The fund finance market has grown in leaps and bounds in recent years, but the collapse of three major providers of subscription credit lines – Silicon Valley Bank, Signature Bank and First Republic Bank – has had a profound impact on lending capacity. The surge in base rates and slowdown in fundraising has raised further questions for fund finance.
For our Fund Finance Report 2023, we spoke with experts across private markets to discover how lending is adapting to the changing conditions and why NAV financing is increasingly seen as a key area for expansion. Here are five takeaways.
1The ‘flight to quality’
The banking turmoil has tested the resilience of the fund finance market, says Albert Tan, partner and co-head of fund finance at Haynes Boone. “Yet, despite the challenges, lenders generally stayed very active in underwriting and closing transactions in the space.
“At the same time, we are seeing a flight to quality, where tier one US and international banks are fielding unprecedented volumes of calls from fund sponsors seeking new relationships with quality, stable counterparties.”
This, says Tan, means that lenders can be “very selective and strategic” on their relationships – and opportunistic to capturing new relationships and solidifying existing ones.
2The NAV opportunity
There is enormous excitement among lenders about how fund-level NAV lines can be used to drive value creation through extended hold periods, given the challenging exit environment. To lenders such as New-York based Hark Capital, the questions surrounding the rise of NAV financing are simply part of the “adoption arc” typical of any new financing tool.
“Roughly a decade ago, the subscription facility market was in its early stages and viewed as an aggressive fund management tool. Now, it is a feature used by more than 90 percent of private equity funds, according to Rede Partners’ NAV Financing Market Report – 2022/23,” says Doug Cruikshank, managing partner and founder of Hark Capital.
“More recently, continuation funds have followed a similar adoption arc. It is reasonable to assume that if the market continues to become more standardized and the dynamics described above persist, NAV loans will take their rightful place as an important, established asset class within private credit.”
Dave Philipp, a partner in the fund liquidity solutions group at Crestline, agrees: “As fund finance has evolved over the last decade, the market has gone from a niche product to a true portfolio management tool, essential to the operating business of sponsors. Subscription lines of credit have long provided clarity in the cadence of capital calls while being accretive to the overall return profiles of the managers.
“NAV-based financings offer flexible capital with a varied use of proceeds that can provide stability during times of volatility and cost-effective leverage to grow business in a normalized investing environment.”
3Hybrid approaches find favor
The market is adapting to the tightened times with innovative solutions. One much-discussed possibility is “hybrid” loan facilities, which are underwritten on the basis of both a fund’s investor capital commitments and its investment portfolio.
These are finding favor with continuation funds, as they are perfect for filling funding gaps caused by differences between the vehicles’ deal sizes and ticket amounts from secondaries investors.
“In instances where sponsors and their lenders find it difficult to implement a standalone subscription or NAV facility for a continuation fund, hybrid facilities that look to both the uncalled investor capital commitments and investment portfolios of continuation funds on a combined basis have proven to be a valuable solution,” say Cadwalader partners Patrick Calves, Brian Foster and Samantha Hutchinson.
4Experience counts more than ever
Challenging times require cool heads – and that’s why know-how and experience are more vital than ever, says Anastasia Kaup, a partner at Fund Finance Partners.
“Fund sponsors find themselves in a perfect storm of challenging regulatory, capital markets and fundraising environments that limit their options for fund leverage and liquidity,” she says. “However, all is not lost – there are still banks that are ‘open for business,’ and many fund sponsors are still successfully obtaining fund financing to achieve their objectives.”
Kaup acknowledges that it is taking more time and greater effort to achieve these objectives. “But with experienced, knowledgeable, creative and resourceful advisers, fund sponsors are successfully navigating the inhospitable waters and delivering for their constituents.”
Choosing the right partner is essential. “Clear communication skills are very important,” says Khizer Ahmed, founder and managing member at Hedgewood Capital Partners. “Understanding how to negotiate and run different elements of the process is vital, as is the ability to articulate issues and make sure all parties are kept appropriately apprised throughout. Good project management skills are needed, and, in our experience, a good relationship with lenders is also important.
5Fund finance has huge unrealized potential
“NAV finance is all about the unrealized value that exists in private equity,” says 17Capital managing director Dane Graham. “There is somewhere between $5 trillion and $7 trillion in the private equity asset pool today and allocations to private markets are expected to outpace those to public markets going forward, so that pool is only going to grow.
“Take-up will continue to increase, driven by the flexibility, ease of use and value-enhancing benefits NAV finance offers. All in all, we believe that NAV finance will become a $700 billion market by 2030, with additional upside potential.”
Many observers agree. “We are definitely starting to see NAV solutions offered to LPs facing liquidity issues where the investor doesn’t want to sell at a double-digit discount,” says Gerald Cooper, partner at Campbell Lutyens.
Indeed, despite its cyclical nature, this appears to be a market poised for growth. “Clearly in a difficult economic environment, NAV financing and preferred equity solutions are becoming more attractive due to the bid-ask spread, but I think we will see this market expand even as conditions improve,” says Cooper.