Marcus Emadi | Director at Turning Point Capital
CONTENTS
How Important Are Credit Ratings for Subscription Facilities and NAV Financing Structures?
The importance of credit ratings varies depending on the context, lenders, and investors involved. While ratings are beneficial for regulatory capital treatment or distribution purposes, they are not always required. In some cases, alternative risk assessment methods can eliminate the need for ratings. In a private market like fund finance, confidentiality around asset valuations can hinder obtaining ratings, as this requires sharing information with rating agencies. However, credit ratings still support risk distribution and help expand lending volumes, especially in supporting insurance-backed investments to reduce correlation risk.
Do You See Hybrid Facility Lines Progressing as an Offering? Are There Limitations?
Hybrid facilities, combining multiple financing structures into one, are increasingly useful. They can be tailored to a fund’s lifecycle, from securing uncalled capital to supporting continuation vehicles. However, these facilities are complex and can carry higher execution risks. Their usefulness depends on whether the fund’s needs align with the advantages of both financing options. Negotiating such deals requires a balance between flexibility and structure.
How Can NAV Transactions Be Considered Leverage-Neutral?
NAV financing offers the potential for funds to optimize portfolio-level leverage without rebalancing leverage across individual companies. “Look-through” leverage, or leverage on leverage, can be sustainable if NAV proceeds are used for refinancing or bolt-on acquisitions, reducing overall leverage. However, using proceeds for distributions may increase leverage across the fund. NAV facilities are growing in use, especially in response to rising interest rates on floating and unhedged portfolio company debt, which pressures covenants. By refinancing portfolio company debt with a PIK (Payment-in-Kind) facility, funds can maintain leverage neutrality while benefiting from increased covenant flexibility and released cash.
Are Lender Credit Capacity Constraints Holding Back Growth?
While lender capacity constraints may exist, the market remains liquid, with active collaboration between lenders and sponsors. Strategies such as syndications, credit ratings, and non-bank lenders help address potential limitations. Increasingly, credit risk insurance and securitization are expected to alleviate these constraints. Adhering to counterparty concentration limits in fund Limited Partnership Agreements (LPAs) helps manage exposures effectively, ensuring continued growth despite credit capacity challenges.
Are There Asset Class Preferences for Lenders in the Fund Finance Space?
Lenders often have preferences for asset classes based on risk profiles, liquidity, and historical performance. Private equity, real estate, and infrastructure are popular due to stable cash flows and tangible collateral. However, more specialized lenders may gravitate towards higher-risk asset classes, such as venture capital, natural resources, and distressed assets, depending on their individual risk appetites.
How Can NAV Transactions Be Considered Leverage-Neutral?
NAV financing offers the potential for funds to optimize portfolio-level leverage without rebalancing leverage across individual companies. “Look-through” leverage, or leverage on leverage, can be sustainable if NAV proceeds are used for refinancing or bolt-on acquisitions, reducing overall leverage. However, using proceeds for distributions may increase leverage across the fund. NAV facilities are growing in use, especially in response to rising interest rates on floating and unhedged portfolio company debt, which pressures covenants. By refinancing portfolio company debt with a PIK (Payment-in-Kind) facility, funds can maintain leverage neutrality while benefiting from increased covenant flexibility and released cash.
Are Lender Credit Capacity Constraints Holding Back Growth?
While lender capacity constraints may exist, the market remains liquid, with active collaboration between lenders and sponsors. Strategies such as syndications, credit ratings, and non-bank lenders help address potential limitations. Increasingly, credit risk insurance and securitization are expected to alleviate these constraints. Adhering to counterparty concentration limits in fund Limited Partnership Agreements (LPAs) helps manage exposures effectively, ensuring continued growth despite credit capacity challenges.
Are There Asset Class Preferences for Lenders in the Fund Finance Space?
Lenders often have preferences for asset classes based on risk profiles, liquidity, and historical performance. Private equity, real estate, and infrastructure are popular due to stable cash flows and tangible collateral. However, more specialized lenders may gravitate towards higher-risk asset classes, such as venture capital, natural resources, and distressed assets, depending on their individual risk appetites.
Do Fund Finance Lenders Create Systemic Risk?
In theory, systemic risk could arise if the same limited partner (LP) base invests across multiple asset classes targeting the same collateral. However, in practice, different LPs tend to invest in distinct asset classes, reducing the risk of systemic exposure. Conflicts of interest can also arise when LPs invest in both equity funds and senior debt for the same assets. Proper management of these conflicts is essential for ensuring the stability of the financial ecosystem.
What’s Next for Fund Finance?
The LMA continues to engage with the market to clarify misconceptions surrounding fund finance. Plans for the immediate quarter and potential activities for H1 2025 are being shared with the fund finance community. If you’re interested in shaping the future of fund finance, reach out to Kam Hessling and Scott McMunn.
