NAV resists lev loan market turmoil

The market is seeing an acceleration in evolution since other sources of capital have dried up or become more expensive

The market for NAV loans managed to resist much of the turmoil besetting the leveraged loan market in 2022, according to a survey of 19 lenders conducted by fundraising adviser Rede Partners.

Market players speaking with Private Funds CFO say even some mega-fund borrowers have been unable to get their target borrowing amounts, or unwilling to pay steeply increased pricing. The NAV loan market, on the other hand, has seen only a mild drop in the total value of loans extended, and an actual increase in the number of them, Rede Partners found in its survey.

The North American leveraged loan market saw a 24 percent drop in volume between 2021 and 2022, while high-yield bond issuance dove 78 percent, Rede says. While the lev loan market dwarfs the NAV market in size, the latter saw a drop in total value of deals done of only 12.5 percent over the same time period, from $24 billion to $21 billion.

But the number of transactions increased, Rede found. The weighted average number of deals done by each of the 19 lenders surveyed was five, up from four the year earlier. And lenders are seeing more deals come across their desks, with a weighted average of 21 deals per lender, compared with 16 the year before.

And spreads have resisted the soaring upward pressure seen in the lev loan market. NAV lenders reported an average increase in spreads of only 1.4 percent, and on average are seeking a margin of eight percent. More than three quarters of the lender respondents said they’d raised pricing by less than 200 basis points in 2022.

Silver lining in lending

The comparatively bright picture in NAV lending is being driven in large part by an increase in relatively novel uses for the instruments, which were originally marketed as defensive tools that could be used to bolster struggling portfolio companies, and after the market shocks brought on by the covid pandemic peaked, to make offensive purchases after funds’ investment periods had closed.

But more and more borrowers are using the facilities to increase their distribution-to-paid-in-capital ratios, especially as more managers sought to raise capital even as exit activity slowed and valuations on existing investments sank. Sixty one percent of respondents said they’d seen an increase in the number of NAV deals used solely for the purpose of increasing DPI.

Private Funds CFO recently reported on the use of NAV loans structured as hybrids – with a revolving, subscription credit line-like portion structured into the deal – when raising continuation funds, allowing them to make delayed payments on their borrowings and fill gaps in ticket sizes relative to the target fund size.

And managers are even turning to NAV as an alternative to portfolio company level refinancing. Fund-level facilities are underwritten to the whole portfolio, giving lenders more diversification than asset-by-asset lending.

Lenders strengthen their advantage

Constrained upward pressure on spreads can be attributed in part to the fact that borrowers have become more accepting of pledging some security to lenders. Some 67 percent of the respondents to Rede’s survey said they saw a drop in the number of deals with no direct step-in rights. The majority said they have executed such deals, while only 15 percent said they had no capacity for them at all.

Lenders are also negotiating increases in their ability to challenge manager valuations. Seventy-two percent of respondents said they saw only up to 25 percent of deals that featured no ability to challenge valuations.

When the right is included in deals, lenders are given the right to “a couple” valuation per year, and only for “material” valuations differences, as defined in the NAV facility’s documents. Should a third-party valuation provider, selected from a previously agreed list, find no change from the proposed valuation, the lender pays for the service. Otherwise, the manager pays and must deal with the covenant breach.

Continued evolution

Rede also found that more deals are being syndicated to third parties, if only a small minority ($1.2 billion out of the $21 billion market), and that deal sizes are getting smaller. The firm expects to see further increases in these transactions, where one lender takes a lien on the assets for a lower cost of capital and the other takes a second lien for higher return, Rede said.

The firm expects sponsors to keep finding new uses for NAV facilities. NAV loans have fungible proceeds, and Rede expects their relatively lower cost of capital to be used even to acquire platform investments, and other “more creative solutions.”