GPs and their investors are looking to NAV lending and preferred equity transactions as they look to navigate the liquidity crunch.
There were multiple $1 billion-plus fund finance transactions in the market in the first quarter, according to PJT Park Hill’s Secondary Market Insight Investor Roadmap Q1 2023 report.
Those deals were largely focused on NAV-based lending and preferred equity options, Christina Bohm, principal at PJT responsible for alternative liquidity solutions and fund finance, told Secondaries Investor.
There have been a few sizeable NAV-based financing transactions completed by GPs. Those managers raised against their portfolio of 10 to 15 or so assets at very modest loan to value ratios in order to use those proceeds to primarily re-invest back into their portfolios, which is an increasing theme, Bohm said.
Given that IPO markets are muted and traditional M&A has slowed, NAV lending can be a way for GPs to generate liquidity, in particular to use some of the proceeds to re-invest into their portfolios.
“There is such a premium on liquidity at the moment… We think this is just in one of those pockets [to unlock liquidity], but it’s a pocket that has a lot of attention on it right now,” Bohm said.
There have also been some large preferred equity transactions initiated by institutional LPs “where maybe an outright sale wasn’t very attractive” because the investor didn’t like the valuation or bids on assets, or they didn’t want to take a markdown, Bohm said.
In these transactions, LPs can place their fund commitments into a special purpose vehicle, which in turn essentially issues a preferred security, Bohm said. For some secondaries buyers, they see preferred equity as having an attractive risk/reward profile as they have priority over distributions coming off of the portfolio and they’re able to get exposure to more underlying NAV in a senior structure.
When it comes to GP-led secondaries transactions, preferred equity transactions can make sense – generally speaking – where a portfolio is more concentrated; if there are structural reasons why lenders won’t be able to view it as a secured loan; or if a portfolio holder wants more proceeds than a NAV lending transaction would be able to provide, Bohm said.
“If you think about it on the risk spectrum, preferred equity is going to be further out on the risk curve than a NAV lending transaction. So all else equal, if you’re looking at the exact same pool of assets, a NAV lending deal is going to have a lower advance, better security for the lenders, more restrictive covenants, probably more onerous reporting and ongoing requirements for the borrower,” Bohm said.
A preferred equity structure “will generally have higher initial proceeds, fewer covenants, but will be more expensive, and so you’re effectively trading price for flexibility and for upfront day one cash”, she added.
More players come to market
On top of these large transactions, there have been at least 30 new entrants in the fund financing market, according to PJT’s report.
Of the over 90 participants and over 200 meetings PJT had with non-traditional and new market entrants, which provided insight for PJT’s report, 25 percent of all investors participated in a fund finance transaction with a growing number of investors launching dedicated pools of capital.
There are a number of managers with credit products that are adding fund finance as a sub-strategy, according to Bohm. She believes this is because it is a fast growing area and more market participants are engaging in conversations around it.
“These new entrants are realising that if they want to continue to deploy and find attractive, risk adjusted returns, fund financing is an interesting place to go,” she said.
Fund financing is also a catch all: “There’s a lot of different ways that you can invest in this vertical so I think… that’s another reason why there are groups that are new entrants. It’s a pretty wide net in terms of what I think people think of when they say ‘fund financing’,” Bohm said.