Through the initial impact of COVID-19, sponsors looked into fund-level financing to seeking liquidity to capitalize on market dislocations disruptions. Net Asset Value (NAV) facilities, which are backed by the total equity value of fund’s portfolio, grew in demand and matured.  NAV financings have been used not only to make follow-on investments and provide liquidity to portfolio companies, but also to accelerate distributions to investors or as a bridge to make investments that are sold to subsequent funds of the sponsor.

As the NAV market becomes more mainstream, a survey conducted by Proskauer^[1] indicates 19 percent of closing Loan to Values (LTVs) were reported to be above 25 percent. Additionally, 65 percent of the closing LTVs for respondents’ NAV loan portfolios fall between 10 and 25 percent. This increasing leverage within the Alternative Investment Funds (AIF) universe poses potential credit risks to the lenders to the funds.

Members of the fund finance team of this institution are responsible for origination, measuring and managing credit risk of the funds and pricing for the underwritten loans. They were seeking a standardized, but tailored framework for evaluating specific risks NAV facilities pose. In addition, the credit manager’s key sponsor was interested in leveraging a comprehensive and transparent credit solution for assessing the creditworthiness of the NAV transactions.

Pain Points

Proskauer’s survey found that two of the most common  closing LTVs in NAV lending strategies are between 10 and 25 percent. It is important to understand and to assess the key qualities of the borrower and underlying assets, which makes lenders comfortable taking on higher risk while pricing the greater risk into the loan.  Additionally, as the NAV lending has matured, the NAV facility has also been prudently structured to provide liquidity and to help mangers to fulfil their fiduciary duty to its investor clients. As a result, this institution needed a comprehensive, standardized framework and stringent guidance for assessing the NAV facilities’ specific credit risk consistently across the board.

The credit risk analysis is challenging for several reasons.

• The AIF universe comprises mostly unrated entities and transactions, so there is no readily available assessment of credit risk.
• The NAV facilities enable the sponsors to cherry-pick provisions from the underlying eligible portfolio of assets, as per leveraged credit agreements. This makes it difficult to have a consistent method/guidance on calculating the asset value at stress and the leverage (i.e., loan-to-value (LTV) ratio).
• An important factor for the LTV ratio is the diversification of the underlying loan portfolio.  The more diversified the loan portfolio, the more favorable the LTV terms may be for the borrower. However, incorporating the portfolio concentration/diversification into credit assessments and/or pricing is not straightforward and transparent.
• The prudence of deal structure can have impact on the NAV facilities credit worthiness.  No deal structure is the same, this makes difficult to have consistent guidance on covenant credit analysis (including analysis on cash sweep mechanism).     

In order to meet the growing demand for NAV facilities over the last few years, the institution’s credit risk and fund financing teams, who have extensive knowledge of the market and deals, have been working with S&P Global Market Intelligence (“Market Intelligence”) to learn more about the standardized solution and to create customized solutions for NAV facilities, with the continued support of the Market Intelligence team.

Solution

In collaboration with the institution credit risk team, the Scorecard for NAV facilities combines Market Intelligence’s proprietary AIF Credit Assessment Scorecard and NAV market and lending experience to providean essential tool for identifying and assessing the various factors affecting the creditworthiness of NAV facilities and managing potential default risks with fund portfolios.

The AIF Scorecard solution includes:

• An Excel®-based model that provides a consistent framework for calculating credit risk, with a focus on leverage, liquidity risk, concentration risk, asset quality and deal structure pros and cons.
• The ability to identify default risk through quantitative and qualitative factors tailored for NAV facilities. Users can generate probability of default (PD) values for AIF NAV facilities and perform sensitivity analyses, scenario analyses and stress tests.
• Credit scores that are designed to broadly align with S&P Global Ratings credit ratings^[2], supported by historical default data back to 1981.
• A comprehensive handbook and standardized framework providing guidance on the stressed leverage calculation to understand the LTVs for NAV facilities. Users can also refine their view of stressed leverage on specific risk factors, including concentration, market risk, risk of strategies and more.
• Additional tailored guidance on credit analysis on covenant, including deal structuring, cash sweep mechanism and more.
• Scorecard implementation and application training workshops.
• Ongoing analytical and operational support.

Key Benefits

The fund financing and credit risk management teams felt that Market Intelligence offered a sound methodology and tailored model to evaluate the credit risk of AIFs, as well as NAV facility instrument-level credit risk. The teams subscribed to the offering and value having:

• An efficient and easy-to-use approach for scoring portfolios for a wide range of AIFs and fund financing transactions.
• Transparency with in-depth model development documentation that identifies how the Scorecard was created and its use of data.
• A rigorous annual review process that validates the model to maintain its performance and reflect updates in a User Guide.
• A due diligence tool for the fund financing team to use on various risk factors for a NAV transaction.
• Training and on-going support to understand the range of applications for the Scorecard and to receive on-going analytical support and updates.

 The AIF Scorecard for NAV facilities provides the institution with a comprehensive tailored solution to better assess and manage potential risks incurred when offering leverage to fund vehicles. Alignment with the S&P Ratings’ methodology with customisation specific towards NAV facilities offers benefits when it comes to loan syndication.