Quiver Quantitative - Investors in private equity funds are considering a costly proposition to free up their stranded capital: taking out loans against their holdings, sometimes at rates as high as 10%. This "net-asset-value" financing trend emerged as private equity firms, currently managing $4.8 trillion in assets, resisted selling assets in a weak market for mergers and acquisitions. Now, lenders, including 17Capital, Apollo Global Management (APO), and Ares Management (ARES) are targeting these firms’ clients. While these loans offer a short-term solution to liquidity issues and the need to reinvest, they come with substantial risks, including high-interest rates and the potential for significant losses if the underlying assets depreciate.
Prominent lenders in this space, such as 17Capital and Apollo, are witnessing a surge in inquiries about such financing solutions. The growing interest in NAV loans stems from a decrease in typical exit strategies for private equity investments, like M&A activities and secondary market sales. NAV loan providers argue that these loans can help investors maintain liquidity and manage their portfolios better, especially during economic downturns. However, these loans can also negatively impact returns, with distributions primarily used to service debt.
Yet, the broader market outlook for NAV financing is optimistic. 17Capital, backed by Oaktree Capital (OAK), projects the market could expand from the current $100 billion to over $700 billion by 2030. The increase is attributed to a slower rate of investment realizations. However, many experts caution against NAV loans, highlighting the amplified risks associated with leveraging already-leveraged portfolios. They argue that in an economic downturn, these loans could exacerbate liquidity problems, potentially leading to defaults.
Critics of NAV loans, like Andrea Auerbach from Cambridge Associates, suggest that there are alternative solutions that investors could explore to maintain liquidity without resorting to such expensive borrowing. Smaller institutional investors, in particular, might lack the expertise to properly assess these loans, leading to potential pitfalls. A confluence of factors, such as a stagnant M&A market and depreciating holdings, could trigger a loan default, making some portfolios even more illiquid.
This article was originally published on Quiver Quantitative