Liquidity-hungry GPs are looking at how to borrow against existing portfolios, but deal flow is limited because global credit providers are holding back, banks are wary, and interest rates are high

Tau-PAM, Asia’s first independent platform focused on providing liquidity to private equity firms by issuing loans secured against portfolios of investments, wants to resolve a mismatch. On one hand, GPs are sitting on sizeable unrealised net asset value (NAV) and lack the leveraged financing tools of their Western peers to address it. On the other, banks are reluctant to step into the breach.

“Banks like to lend to rated counterparts or have visibility on the cash flows they are lending against. When they do secured lending, the ineligibility of collateral in private equity makes NAV loans inefficient from a capital charge perspective. As a banker, I became frustrated that we couldn’t deploy pure asset-based financing solutions for sponsors in Asia,” said Samuel Plagnard, a managing partner at Tau-PAM.

He established the firm last year after leaving Natixis and teaming up with partners from private equity and banking backgrounds. Tau-PAM is pursuing part of an estimated USD 600m in unrealised NAV across ex-China buyout and growth holdings. Including private equity real estate, the total nears USD 800bn.

For now, there is no fund. Tau-PAM has agreements with a few large investors that permit it to pursue opportunities of up to USD 200m in size. However, Asia’s middle market is considered the sweet spot, given limited access to recap financing means that the segment is low-levered versus the US and Europe.

“There’s a need for private credit, but the way it has been deployed in the US and Europe, you can’t replicate that in Asia, at least in a scalable way. I believe the NAV lending route is better suited to the region’s fragmented markets,” said Plagnard.

Few, if any, global credit players are willing to try, preferring to address the region opportunistically via broader relationships with large financial sponsors or highly structured solutions. This mindset appears to underscore Asia’s status as a nascent market where local complexities, limited fund sizes, and inexperience with this kind of finance impede growth.

“We’ve done some deals in Asia, but they tend to be through global groups that have Asian funds. Our investment teams cover Europe and the US, and they are extremely busy,” said David Wilson, a partner at 17Capital, which specialises in lending against portfolios and against manager fee streams.

“There’s demand in Asia, and the market will grow, but it might make more sense for local groups to be in and around that. For us to do it, we would need people on the ground, which is a huge commitment.”

An unmet need  

Demand for NAV financing – or interest in the possibilities it presents – is certainly rising, as evidenced by the uptick in enquiries received by providers and advisors. Little of this is translating into action. One LP with meaningful exposure to Asian funds managed by global and pan-regional sponsors said he hadn’t seen it widely adopted or even discussed at LP advisory committee meetings.

Some fund finance teams at banks that primarily provide subscription line financing against undrawn LP commitments to funds claim to be issuing NAV facilities to sponsors beyond the large pan-regional players. They include Jean-Baptiste Peloux, head of leveraged and sponsor finance for North Asia at BNP Paribas, though he admits that credit funds are getting more traction than private equity.

Meanwhile, Soumitro Mukerji, a partner in the banking and finance practice at Mayer Brown, has worked on four NAV facilities in the past three years. Over the same period, he was involved in 60 subscription line transactions. The NAV facilities were for real assets and credit funds. Other industry participants offer similar accounts.

“Direct private equity NAV financing is tricky in Asia, especially now, and it’s not a space we are playing in – we prefer the PE fund-of-funds space” said Fi Dinh, a managing director and head of fund finance for Asia Pacific at MUFG Investor Services.

“There are a lot of questions about continuation funds and NAV financing as means of generating DPI [distributions to paid-in]. It hasn’t really picked up. If you have a benign leveraged finance market, financing NAV puts you further away from the asset. Pure NAV is going to be challenging.”

The rationale for alternative forms of liquidity like NAV facilities is visible in Asia’s exit and fundraising numbers. In 2023, they trailed the average for the prior five years by 31% and 15%, according to AVCJ Research. Some managers seek alternative forms of liquidity to generate DPI; others recognise holding periods and fundraising processes will be protracted, so they want to support existing portfolios.

For 17Capital, COVID-19 served as an accelerant for NAV facilities in the US and Europe, because with portfolios under stress, GPs explored all possible sources of financing. “They educated themselves quickly,” said Wilson. “Then the market bounced back, and they started borrowing from us not for the distressed situations they had investigated, but for growth. There were a lot of M&A opportunities.”

Asia-based portfolio companies faced similar challenges, but managers didn’t have the same product suite. Rather, financing solutions were proposed by a string of opportunistic providers – not just generalist credit funds – mostly on a single-asset basis. One placement agent recalled receiving referral requests from groups looking to lend money “at 15%-17%, crazy numbers.” Uptake was limited.

In the absence of an entrenched market, other providers offered NAV-like facilities at the fund level. Ion Pacific, for example, specialises in structured secondaries where economic interests in VC and growth equity funds are reassigned without changing names on LP rosters. Preferred equity is one description. Michael Joseph, Ion Pacific’s co-CEO, said the “best equivalent would be a NAV financing-type structure.”

The firm saw a deal frenzy at the back end of the pandemic, often involving GPs that wanted to placate LPs by returning some capital before asking for fund life extensions. Another surge in activity came in the final quarter of 2023. According to Joseph, this was when managers waiting for the bid-ask spread on traditional buy-sell transactions to narrow lost patience. “Time is not their friend,” he observed.

Structure and size

Unlike providers of NAV facilities to private equity funds, Ion Pacific cannot rely on a consistent yield because assets are minority positions in early-stage companies that generate little if any cash. Instead, the firm negotiates a division of future cash flows with the manager.

Tau-PAM is also open to lending against venture and growth equity fund assets. Plagnard said solutions would be pre-IPO financing and focus on situations where there is a clear path to exit within two years. In addition, due diligence would concentrate on the target GP’s ability to deliver performance.

This is part of the “huge blue ocean” Plagnard envisages emerging in the middle market – an ocean that banks are reluctant to fish. However, asset type is only one deterrent. More formidable obstacles to their ability and willingness to participate in NAV financing in Asia involve structure and size.

First, funds for which NAV facilities are contemplated tend to be several years old and limited partnership agreements (LPAs) were often drafted without such actions in mind. For example, they may prevent GPs from granting security interests over assets to NAV lenders, restrict the use of debt at the fund level or below the fund level, or impose limits on the tenor of fund-level debt.

According to Makiko Harunari, a partner and head of the Asia banking and credit practice at Simpson Thacher, tenor limitations on fund-level debt are a common feature of LPAs for funds in Asia. They may be problematic because, unlike subscription lines, NAV facilities are typically repaid using proceeds from the underlying investments, which may take time.

“What we are seeing is sponsors starting to have these discussions for funds that are fundraising now,” Harunari said. “Funds are also anticipating possibilities for NAVs when making investments. They are saying, ‘In three years, we may want to put in NAV, so let’s structure investments to keep that optionality.”

Second, size becomes a challenge because loan-to-value (LTV) ratios on NAV facilities offered by banks tend to be in the 10%-15% range. Working to a minimum loan size of USD 100m-USD 150m, sub-USD 1bn funds are unworkable. That threshold may tick upwards if certain assets – typically those from hard-to-monetise and growth capital-oriented jurisdictions – are excluded from LTV calculations.

Peloux of BNP noted that funds below USD 500m in size would be difficult due to a potential lack of diversification, single investments being too small, and funds being relatively small at inception. Moreover, BNP is highly selective. Financial sponsors must not only be of high quality but also actual or potential drivers of other business lines at the bank. In short, the effort must be worthwhile.

“For a deal to make sense, you need a sizeable portfolio of assets, otherwise it’s not worth it relative to the complications involved,” said Pierre Maugue, a partner in Debevoise & Plimpton’s finance group.

“To the extent the fund has investments in companies across Asia, it is harder to analyse from a lender’s point of view. There is country risk, currency risk, and legal complexity when taking pledges of equity interests in companies that might be held through Cayman Islands holding companies.”

Levels of flexibility

For fund finance teams accustomed to subscription lines, NAV financing requires heavy lifting and often coordination with other units within the bank. One industry participant recalled an instance in which a real estate team resisted helping fund finance colleagues structure a NAV facility for a real estate fund, arguing it could make more money doing traditional asset-by-asset loans in the same amount of time.

Tom Higham, a partner and banking and finance practice leader at Australia-based Allens, added the country’s Big Four banks have until recently declined to participate in NAV financing despite being active providers of subscription lines in the domestic market. Other financial institutions have taken the lead, but they have primarily focused on facilities for credit funds.

“When you look at asset-level financing, you bring in expertise from the relevant asset-level teams to structure and underwrite the credit risk. I’ve seen more NAVs in private credit because it’s more like cash flow lending and it’s easier to do the modelling,” said Dinh of MUFG.

“For private equity, the sector expertise required depends on the composition of the portfolio. And then the bigger the bank, the more silos.”

Hybrid facilities may offer the comfort of some middle ground. In their purest form, hybrids comprise two tranches, a subscription line and a NAV facility, each with its own collateral package and perhaps with different sets of lenders. Emphasis shifts from the former to the latter as the deployment progresses. It is described as highly bespoke and challenging to put together.

According to several advisors, in the limited number of situations this solution has been used in Asia, it tends to be heavily weighted towards the subscription line with little claim on the portfolio assets.

Credit providers, by contrast, position themselves as one-stop shops that offer speed and certainty of execution, albeit for a higher price. LTVs are higher, sometimes above 30%, and there is greater flexibility around repayment. Rather than require a consistent stream of repayments, they can introduce payment-in-kind mechanisms or carve up cash flows from the portfolio like a structured secondary deal.

“A bank may want to get repaid on every asset sale a fund makes. We can use LTV and diversification tests to allow a fair amount of early liquidity flows to be paid to the LPs without requiring them to pay down,” added Wilson of 17Capital. “Our loans also have a longer behavioural duration.”

This pragmatism extends to collateral. Should borrowers not want to grant security interests over assets to NAV lenders – or if the LPA forbids it – credit providers may agree to lend on a collateral-lite basis. Due diligence processes can be cheaper and swifter as a result.

“NAV facilities can be very costly in terms of diligence because if the fund has 20 assets and must give a share pledge over an entity holding those 20 assets, the fund and its advisors have to review all the regulatory, tax, co-investment, joint venture partnership, asset-level debt implications,” said Harunari of Simpson Thacher.

One investment professional with a global credit provider described NAV facilities as a key area of focus for multiple pools of capital even in the absence of any dedicated vehicles. On the borrower side, it remains to be seen how quickly these players can achieve critical mass in a market where leveraged finance remains dominated by banks and characterised by price-sensitive, relationship-driven lending.

“Sponsors want banks to provide NAV facilities,” said Mayer Brown’s Mukerji. “Even for deals involving large sponsors or portfolios of listed securities for which valuations can be calculated easily, we see a substantial difference between a sponsor’s pricing expectations and what credit funds offer. Most sponsors aren’t willing to pay that much money to get NAV deals done.”

This view is endorsed by a pan-Asian fund manager who has been pitched NAV solutions. A bank facility would be entertained, though the quantum of capital offered to date has been too small. As for credit providers, “they were 500 basis points more expensive,” the manager said. “I’ve seen term sheets saying 15%, but the underlying assets aren’t growing at 15%.”

The irresistible rise?

While most industry participants believe a deeper and more diversified pool of lenders – including independent credit providers – would contribute to the development of NAV financing in Asia, they don’t see it as the stand-out priority. Education is certainly considered important, for GPs in the region that might be less familiar with the product, and more broadly, for their LPs.

The LP take on NAV financing is generally one of scepticism. Speaking at the recent AVCJ Private Equity Forum Australia & New Zealand 2024, Stephen Whatmore, head of private equity at QIC, drew comparisons with the surge in collateralised loan obligation (CLO) issuance ahead of the global financial crisis, and questioned the wisdom of placing fund-level leverage on top of asset-level leverage.

Glenn Riley, head of private markets at Commonwealth Superannuation Corporation (CSC), highlighted the practice – not widespread – of using NAV facilities to provide liquidity to LPs ahead of a fundraise. This concern is coalescing, industry-wide, into greater scrutiny of the use of proceeds. Supporting bolt-on acquisitions is acceptable; facilitating distributions and passing on the cost of that debt to LPs is not.

According to Andrew Bellis, global head of private debt at Partners Group, which recently launched a dedicated NAV finance strategy intended to provide liquidity for GPs and LPs, the scepticism will dissipate much as it did for subscription lines. “We think NAV financing will follow the same trajectory and if you factor in its use in LP solutions, the addressable market is enormous,” he said.

Asia is expected to ride this wave, but further support could come through changing competitive dynamics within the industry. NAV financing gained momentum in the US and Europe partly because an influx of new entrants to the subscription line space prompted providers to consider other options.

Maugue of Debevoise predicts a similar evolution in NAV financing. “As the market becomes more crowded and competitive in the US and Europe, banks and funds will ask where they can find growth – and they will look to Asia,” he said.

There remains, nevertheless, one overriding impediment to uptake: interest rates. A higher cost of capital acts as a disincentive to its use, and Peloux of BNP sees a link between this and Asia failing to live up to an earlier bullishness on NAV financing. “There is clearly appetite on the bank side,” he said, “but it remains to be seen if GPs or LPs believe it is the right strategy for them in the current context in Asia.”