Are there characteristics of NAV facilities provided by credit funds which are different from NAV facilities provided by banks?
Drawdowns
Most credit fund lenders will either need to draw down from investors or utilize a subscription line facility prior to advancing funds to a private equity fund borrower. If a subline is not in place, the credit fund lender will need to manage its obligations to the underlying borrower to fund a utilization by ensuring that there is a sufficient utilization period to allow it to drawdown from its investors. This means that sometimes a longer drawdown period is provided for in the NAV facility. (e.g. 10 or 12 Business Day period) If the credit fund lender itself has a subscription line facility it can use, this drawdown period may be reduced to say 3 to 4 days of receiving a utilization from the NAV borrower.
Different pockets of capital
When a bank provides a facility, it is typically one single entity that will be the lender (unless it isa syndicated facility with different banks). When a credit fund or non-bank lender is funding, it may end up drawing from different pockets of capital managed by the same manager. Therefore, it is not surprising to see a number of different lenders, albeit managed by the same fund manager, be a lender of record when the facility closes. A syndicated form of facility is very often used that has as the facility agent, an entity controlled by the manager, or it may have a third party agent appointed.
Are all LMA and LSTA provisions required in the Facility?
There are several LMA or LSTA provisions in facility agreements that are really only there to protect regulated bank entities. Therefore, provisions such as Basle III, increased costs and Bank Levy provisions are not as relevant to a non-bank lender. Caution should be exercised when using a bank NAV form of facility agreement to document a NAV facility to be entered into by a non-bank lender, as alterations will need to be made.
Licensing in local jurisdictions and choice of lending vehicle
Some jurisdictions in Europe and elsewhere, require the lender to be licensed banking entity under their local regulations or European regulations. It is unusual for the non-bank lending vehicle to have any sort of bank license and so it is crucial prior to commencing any NAV financing that the licensing requirements are analyzed to ensure the right lending structure is in place to comply with the regulations.
Insurance money and ratings
Many non-bank lenders are relying on their source of funding from insurance companies and pension funds. For this lending to profitable it is often required to obtain a rating of the debt (either a public or private rating). An increasing number of banks are now also seeking to rate the debt, but the non-bank lenders have been investigating this now for a number of years. Borrowers and their counsel should ask their non-bank lenders upfront whether a rating of the debt will be sought.
Withholding Tax considerations
We work with many non-bank lenders whose lending vehicles are set up in the US (typically Delaware). The choice of jurisdiction of the lending vehicle and the withholding tax position between the borrower and the lender are all preliminary considerations that should be addressed up-front. There are many jurisdictions in Europe that do not have a withholding tax treaty with the US to neutralize any withholding tax hit. These lenders may often have to set up local European vehicles or lend to a borrower in a jurisdiction that does not have withholding tax or in a jurisdiction where there are withholding tax exemptions.
Bank Leverage to credit funds
We work on many transactions for lenders providing back leverage facilities to credit funds who have provided NAV facilities. It becomes very attractive to some lenders if a credit fund borrower has in its portfolio several NAV facilities with different borrowers. The back-leverage lender has good diversification as it will be lending against a pool of NAV facilities that themselves have diversification across different assets. Very often the back-leverage provider will itself be a bank. As the spreads that non-bank lenders obtain on NAV facilities tend to be higher and bank NAV facilities, it can make a credit fund more competitive when competing with bank lenders for NAV facilities to private equity borrowers.
Transfer of lenders rights
Any restrictions on a lenders right to transfer the loan will always be hotly negotiated and this is particularly the case when there is a non-bank lender under a NAV facility. The underlying borrowers will want to make sure that the details of the facility and other confidential information are not passed into the hands of the borrowers’ competitors. However, the non-bank lender may need to securitize the loan, or offload exposure, particularly if the non-bank lender has some sort of open ended or evergreen structure. Most European facilities whether provided by banks or non-banks allow the lender to transfer to its affiliates or if there is an event of default continuing, however there may be other circumstances where a non-bank lender will require flexibility to transfer the loan.
Credit support alternatives for NAV facilities
It is quite usual for a bank NAV facility to provide the lender with security over the portfolio of the private equity borrower fund, either through an umbrella share pledge/charge or through share pledges over certain of the assets of the fund. We have seen NAV facilities to large and reputable sponsors where this “equity pledge” recourse is missing and the lender must rely only on security over a bank account into which distributions from underlying investments are swept. Where sponsors have difficulty providing these equity pledges, perhaps due to change of control provisions in shareholders agreements or due to the regulated nature of the private equity funds assets, non bank lenders have sometimes accepted alternative recourse structures to mitigate the lack of an equity pledge.
Examples include the provision of an equity commitment letter signed by the fund over of the borrower agreeing to inject equity into the borrower if certain events occur. We have also seen an uncalled capital commitment minimum ratio inserted into the facility agreement, so there is always a minimum amount of undrawn capital in the borrower while the NAV facility debt is outstanding. Sometimes there is a fund level guarantee provided by the fund to the non-bank lender to support the NAV debt incurred by the holdco borrower.
If there is concern that monies may not be paid over by the topco’s of each investment into a bank account controlled by the non-bank NAV lender, a deed of covenant could be sought, which will have various topcos agreeing to sweep any cash they receive to the designated bank account. Some of our non-bank lenders are even prepared to provide a preference share facility rather than a loan facility to some of their private equity fund borrowers if there are advantages to the borrower. This “Pref Facility” could be established by amending the share capital of the fund borrower or one of the aggregator entities in the fund borrowers equity structure, or through the parties entering into separate loan facility style document under which the parties contractually agree that the non-bank pref provider will be paid out first.
JV vehicles as lenders
Where multiple credit funds with different managers want to provide a NAV facility to the same borrower, we have also seen such credit funds set up a separate JV lending vehicle that they contribute capital to. This JV vehicle will be the lender of record on any underlying NAV facility provide, and the different credit funds who are providing the source of funding under the NAV facility can agree the commercial arrangements between them at the JV vehicle level. This has the advantage of limiting the underlying borrower’s involvement or consent to the intercreditor arrangements.
Bad boy acts
Most of our credit fund clients want us to analyze upfront the bankruptcy risks associated with any given NAV structure and how these can be mitigated. We are very often called upon to write an enforcement memorandum that sets out the legal and practical steps needed on an enforcement to seek repayment of monies owed. A Bad boy guarantee is sometimes a protection that our non bank lenders require. Broadly speaking, this involves having another entity of substance such as the fund that sits above a NAV borrower or the regulated investment manager that manages the fund borrower, agreeing to guarantee the debt in the event a bad act is carried out (like fraud or willful misconduct). The idea is that this disincentivizes any fund manager from instructing any transfer of assets out of the portfolio in breach of the borrowers undertakings.
Interaction between a subscription line facility and NAV facility
It is important when providing a NAV facility below the fund to consider whether there is any consent needed from a subscription line lender at the fund level. A subscription line facility will typically prohibit any other debt at fund level, but it may not prohibit the giving of an equity commitment letter, insertion of NAV debt below the fund or the existence of covenants in the NAV facility relating to the amount of uncalled capital that is held back. ILPA has recently issued guidance to its investors on NAV facilities and certain disclosure requirements and recommendations. These should be considered by both bank and non-bank lenders prior to putting in place a NAV facility, so that the NAV lender is comfortable that relevant investor consents are in place for the financing.
Conclusion
We have seen the substantial growth of credit funds after global financial crisis in 2007/2008. Following last year’s bank failures and a tightening in banking regulation, we are now seeing a new wave of growth in credit funds and a lot of these funds are focused on providing NAV facilities to private equity, secondary and other funds. The way in which these NAV facilities are provided by credit funds and other non-bank lenders need to be carefully thought about and certain nuances referred to above considered early in the life of the transaction to ensure speedy and efficient execution.
This article will be published in next weeks edition of Praxio's Fund Finance Magazine.