Loan at 10% interest to obtain…

Bloomberg – Investors with money tied up in private equity funds are considering switching to an expensive formula: Borrow against your sharessometimes at double-digit interest rates, until the market situation improves.

The “net asset value” financing mechanism has already begun to be used to raise cash among private equity firms with assets of $4.8 trillion, which have refused to offer their investments for sale, in a context of weakness in the mergers and acquisitions market. Currently, credit institutions also offer this type of loan to clients of these companies.

Lending institutions such as 17Capital and Apollo Global Management Inc. (APO) and Ares Management Corp. (ARES) is a bull market geared toward private equity fund investors. In theory, it is a The most attractive way for pension funds and other institutional investors to raise money cash instead of selling their financial holdings at deep discounts today. These loans would help them obtain the necessary liquidity to invest in other assets and stabilize their high allocations to private equity funds.

The drawback here is the high cost, interest rates can range from 8% to 10%, and the potential for huge losses if the value of private equity shares, which in some cases were already overburdened with debt, deteriorated.

“It’s another tool in the toolbox,” he said in an interview. Joel Holsinger Co-Head of Alternative Credit at Ares. “As we saw in the NAV market, I think this market will grow from here.”

Los Angeles-based Ares has been in talks with institutional investors on the topic Net asset value loans (net asset value) and other structured solutions such as preferred stock,” Holsinger said. So far, he said, appetite has been less active than among private equity sponsors because investors are waiting to see if the asset sales market will improve and distributions will increase.

Liquidity tightening

More private equity firms are turning to NAV loans to manage their investment portfolios as business activity declines and fundraising remains a challenge. Average private equity returns from the largest publicly traded U.S. companies were down 43% as of June 30 over the past 12 months, according to data analyzed by PitchBook. Fundraising is down 57% this year through June 30 compared to the same period in 2022.

In this context, 17 Capital, the leading provider of NAV financing owned by Oaktree Capital Management, estimates that the market could grow to more than $700 billion by 2030, from about $100 billion today.

Despite the cash drought, there is caution about lending at net asset value because adding expensive debt to an already leveraged portfolio amid high interest rates and an uncertain economy can create a toxic mix.

“As far as LP is concerned, it is very risky,” he said. Gaurav Patankar, chief investment officer at MercedCERA in Merced County, California. “By leveraging your investment portfolio, you are creating equity risk from what should be credit risk.”

Selling shares on the secondary market is usually the preferred method of raising cash. But current discounts may be difficult to digest (they are at least 10% of NAV and closer to 50% for venture holdings), prompting investors to at least explore the idea of ​​NAV loans.

Inflated allocations

She said Apollo had received an increase in inquiries from large pension funds seeking liquidity and defusing the so-called denominator effect. Brett Lees, Head of structured credit at the New York-based firm. This is what It occurs when the value of publicly traded stocks and bonds declinesThis left private investments as a larger portion of the total portfolio, thus violating strict limits on the amount of money some investors could hold in private assets.

That wasn’t enough to convince a potential borrower of its net asset value, according to a person familiar with the matter. A major government pension plan reached out to lenders for a loan, but ultimately decided to simply increase the private capital limit, said the person, who was not authorized to discuss the confidential talks publicly.

The loan-to-value ratio for NAV loans to finance portfolio holdings can range from about 30% to 50%, which is higher than the 30% cap for loans to buyout funds, according to Pierre Antoine de Silence One of the founders of 17 Capital. Fund portfolios may have greater leverage because they are highly diversified, due to their broader mix of assets.

De Silence said 17Capital is having a lot of conversations with institutional investors about NAV loans and sees the deal process taking shape, citing more opportunistic investors looking for new crops of investments. “The slowdown in achievement has had its effect,” he added.

Potential withdrawal

Investors with larger portfolios can get better prices due to the size and diversity of their holdings. But interest rates are still relatively high, so you should resort to an NAV loan It can generate drag on yields Because any distribution that comes first must go toward repaying the loan.

“There are many options an LP could pursue if it cannot wait for liquidity, and some of those options are probably easier or more attractive than the NAV option,” he said. andrea Auerbach, Director of Global Private Investments at Cambridge Associates.

Small institutional investors don’t always have the resources to properly evaluate these loans, making it difficult to get approval from their investment committees, Patankar said. Moreover, an economic slowdown may exacerbate a cash crunch as M&A markets decline and their property values ​​that support their NAV loans collapse. This would make it more difficult to sell assets and may lead to default on the loan.

“In a perfect storm, the LP portfolio will be more liquid rather than monetized,” Patankar said.

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