Key features and negotiation points of NAV facilities for credit funds 8 min read
In recent years, the maturing fund finance market in Australia has seen an increase in net asset value (NAV) facilities to supplement the popular subscription financings. As funds mature and investor commitments are utilised, the potential for NAV products to enhance cash flow efficiency and increase investment capacity has led to greater interest.
At the same time, high interest rates globally have led to a significant increase in closings of private credit funds, as sponsors see the attractiveness in deploying capital in this asset class while macroeconomic conditions prove challenging for other types of deployment. Convergence of these two trends has resulted in considerable market interest in NAV facilities being put in place for private credit funds.
In this Insight, we take a look at the key features of NAV facilities for credit funds and the key negotiation points for both borrowers and financiers on these transactions.
Key takeaways
- NAV facilities for credit funds are an evolving part of the fund finance market in Australia, with bespoke terms and covenant packages to suit the specific composition and commercial needs of each credit fund.
- Approach to valuation and calculation of the borrowing base/LTV requirements vary widely. Certain facilities allow valuation by the fund itself, while others require third party or financier valuation. Differing advance rates and concentration limits may also affect the operation of the NAV calculation.
- Certain facilities require the loan portfolio to be transferred into an SPV.
- Financiers may require different forms of risk management, including a consent right prior to new or refinanced loans being included within the borrowing base, limitations to exposure to underlying loans with maturity longer than the NAV facility, or amortisation or cash sweep triggers that operate pre-default.
Who in your organisation needs to know about this?
For financiers: credit, deal and legal teams.
For borrower funds: deal and legal teams.
NAV facilities for credit funds: the key features
Large range of approaches
The significant uptick in interest for NAV facilities for credit funds is a relatively new phenomenon and a nascent area in the Australian fund financing market. Our observations to date suggest there is significant variation in the key terms of such facilities in the market. Financiers are crafting bespoke arrangements and covenant packages for the specific makeup of a sponsor fund's underlying loan portfolio and its particular commercial needs. While it is difficult to speak of a uniform market approach on many of these issues, key themes have emerged as the main structural considerations for both borrowers and financiers on these transactions.
Borrowing base / eligible NAV
NAV facilities invariably contain some form of loan to value (LTV) ratio or borrowing base concept where the amount of borrowings available to be drawn under the NAV facility is sized against the strength of the underlying security pool, represented by the set of 'eligible' or included loans that fulfil specific eligibility criteria. The method used for calculating the eligible NAV or borrowing base is a key consideration on these transactions.
Advance rates applied by financiers against the eligible loans in the portfolio vary widely between transactions. Some transactions incorporate a flat advance rate across all eligible loans for the purposes of the eligible NAV calculation, while others utilise a matrix of differentiated advance rates based on the type of underlying loan (eg with higher advance rates afforded to highly (and externally) rated loans).
The NAV calculation commonly incorporates concentration limits that limit financiers' exposure in circumstances where too much of the loan portfolio is concentrated in a particular area. Concentration limits take many forms bespoke to the makeup of the credit fund's portfolio. They may include maximum exposure to a single underlying borrower, minimum number of loans/investments comprising the portfolio, geographical limitations or exposure to a particular industry. In each case, any amounts in excess of the relevant concentration limit are disregarded for the calculation of the eligible NAV.
Depending on the needs of the sponsor, the documents may also contemplate a 'ramp-up period' where covenants or concentration limits in the documentation may be loosened during the initial period where a credit fund is building up its investment portfolio.
Valuation process
How an underlying loan portfolio is valued for the purposes of the NAV ratio is a key structuring issue which should be considered as part of putting together the terms of a NAV facility.
We see different approaches taken, including:
- valuation by the fund itself (typically subject to the NAV financier's right to challenge valuation in agreed (or limited) circumstances, including by referral to a third party);
- valuation by the financier;
- valuation by an independent third party or pre-agreed list of approved valuers; or
- valuation by other external reference.
Each approach benefits financiers and borrowers in different ways and may be a point of negotiation between parties depending on the commercial priorities for the fund in question.
Financier consent prior to investments being included in NAV?
The market approach to inclusion of new loans within the borrowing base following establishment of the NAV facility is again not uniform. On certain transactions, financiers will insist on retaining a consent right before a new underlying loan can be included within the borrowing base. On others, sponsors are able to designate new portfolio investments as 'eligible' without further financier approval, provided the relevant eligibility criteria set out in the NAV facility has been met. The chosen approach will need to reflect the parties' agreed position as to risk allocation and practical considerations as to the fund needing financier consent in each instance prior to a new investment contributing to the NAV calculation.
Do underlying loans need to be transferred to a separate SPV?
It has been a requirement of certain financiers operating in this space that loans of the credit fund must be transferred into a bankruptcy remote SPV before the NAV facility can be banked. For certain financiers, use of a securitisation-style SPV and tranching of debt may allow the financier to take advantage of capital treatment benefits under their applicable regulatory frameworks and enable more competitive pricing to be provided to the fund borrower. That said, it may be a significant administrative burden on the credit fund to transfer its loan portfolio from the principal fund itself into an SPV. Where this is required, the fund will need to engage in a due diligence process on its underlying portfolio to check restrictions around transferability and whether, for example, consent of the underlying borrowers will be required for a transfer (even to an affiliate SPV entity). Other facilities do not require any separate transfer and can be banked against the primary credit fund itself.
Cash sweep and mandatory amortisation triggers (pre-default)
Another unique feature commonly seen in credit fund NAVs is a separate cash sweep or mandatory amortisation requirement on the occurrence of certain trigger events, short of an actual event of default or full mandatory prepayment event occurring. These triggers vary but can include an available limit / borrowing base deficit, a substantial decline in eligible NAV, there being an insufficient number of eligible collateral at a particular time, or any diversification criteria not being satisfied. Another common trigger is the availability period elapsing, which commonly occurs on such transactions some time prior to the maturity date. These triggers allow financiers to manage risk exposure by ensuring outstanding debt is paid down on the occurrence of such trigger events, but without exposing the borrower to the significant implications of an event of default or full mandatory repayment event.
Tenors of underlying loans / refinances of underlying loans
Another point for financier consideration is the extent to which the tenor of the underlying loans in the portfolio aligns with the facility term of the NAV facility itself. The receivables relating to repayments of an underlying loan for which the maturity or amortisation schedule extends past the NAV facility's repayment date may not be available to the credit fund as part of servicing its debt under the NAV facility. To address this, the eligibility criteria on the NAV facility may require that underlying loans fall within a particular tenor, or that underlying loans cannot have their maturity or repayment schedule extended or postponed. Similarly, concentration limits may operate to limit exposure to underlying loans with a maturity longer than the term of the NAV facility, potentially utilising a weighted average maturity calculation across the portfolio for these purposes.
This issue is also present when an underlying loan gets refinanced, such that the effective maturity of the loan is extended but no loan monies are actually repaid to the credit fund. In such situations, certain financiers have required an additional consent right prior to the refinanced loan being (re-)included in the NAV borrowing base. Other transactions provide that a refinanced loan will automatically be reincorporated within the NAV if the NAV financier does not actively exclude them within a particular decision period, provided that relevant documentation / credit information in relation to the refinanced loans is provided to the NAV financier.
Where to from here?
As the above points demonstrate, there is, at present, a large variance across the Australian fund financing market as to terms used in NAV facilities for credit funds. As these transactions increase in frequency over the coming years, it is possible that a more standardised approach to terms will emerge. In the meantime, both financiers and borrowers should be aware of these key negotiation points to ensure that a suitable set of terms appropriate for the credit fund in question can be agreed by all involved in the transaction.