Australia | Publication | June 2023
Subscription finance has experienced significant growth over the last decade, particularly in the United States and European funds financing markets. With the growth in private equity funds sourcing alternative funding strategies, subscription finance is an offering that provides an attractive cash-flow management tool. This is because it is usually offered on relatively inexpensive credit, subject to the quality of the uncalled investor commitments. For these reasons and more, subscription finance has grown from the traditional bridging/short term facilities to an ever increasingly important source of funding for funds.
Asian-Pacific markets have, in the last five years or so, seen a similar and spectacular growth in the use of subscription finance. This is particularly the case for funds at inception or in the early stages of its life cycle, where the uncalled investor commitments are plentiful. For funds where the investment periods are maturing or have matured, there has been a recent shift in the United States and European markets from subscription facilities to NAV or hybrid facilities. If the funds financing trends from the United States and European markets offer any guidance, NAV and hybrid facilities may soon follow suit on this side of the world.
In this article, we explore what are a NAV and hybrid facilities, the characteristics of these facilities and the benefits of utilising them.
A NAV credit facility has many forms, but at its simplest it is essentially a term or revolving facility provided to the fund against the net asset value of the portfolio of assets it holds. Unlike subscription facilities, which looks at the cashflows from the uncalled capital from eligible investor commitments (i.e. the cashflow analysis is ‘upward looking’), NAV facilities looks at the cashflow from the portfolio of assets that the fund has invested into (i.e. the cashflow analysis is ‘downward looking’). Although it looks at the fund’s portfolio of assets, it is not the same as asset level financing (which will be explained in a bit more detail below). Therefore, for a fund where the investment period has expired or is near maturity, NAV facilities are particularly useful for the ongoing liquidity management of the fund. This is because these funds are generally no longer eligible to obtain subscription facilities.
A hybrid facility is a blend of both a NAV and a subscription facility, where the Lender looks at both the uncalled capital as well as the net asset value over the portfolio of assets, hence the reference to it being a ‘hybrid’. This is suitable for funds that still have uncalled commitments ‘in the tank’ yet starting to build up its portfolio, and would want to take advantage of its growing NAV to maximise its leverage.
As NAV facilities look at the portfolio of assets, it is usually structured as a term or revolving facility with either (i) a general leverage ratio against the net asset value of the entire portfolio, or (ii) a borrowing base facility with an advance rate against the relevant ‘eligible’ assets. The latter is the more prevalent structure, and depending on the type of asset, often eligibility criteria and advance rates are heavily negotiated. The rate of advance is also pegged against the borrowing base / leverage ratio which is subject to fluctuations, and is often the case that lenders tend to also include certain headrooms against these ratios. Deterioration of these ratios to certain set levels serve as triggers, which can result in draw stop, mandatory prepayment, cash-sweep, or Events of Default.
With respect to the security package, as these types of facilities are ‘downward’ looking, a typical security package will include:
A NAV facility is not to be confused with financing provided at the asset level, where the financing is provided against the underlying assets of the portfolio. The distinction here is that NAV financing is looking at the cashflows generated from the portfolio of assets (i.e. distributions and recoveries) rather than the underlying assets itself. Therefore, provided a fund is structured properly, it can obtain leverage at each of the levels (being NAV/subscription facility at the fund level with the security against the cash flows of the fund, and separate asset financing at the asset level).
There are many reasons why NAV facilities could serve as a suitable alternative and/or additional source of liquidity for funds. Some of the benefits of NAV facilities are outlined below.
| Subscription Facility | NAV Facility | |
| Fund life cycle | Inception (where uncalled capital is at its maximum) | Towards the end /expiry of investment period |
| Pricing | Usually cheaper (subject to rating of investors) | Dependent on quality of underlying assets, but generally speaking, higher than subscription facilities |
| Collateral | Pool of available uncalled capital and ‘quality’ of investors | Portfolio of the fund’s investments |
| Due diligence | Due to the focus on uncalled capital, due diligence is carried out with respect to the fund documentation, particularly around the fund managers rights to call on unfunded commitments, mechanics on the calls, investor default, concentration of commitments and so forth | Due diligence is carried out with respect to the underlying portfolio, which includes: the investment vehicle’s title to the property, enforceability of its rights with respect to the underlying investments, fund calculations and reporting on net asset value and so forth |
| Tenor | Traditionally, subscription facilities are short term facilities that are used to bridge the funding gaps between investor calls. Although there are longer terms, it is nevertheless for a shorter period, in any case within the investment period | Generally longer and tailored to meet the fund manager’s needs |
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