Reed Smith recently moderated a panel comprised of non-bank lenders and rating agency experts, including representatives from Apollo, Velocity, Crestline, BC Partners, No Limit Capital, Fortress, Abrdn and KBRA. Below is a summary of the key takeaways and industry perspectives from the discussion. 

At a time of increased volatility in global financial markets, adapting quickly to new challenges is crucial. Innovation is a key component in this respect and, when it comes to innovation, the fund finance market has a strong track record.

Two key themes have dominated conversations in the fund finance market over the last twelve months: the increased involvement of rating agencies in deals, and the significant potential of net asset value (also known as “NAV”) transactions. At Reed Smith’s recent webinar “Innovation in NAV and Hybrid Credit Facilities: The Non-Bank Lender and Rating Agency Perspective”, led by Reed Smith partners Leon Stephenson and Erin England, a diverse panel of non-bank lenders and rating agents came together to share their experiences.

In addition to the prepared discussion topics, which centered on trends in NAV structuring, collaboration between bank/non-bank lenders, and the rating agency process, panelists fielded questions from the more than 300 online participants.

NAV, hybrid, and the search for durable sources of value

As one of our panelists remarked, NAV financing can be considered across a spectrum of lower risk to higher risk profiles, with many markets in between. As a principle, however, for those structuring the deal, the key is to look for durable sources of value. Dealmakers should focus on identifying pools of value and structuring around those pools, with an emphasis on being practical in how they take security and the way it is used.

There is a common perception among borrowers in the market regarding banks vs. non-bank lenders: that banks are competitive on pricing but more rigid in their security and recourse requirements, whereas non-bank lenders differentiate themselves by being more flexible in their approach but charging higher rates. From a borrower’s perspective, the focus is on balancing flexibility and pricing. Inevitably, the sensitivities in negotiations center on recourse and control of assets. Non-bank lenders are offering hybrid credit facilities more frequently than in prior cycles. While traditional hybrid facilities have been a blend of capital call and NAV financings, there has been a move towards hybrid facilities that are NAV based with preferred equity features. These types of facilities are becoming increasingly interesting for sponsors where liquidity is tightening.

Education ahead of deal execution

Panelists remarked that they are seeing a high volume of NAV financing “window shoppers”, meaning potential lenders and borrowers are interested in educating themselves fully about the product before committing to a facility. This is to be expected given that the NAV market is, by many accounts, in its nascent stages and borrowers are still familiarizing themselves with the product and the potential uses of the additional capital. With that said, the panelists unanimously agreed that it is incumbent on market participants to help the wider market understand the NAV product and the opportunities stemming therefrom.

Among the growing trends in the NAV space is the usage of Term Loan A / B structures, which allows bank and non-bank lenders to meet the sponsor’s needs on flexibility and pricing. Other key features built into NAV facilities relate to secured and unsecured delayed draw term financings with lower and higher advance rates respectively.

A rating agent's perspective

The panel conversation then turned to trends in the rating agency space. It was acknowledged that there has been a notable uptick in requests for ratings over the past year across all types of fund finance transactions. This is likely the result of increased attention from investors on the insurance industry.

To rate a NAV transaction, rating agents are looking for, among other things, diversification in the collateral pool and a reliance on multiple sources of value. Dealmakers are also thinking ahead and looking to involve rating agents earlier in the underwriting process to allow them to syndicate quickly post-closing.

The driving forces behind ratings are varied. For some investors it is a nice to have, for others it is deal-critical. Some alternative lenders have even developed their own internal rating agency methodology. Another key issue is determining at what stage of the deal a rating is required. Certain investors can live with an indicative rating while others may require the rating ahead of final close. Obtaining a rating typically takes between 3-4 weeks for a subscription line facility and between 5-6 weeks for a NAV facility.

Every client will have a minimum ratings hurdle; some may even have an annual rating requirement, so it is not always a "one-and-done" process. A key factor for many alternative lenders is to find investors that are looking to buy and hold rather than buying to trade.

Bank failures, liquidity, and predictions for the next 12 months

When asked how recent bank failures have affected business, panelists recounted anecdotes of weekends spent trying to assess the fallout, as well as identifying potential opportunities arising therefrom.

In the short term, the bank collapses have resulted in a shortage of capital in the market which creates opportunities for non-bank lenders that would not have been seen 6-9 months ago. However, the consensus is that it will be six months or so before the lasting effects will be evident, when borrowers roll off their current short term capital call facilities.

Asked about their predictions for the fund finance market in the next 12 months, one theme was apparent: liquidity. Fundraising headwinds and lower deal activity mean managing liquidity is critical for sponsors. NAV and hybrid facilities are fertile areas for unlocking sources of value to buffer these liquidity needs. It is predicted that demand will continue to grow and outstrip supply and there is potential for a secondary market for NAV financings to develop to bring additional lenders into the fold.

Conclusion

The general sentiment coming out of the panel discussion is that a marketplace that was previously fragmented is now coming together to be more open and collaborative. There is a role for all market participants in the NAV and hybrid credit facilities market to supply liquidity to funds and to reveal the quality of those transactions via ratings.

Rating agents, banks, and non-bank lenders are finding creative ways to work together. The opportunities brought about by the current market volatility will no doubt be seized by those who are thoughtful and deliberate in their approach to working together with borrowers, banks and non-bank lenders alike. A continued emphasis on knowledge sharing will facilitate more frequent and better quality transactions, and the panelists agreed that there is an onus on the incumbents to educate the market. As the saying goes, a rising tide lifts all ships.