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Across the global alternative investment funds (AIFs) that we rate, we see continued interest in utilizing net asset value (NAV) facilities to manage liquidity, alleviate foreign exchange risk, and return capital to their limited partners (LPs)--in an environment that's less conducive to monetization.
What We're Watching
Some AIFs have added leverage through NAV facilities, which are loans backed by the funds' underlying assets. This activity has raised concerns among some market participants that funds could be levering up to pay down equity investors amid challenging conditions shaped by uneven liquidity and strained valuations.
AIFs' borrowings often evolve over the course of their lifecycle. During the investment and inception phases, AIFs tend to use subscription lines of credit--short-term facilities backed by capital commitments from LPs--to fund their investments. As funds mature and build up their asset bases, they may also add leverage through NAV facilities. These loans may be used for liquidity, general risk management, and returning proceeds to LPs, among a plethora of additional purposes.
What We Think And Why
The rapid expansion of private debt markets represents a nascent opportunity for market participants to understand the risks across such transactions. The analyses of our publicly rated AIF universe of a dozen peers and portfolio with private ratings clarify the dynamics of fund finance. Whether it's private or public, unrated or rated, credit is credit. Because private credit players face many of the same fundamental risks as rated issuers, AIFs can benefit from the transparency that comprehensive ratings provide--especially as both the NAV facility asset class continues to expand and the role of investment funds becomes a more prominent part of financing corporate growth (alongside traditional leveraged buyout and mergers and acquisitions activity).
S&P Global Ratings' fund ratings criteria is used for analyzing the creditworthiness of AIFs and their associated borrowings--including unsecured and secured debt, NAV facilities, and subscription lines. Investors, banks, insurers, and other market participants may use our rating analysis as a useful benchmark view of risk as they consider their capital allocations, distribution, and pricing within this space.
Our global framework for rating AIFs describes how we calculate stressed leverage for different types of funds; how we capture the risks related to the funding and liquidity of different fund structures holistically; and how we incorporate qualitative assessments as we rate instruments issued by AIFs, including their NAV facilities. Alongside the diversity and stability of its funding and liquidity, our rating analysis reflects a fund's ability to repay its recourse liabilities on time in a hypothetical liquidation scenario following 'BBB' or moderate stress (informed by conditions observed during the Great Financial Crisis). The scenarios stress funds' asset values and inform our view of their leverage. These stress assumptions incorporate a prioritization of risks and are built into the ratings--which acknowledge and incorporate the risks associated with opaque private markets.
We believe that strained conditions in private capital markets are pushing more funds towards using financing, like NAV lines, to support their liquidity. Within our rated universe of AIFs, some funds are operating with significant cushions relative to the fund ratings. Adding additional NAV loans to funds already close to a ratings threshold could pressure ratings if asset valuations fall on a sustained basis.
What Could Change
We expect the approximately $150 billion in NAV facilities that some market participants have currently seen in the market to double within the next two years.
At the same time, funds' growing appetite for NAV leverage may lead to pressure if the economy slows. S&P Global Ratings believes private credit funds overall will face rising defaults in their asset portfolios in 2024. Our corporate default studies and middle-market credit estimates show defaults and negative rating transitions at multiyear highs--an indication that newer funds, and funds with elevated leverage and tight liquidity, could see the resilience of their investments, returns, and ratings be put to the test.
Writer: Molly Mintz
This report does not constitute a rating action.
| Primary Credit Analysts: | Devi Aurora, New York + 1 (212) 438 3055; devi.aurora@spglobal.com |
| Matthew B Albrecht, CFA, Englewood + 1 (303) 721 4670; matthew.albrecht@spglobal.com | |
| Methodology Contact: | Nik Khakee, New York + 1 (212) 438 2473; nik.khakee@spglobal.com |
| Secondary Contact: | Alexandra Dimitrijevic, London + 44 20 7176 3128; alexandra.dimitrijevic@spglobal.com |
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