United States of America: NAV Finance Market Update
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Between Omicron, the holidays, and the year-end closing, it was a frenetic end to 2021. But now that the calendar is 2022, this week we wanted to reflect on the state of NAV funding the market and give some insight into the trends we’re seeing as 2022 kicks off:
Transaction volume. 2021 was another year of significant growth in demand for NAV products. This growth is expected to continue until the beginning of the new year. Where in the past years (up to 2021) we’ve seen some dip in deal activity in January (presumably everyone took a breather after the busy month of December), this year we’re moving full steam ahead with a whole slate of new deals.
new lenders. We have seen a marked increase in new lenders (including both banks and private lenders) entering the NAV market and potential new lenders showing curiosity about the range of potential product offerings. Of particular note are the asset managers and insurers, who have been leading the way in some of the larger transactions. It is our hope that as more lenders enter the market, NAV loans will be considered less esoteric and become more widely available to sponsors looking for leverage and liquidity improvements.
A variety of borrowers. In addition to private equity funds, secondary employee funds, hedge funds, and hedge fund funds, we saw significant demand for funding in 2021 from registered alternative investment firms, family offices, and pension funds.
- Registered alternative investment firms are public investment funds registered under the Investment Firms Act of 1940 that invest in a portfolio of private equity funds or participate in hedge fund or private equity-like investment strategies. They often rely on lines of credit for investment leverage, to manage cash, or to fund periodic repurchases of shares from their investors. We are currently working on several loans for these mutual funds.
- The evolution of family offices continues to increase, family offices were the borrower for much of the largest NAV, secondary and hedge fund deal funds we worked on in 2021. Having closed many large family office transactions in the closing days of 2021 and these are in the early days of 2022, we expect more work with family offices next year.
- While we didn’t see a huge volume of transactions for pension funds in 2021, those transactions were significant. We have spent a lot of time briefing clients on issues such as UBTI, sovereign immunity, capacity and authority. Based on the number of inquiries, we expect an increase in the number of pension fund financings in the coming year.
margins. It can be difficult to track spreads in the NAV financing market due to the breadth of products, the diversity of risk profiles, and the pool of lenders and borrowers. However, looking at only comparative subsets of trades, the trendlines are clear. The variances narrowed from their epidemic peaks in the fourth quarter of 2020 and the first quarter of 2021. However, the variances did not reach pre-pandemic levels. For 2022, it will be interesting to watch the tug of war between (potentially) increasing rates and increased competition as new lenders enter the NAV market. Market volatility (or lack thereof) will certainly be another major factor to watch.
- Continuous financing of private equity funds. Despite rising stock values, many sponsors still see the potential for significant returns on their underlying investment. Sponsors have deployed fund-wide debt to fund dividend recapitalization and facilitate the launch of ongoing funds, enabling them to delay investigation events and extend the life of those investments.
- Margin loans and pre-underwriting loans. The market for pre-IPO and margin loans has caught fire, as lenders have increasingly gained comfortable funding positions by moving from the private sector to the listed… and beyond. High valuations, a crowded IPO market and low interest rates in 2021 provided ideal conditions for a significant increase in these types of financing. We will wait to see if higher interest rates and increased volatility in the public equity markets dampen the enthusiasm we’ve seen in the last year for these products or if market appetite for these products continues unabated.
- Preferred equity and preferred leverage. In addition to the usual players in the preferred stock space, we saw strong participation by secondary funds in the market for preferred stock in 2021. Preferred stock has often been accompanied by financing – either in connection with an acquisition by a secondary employee fund or recapitalization of dividends by the issuer of the stock the favorite.
- secondary financing. With large subordinate fund sponsors continuing to raise record amounts of capital, mega funds are likely to support strong levels of trading in the secondary market. We expect that a material part of this trading will be financed by debt.
- hedge fund financing. 2021 was a strong year for hedge fund financing. Not surprisingly, much of this activity has been the result of new fund launches before, and significant mandates being given to separately managed accounts, to the biggest hedge fund investment managers. But we’ve also seen a recent rise in single manager hedge fund transactions (loans to feeder funds, general partners, management firms, or managers secured with interests in a single affiliated hedge fund). This market has been relatively quiet for the past few years.
- portfolio hedge. The LIBOR adjustments dominated attorneys’ schedules in the fourth quarter, but we are in a lot of discussions with lenders and borrowers about strategies to more efficiently integrate currency and interest rate hedging programs into financing offerings. Given the increasing international focus of portfolio investment and concerns about potential interest rate increases, we expect to spend more time on portfolio hedging issues in 2022.
- grow up. While new deals get all the attention, increasing the volume of existing deals has been the quiet driver of earnings growth for many companies focused on NAV. Staying close to customers and providing flexibility to meet their evolving needs pays off. Increases in portfolio valuations and investors’ expectations of accelerated returns to capital were material factors that drove prices higher.
ESG. ESG dealmaking has been an increasingly relevant topic over the past couple of years, and as discussed extensively in Friday FundIt has become a growing component of the IPO financing market in general. However, on the NAV side of the market, we still have to see ESG make meaningful progress in structuring and documenting deals. NAV facilities are usually provided to funds in the later stages of their investment activity or funds that use NAV financing to obtain or benefit from a specific investment or investment portfolio. This obviously makes it difficult to provide financing incentives to a fund based on ESG investment metrics in these contexts. However, it will be interesting to see how ESG continues to affect the fund markets in general and whether we start to see ESG have an impact on the NAV funding market in particular.
LIBOR / SOFR MODIFICATIONS. While the LIBOR treatment has been in full swing for some time in the world of subscription financing, LIBOR’s transformation is just beginning in the US NAV markets. Given the more targeted use of NAV funds in general, there is usually a smaller subset of currencies available to borrow for any given facility. As a result, the December 31, 2021 LIBOR transition date for non-US dollar LIBOR rates had a much smaller impact on NAV funding (at least in the US) than it did in the subscription space. We expect 2022 to be a different story.
Pandemic 4.0.1 Update. Other than some canceled plans and a short-term return (hopefully) to WFH, the market has so far proven impressively resilient in the face of Omicron and its incredible cases. Whether it’s because of the prevailing wisdom that this latest wave will abate as fast as it has flowed or we’re all more familiar with the rules of the game regarding the pandemic at this point, the deal flow is buoyed forward and the macroeconomic concerns of the new world order were once again focused on matters. Ordinary like Fed optimism and inflation.
We wish everyone a happy and healthy New Year. We are very excited to be spending time in Miami for the FFA Global Symposium next month and working with you again this year, whatever 2022 may bring.
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