Navigating the growth of NAV and hybrid facilities in Funds Finance

What is a NAV facility, and what is a hybrid facility?

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.

What are the characteristics of a NAV Facility?

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:

1. Security over the shares of the holding SPV/investment vehicle (the entity that holds the underlying assets);
2. All asset security to be granted by the holding SPV/investment vehicle
3. Distribution rights from the holding SPV; and
4. Cash accounts to which distributions are paid into.

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).

Why use a NAV Facility?

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.

1. As mentioned above, NAV facilities have developed in the last few years as an answer to funds reaching the maturity of their investment periods, calling for the need to switch the funding to be provided against the invested assets, from uncalled capital. This allows fund managers to access funding where the fund has depleted liquidity from its committed capital.
2. Generally speaking, compared to a subscription facility, there is more room to structure and tailor NAV and hybrid facilities to suit the fund manager’s requirements.
3. Where a fund is not otherwise eligible for subscription facility (e.g. if it doesn’t have sufficient uncalled capital, or its investor base doesn’t meet the criteria of the lender), a NAV facility can provide an alternative source of credit.
4. From a Lender’s perspective, NAV facilities generally demand higher margins to subscription facilities.
5. Where a significant investor/investors with substantial investment wishes to withdraw from the fund and the fund manager does not wish to prematurely sell the assets from the portfolio, or where the assets are relatively illiquid, NAV facilities may provide a solution to patch the gap.

NAV Facility vs Subscription Facility: A comparison