Large pension funds and other large institutional investors have begun opposing their private equity portfolio lending to raise cash after slowing trading activity and slowing public offerings, hoping to exit trillions of dollars in aging transactions.
In recent months, investors have begun to turn to so-called net asset value loans to improve liquidity, and according to those involved in the transaction, there is little money when the majority of their portfolios are locked in private equity, venture capital and real estate assets.
The borrower's strategy of pledging its fund shares as collateral for the loan is primarily used by private equity groups to discover cash to fund acquisitions or dividends. However, investors have adopted it in their acquisition of funds as a way to prevent cash from selling assets at unfavorable prices.
Private equity investors lack cash because the allocation of their funds paid over the past three years was about half the historical average, resulting in inventory of unsold private equity transactions hitting a record $3TN last year. According to Cambridge University Corporation, there is now a $4 billion to $50 billion cash shortage that should be returned to investors.
At the beginning of the year, traders predicted a rebound in M&A and public goods, and these rebounds would reduce inventory. But Donald Trump's trade war has frozen activity, and private equity executives now predict the IPO may be suspended this year.
“It’s not like a sudden flash of switch,” said Michael Hacker, global head of portfolio finance and partner of Carlyle Alpinvest’s second-tier team. “Many of the current market activities go back in one way or another to last year, when many of the expected exit activities were not achieved.”
NAV loans are often considered as alternatives to selling private equity in the secondary market, another route for investors to raise cash in recent months. By borrowing, investors can get cash without discounted prices and realizing the loss.
These loans are usually four to five years and the loan-to-value ratio is about 20%, causing buyers such as buyers and private credit funds to regard them as safe assets.
NAV loans have caused controversy on Wall Street because they require investors to cross-merge their fund assets: essentially, obtaining loans with large amounts of assets, putting their entire fund investment in danger. Last year, an industry trade agency released guidelines on using NAV loans to pay dividends, after the Financial Times reported on the growing use of such a strategy.
Niche Player 17 Capital and major companies Carlyle and Ares Management are one of the most active providers of NAV loans.
Several years ago, investors first started taking out NAV loans, as using financial engineering tools such as fund securitization became a more mainstream way to withdraw cash from logjam for unsold assets.
Other investors who have already received NAV loans are home offices and sovereign wealth funds, according to people involved in the deal. The largest loan has so far reached $800 million, although people familiar with the pending transactions say they will soon fall off at $1 billion.
"It's a liquidity management tool that not everyone uses, but the largest, more complex limited partners are being used to help manage their balance sheets," said one lender who finances these loans.