There’s been a lot of debate in recent months about the use of NAV loans in the wider private market – a fund finance tool that the secondaries industry has been using for many moons now.
Most recently, affiliate title Private Equity International drew attention to a condition found in some NAV facility documents stipulating that capital distributed to LPs via the use of a NAV facility can be recalled. Though on paper any distribution to LPs can be deemed recallable, for NAV facilities these clauses have the potential to cause major headaches for investors. You can find the full article here.
While such distributions will improve the distribution-to-paid-in ratio of the fund being lent against, this capital could be viewed by LPs as a liability and not as liquidity that can be reallocated elsewhere. In essence, the problem some of these facilities are supposed to solve – enabling cash-strapped LPs to re-up to another fund – may not be solved.
“If it’s recallable, sometimes the way the accounting works is… it goes back against your unfunded [commitments] and it doesn’t really count as a distribution,” Allen Waldrop, director of private equity at the Alaska Permanent Fund Corporation, told PEI. Sweden’s Skandia Asset Management has told us it treats recallable distributions from NAV loans in a similar way to Alaska.
This dynamic may become even more complex for funds of funds. A managing director at one such firm tells PEI that a NAV-facilitated distribution from one of their underlying funds raises questions about whether it should be distributed to their own LPs for fear that it will be recalled.
Over the past week, market participants have pointed out the nuances of a distribution being technically ‘recallable’. John Gilligan, director of Saïd Business School’s Finance Lab at Oxford University, says that LPs having to pay back distributions are similar to GPs being on the hook for early carried interest payments to be clawed back in American-style funds. As the ultimate risk is on the LPs, the LP will use a ‘reserving policy’ to back the potential liability, he adds.
Jean-Paul Peters, managing director at alternatives advisory firm Kombit Consulting, points out that recallable distributions must create a challenge for LPs in terms of how they manage their liquidity, versus a non-recallable payback. “LPs have an obligation to meet a 10-day call provision that must mean they need sufficiently quick access to cash/semi-liquid assets that prevent them recycling into different commitments. Surely that is where LPAC engagement in NAV financing processes is critical,” he wrote in a LinkedIn post.
Clearly, NAV loans can be a useful tool within private markets. French insurer AXA Group has been investing via NAV loans since 2017 when a subsidiary financed a
loan for a secondaries fund it was an LP in, Pascal Christory, global head of AXA Investment Managers’ private markets unit told Secondaries Investor this week.
In the GP-led market, the bulk of portfolio financing in the first half of this year was via preferred equity at 54 percent of the $5 billion in transaction volume, according to a survey by PJT Partners, which surveyed more than 90 secondaries buyers. NAV loans within this part of the market accounted for just 19 percent, with GP commitment financing accounting for the remaining 28 percent.
At a time when LPs seeking liquidity may have to take a haircut to the tune of a double-digit discount to net asset value if selling their fund exposure on the secondaries market, cash via NAV loans can provide liquidity without the LP having to part ways with their fund stake – whether it comes via the GP or the LP taking out a facility directly. Context and rationale, as always, is key.
– Alex Lynn contributed to this report.
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