‘Defending the portfolio’: buyout firms borrow to prop up holdings

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Private equity firms have started to borrow against their funds to backstop overly indebted portfolio companies, a new financial engineering tactic meant to cope with higher interest rates and a slowdown in dealmaking.

The manoeuvres, which lenders have dubbed “defending the portfolio”, have cropped up as many older private equity funds run low on cash just as the companies they own struggle with their own debt loads.

Buyout firms have turned to so-called net asset value (NAV) loans, which use a fund’s investment assets as collateral. They are deploying the proceeds to help pay down the debts of individual companies held by the fund, according to private equity executives and senior bankers and lenders to the industry.

By securing a loan against a larger pool of assets, private equity firms are able to negotiate lower borrowing costs than would be possible if the portfolio company attempted to obtain a loan on its own.

Last month Vista Equity Partners, a private equity investor focused on the technology industry, used a NAV loan against one of its funds to help raise $1bn that it then pumped into financial technology company Finastra, according to five people familiar with the matter.

The equity infusion was a critical step in convincing lenders to refinance Finastra’s maturing debts, which included $4.1bn of senior loans maturing in 2024 and a $1.25bn junior loan due in 2025.

Private lenders ultimately cobbled together a record-sized $4.8bn senior private loan carrying an interest rate above 12 per cent. The deal underscores how some private equity firms are working with lenders to counteract the surge in interest rates over the past 18 months.

Vista borrowed money at what it felt were more attractive prices that would allow it to cut Finastra’s interest costs, according to a person familiar with thinking at the firm. The person added that the dislocation in the riskiest corners of credit markets was a “market issue” that Vista believed was unrelated to Finastra.

While it was unclear what rate Vista had secured on its NAV loan, it is below a 17 per cent second-lien loan some lenders had pitched to Finastra earlier this year.

Executives in the buyout industry said NAV loans often carried interest rates 5 to 7 percentage points over short-term rates, or roughly 10.4 to 12.4 per cent today.

Vista declined to comment.

The Financial Times has previously reported that firms including Vista, Carlyle Group, SoftBank and European software investor HG Capital have turned to NAV loans to pay out dividends to the sovereign wealth funds and pensions that invest in their funds, or to finance acquisitions by portfolio companies.

The borrowing was spurred by a slowdown in private equity fundraising, takeovers and initial public offerings that has left many private equity firms owning companies for longer than they had expected. They have remained loath to sell at cut-rate valuations, instead hoping the NAV loans will provide enough time to exit their investments more profitably.

But as rising interest rates now burden balance sheets and as debt maturities in 2024 and 2025 grow closer, firms recently have quietly started using the loans more “defensively”, people involved in recent deals told the FT.

“This is early days for this asset class and as it becomes more mainstream and people employ these facilities more frequently, it’s only natural that you’ll see different uses of them,” said Richard Sehayek, managing director at Ares, one of the world’s largest private lenders. “The defensive play is just one of the drivers for it and as the universe itself grows, that particular part will as well.”

Relying on NAV loans is not without its risks.

Private equity executives who spoke to the FT noted that the borrowings effectively used good investments as collateral to prop up one or two struggling businesses in a fund. They warned that the loans put the broader portfolio at risk and the borrowing costs could eventually hamper returns for the entire fund.

“We get pitched left and right,” said one executive at a large US buyout firm that has resisted such loans. “To me, it seems like pretty risky financial engineering.”

Large banks like Goldman Sachs and JPMorgan have long provided NAV loans, but there has been a growing number of lenders entering the space broadening the usage of the debt. Banks now compete with a specialised group of private NAV lenders like 17 Capital and Whitehorse Liquidity Solutions, in addition to new entrants to the marketplace like private lenders Apollo Global, Ares and HPS.

“Everyone is talking about it,” said a senior banker who advises large US private equity firms. “It is easier to borrow at the fund level with all the NAV financing available than it is at the portfolio company level for certain companies facing distress.”

Executives in the NAV lending industry said that most new loans were still being used to fund distributions to the investors in funds. One lender estimated that 30 per cent of new inquiries for NAV loans were for “defensive” deals.

Private equity executives warned that rising interest rates were making the loans expensive and could come back to haunt investors.

“It could be a big drag to overall performance,” warned one executive.

“People are going to start to feel tight,” predicted the buyout firm executive. “In this cycle, we haven’t seen any car crashes yet.”