this was a product provided by banks – particularly those in Europe – to smaller buyout funds which had limited financing options. Banks were able to understand – and assign a value to the concept of the net asset value of an entire portfolio.
It has undoubtedly moved into the mainstream as a tool in the toolbox of all private equity funds.
Against a backdrop of price mismatches, extended deal timelines and record levels of dry powder, there is a definite push towards NAV lending for larger sponsors.
However, there is also a pull – in the form of higher interest rates which have enabled NAV loans to clear the hurdle for many alternative credit providers. It has attracted new entrants such as Pemberton, Apollo and Partners.
So will NAV lending revolutionize fund finance in the same way that direct lending has fundamentally changed the face of the leveraged finance market?
Not necessarily.
NAV loans remain rooted in their birthplace of buyout funds – albeit available to a wider range of funds and fund sizes.
“The size and depth of the buyout market provides a rich history and data set which has driven this market. Buyouts are a strategy that lenders can understand, value and get comfortable with,” said Jinyoung Joo, a partner at international law firm, Proskauer. “That also enables new players to come into the market. “
There are undoubtedly deals done in the real estate, venture and infra spaces but buyout funds remain a happy hunting ground for NAV lenders.
It is true that NAV loans can, and have, completed club and syndicated deals. But those are the exception rather than the norm. Ticket sizes remain relatively conservative at around $100mln – a size that many individual lenders are willing and happy to provide.
What has changed in recent years – and could define the growth of NAV loans for the immediate future – is the US market.
“Traditionally we saw a greater volume of NAV lending in the European market. That has shifted slightly in the last 12 months, both activity and volumes have increased significantly in the US,” said Paul Tannenbaum, partner at Proskauer. The starting point is the size of the buyout market in the US but that growth has also been propelled by more widespread education. That has improved the ability to get deals done.”
This all points to a healthy outlook for NAV financing. The demand for liquidity is being met by willing lenders and a pool of untapped portfolios are waiting to be unlocked. Heady times indeed.
Not without challenges
Much of the conversation around NAV lending stops here – an unchallenged rosy outlook with exponential growth potential.
However, there are undoubtedly challenges to be faced.
The industry will have to get to grips with the thorny issue of valuations. Sluggish markets dominated by a mismatch of price expectations provides a perfect backdrop for that conversation to take place as something that the whole sector is grappling with.
Industry initiatives, working groups and improvements in fund documentation are also helping the important conversation and education between GPs and LPs.
In the context of the overall benefits – improved fund returns, increased liquidity and flexibility – these are challenges that should be overcome.
While the long term future for NAV lending is not core to Termgrid’s future, we have seen transactions completed on our platform. In exactly the same way that sponsors and lender share information for any other transaction, digitizing those workflows for a NAV facility saves time for all involved.
However, our real interest is the same as that of clients and users. Driving efficiencies, encouraging innovation and ultimately improving returns for all is a goal that we share with the private capital community as a whole.