Jones – We saw some of that innovation at the beginning of Covid when everyone thought the world was going to stop completely in its tracks. Everyone needed to hold on to assets for longer because valuations had gone through the floor. Everyone was asking where the money was going to come from. So, our biggest year for NAV facilities was the first year of Covid in terms of documenting and getting deals to fruition.
By 2021, people got their heads around the idea that a portfolio of, say, 12-15 assets was a manageable size, or even a smaller portfolio of, say, five assets. That then gets into very bespoke financing arrangements. And the different lenders coming to the market also make a difference – the debt funds, and the insurance and pension funds. We’re going to see more of that with a possible recession phase coming up.
Morrison – Fund finance is now frequently used outside of the investment period, so the timeframe in which a sponsor would use on finance is being stretched. One consequence of that is the emergence of GP-led continuation structures which are increasingly common. Lenders and sponsors now realise the benefits of these and are getting more comfortable with them. And my view is that they’re here to stay long term.
Lobbardi – We’re having conversations with our clients around the economy. There are so many numbers thrown out there by economists about where this will land, but we’re going to see an interest rate increase that we didn’t see in 2008. What does that mean in terms of how fund managers think about financing?
We asked that question to some of our clients. When we ask about the capital call facilities, which are used by 95% of the fund managers, the answer is different depending on the size of the fund. Large managers are saying that even if interest rates become high, they will still use this financing because it makes sense for them. They have so much flow that from an admin perspective, not having to call the investors still makes sense.
In the case of small or mid-market fund managers, it’s a different story. They are not as active in terms of deploying capital, so going through all the sophistication of putting financing in place for one or two transactions a year in such uncertain times does not make as much sense.
And there are differences between asset classes. We have so many deals we’re working on where clients have not followed through the investment because the valuation is not right, or they are not sure about the macroeconomic situation. So, things are being cancelled or delayed.
I don’t have the answer to what happens from here on. It will be interesting to see.
Furthermore, higher interest rates and increased cost of capital are putting more pressure on the banks. Banks are telling us they are increasing their pricing, and their appetite is being stricter. So, we’ll see more non-bank lenders taking market share under NAV financing, but also on capital call facilities. We know some non-bank lenders are launching these kinds of products in the next few months.
Morrison – The current macro conditions create very strong opportunities for institutional investors to move into fund finance. The returns are now higher due to rising benchmark rates, and the tightening in bank liquidity we have observed is important because suddenly, there’s this increased demand for institutional or non-bank capital within credit facilities to close the funding gap.
Mehmood – Given their funding model and assuming their assets are on a floating rate, a lot of the institutional lenders and debt funds can capture the benefit of the upside of the rates, with the increase in “all in” pricing (Sonia plus margin) feeding directly into the income they are deriving.
“This is an incredibly innovative space with very smart people. Nothing is off the table in terms of thought process. The basket of things that fund financing can encompass keeps getting bigger.”
Morrison – In certain investments, it can almost double the total yield our investors can obtain from fund finance. There will be winners and losers in these macro conditions. Certain sponsors will deploy heavily during these market conditions, and others will decide it’s just too uncertain. Otherwise, we see this as an opportunity.
Jones – I was talking to a legal recruiter last year in our hunt for associates, and it was a recruiter that wasn’t used to the fund finance market. He said to me: “Tell me what the cycle is like in the fund finance market because I don’t know very much about it.” And I said: “All I can tell you is it’s 20 years old, and it just keeps going up. We haven’t had a cycle yet.”
That’s telling. This is an incredibly innovative space with very smart people. Nothing is off the table in terms of thought process. The basket of things that fund financing can encompass keeps getting bigger.
Mehmood – While there are many challenges coming out of the current situation, I believe it will show how private debt markets can see through a cycle. There will be winners and losers, but it will give the market the credibility to then go into the next cycle because it will have demonstrated that it can survive a full cycle whilst maintaining target returns.
© 2023 funds europe