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Private Credit 

Shubham Saharan

Will Caiger-Smith

This article is part of our new service, 9fin Private Credit. If you're interested in a free trial, contact subscriptions@9fin.com.

Earlier this year, Vista Equity Partners pumped $1bn of fresh capital into its portfolio company Finastra to push a tricky debt refinancing over the finish line. The equity injection was funded by a NAV loan — some of which was ultimately placed with insurance companies.

The Finastra transaction made headlines not just because of its size (at the time, it was the year’s biggest private credit deal) but also because the NAV loan component showed how private equity firms are increasingly borrowing against their own vehicles to prop up struggling investments.

So-called net asset value lending is one of the fastest growing areas of the capital markets, but it has some PE investors hot under the collar. The fact that insurance companies — already under scrutiny for their links to private equity — are getting involved is unlikely to assuage concerns.

More broadly, the role of insurance companies in the Finastra refinancing is an example of just how sprawling the private equity industrial complex has become.

Just a few years ago, banks were duking it out with direct lenders to win mandates for big LBO transactions; now, more and more third parties are being dragged into providing ancillary leverage to power those giant transactions.

The involvement of insurance companies in the credit markets isn’t exactly a brand new phenomenon.

Many giant PE and credit shops have captive insurers: Apollo was one of the first, with its acquisition of Athene, KKR owns Global Atlantic, and Ares has Aspida Holdings. That’s already led to battle lines between PE-backed insurers and independents, for example in the industry’s reaction to new CLO proposals by the NAIC.

But these days, the insurance industry’s interest in credit goes much further. Large independents like MassMutual (which owns credit firm Barings) and Prudential (parent of PGIM) are also keen to get in on private credit’s higher returns.

“You earn a higher return for participating and providing capital in an illiquid fashion,” said Faisal Kassam, managing director and the head of ABS at insurance company Kuvare, at the DealCatalyst Specialty Lender Finance conference in September.

Kassam added that he’s been getting more calls to participate in private credit deals, either as part of a small club of lenders, or as part of a larger lender syndicate.

Of course, insurance companies have limitations in terms of how they can invest. They must minimize losses that would impair their ability to meet future obligations, and generally, this means structuring investments in a way that limits risk exposure.

This is one reason that the exploding popularity of NAV loans divides opinions in the market.

To some observers, lending to a PE fund, with highly levered portfolio companies as collateral, smacks of ‘CDO-squared’ deals and the other kind of leverage-upon-leverage structures that sparked the 2008 crisis. To others, it looks like a way for insurers to get exposure to PE firms through a structure that bakes in an appropriate level of downside protection.

This burgeoning NAV boom also comes amid a cacophony of concern around insurance companies’ involvement in private credit, with everyone from ratings agencies to private equity investors sounding the alarm over the sector’s ”binge” on such investments.

One type of NAV loan, as we’ve discussed before, is secured by the assets of a private equity fund. These tend to have lower loan-to-value ratios at 10% to 25% compared with traditional direct lending deals, which makes them a good candidate for the types of loans insurance companies can have in their portfolios.

It’s also easier for insurance companies to get in on the NAV loan action if they these instruments have a rating.

To which point: KBRA currently rates some 54 NAV loans that are “secured directly or indirectly by private equity assets or interests, with ratings ranging from A+ to BBB,” according to a recent research report. The total value of these 54 loans is $27.5bn.

Around $9.5bn of them are the type we described above: they are collateralized by the portfolio assets of private equity funds.

Nowadays, there are about three main use cases for that first type of PE-portfolio backed financing, according to Stephen Quinn, a senior managing director at NAV lender 17Capital:

A sponsor wants to raise new capital to invest into an existing portfolio company, for example in a buy-and-build strategy (which has become more prominent as M&A activity has fallen)

The sponsor wants to distribute proceeds to investors, as assets in a fund are being held for longer

Extra capital is needed to prop up a portfolio company, whether due to company-specific challenges or broader market pressures (e.g. rising interest costs); such situations are much less frequent, but may become more prevalent in the future

“Managers have realized that traditional sources of capital aren't always appropriate — or, in some cases, available — and therefore alternative financing sources such as NAV loans become important," said Quinn in an interview with 9fin.

The second type of NAV loan in the sample outlined by KBRA is secured by LP interests in seasoned private equity funds. Such loans are typically used by PE secondaries funds to finance acquisitions. They represent $18bn of KBRA’s sample set.

An important point about ratings on NAV loans is that they are not hugely transparent. For example, they may be private and therefore not mentioned in public filings or press releases.

Alongside KBRA, we approached Moody’s, S&P, Fitch and DBRS to ask for comment for this article, asking them to clarify whether or not they rated NAV loans. Moody’s said it does not provide NAV loan ratings, while S&P, Fitch and DBRS did not respond.

With Finastra, it ultimately became clear that an equity injection was the only way to push a debt refinancing over the finish line, sources close to the deal told 9fin.

Before the sponsor stepped in, the company had been mulling options including adding a second lien PIK component to the company’s capital structure. Management also instituted hefty cost cuts, helping boost earnings, as we reported in July. But none of that was enough.

“Putting new equity in materially reduced what the price of that capital would have been," said a person who worked on the transaction.

“If that new equity had not come in, it was possible that an even larger unitranche could have been placed, but the cost of that debt and the cash would have just been, frankly, crippling to the business.”

Vista declined to comment for this article. But ultimately, the additional equity that the sponsor stumped up — thanks in part to the NAV loan — led to even more lenders vying to get a piece of the deal.

“By the end, you had people piling in and there was a significant amount of excess demand for this paper,” said the person close to the deal.

In the end, the major selling point was that the equity injection reduced Finastra’s leverage, compared to previous iterations of the refinancing, the person said.

Ultimately, the deal included a $4.8 billion unitranche term loan and $500 million revolver issued at SOFR+725bps with an OID of 98. This debt sits on top of a large preferred equity component.

As for the NAV loan, that sits outside of Finastra’s capital structure. It was arranged by Goldman Sachs, which declined to comment for this article.

All told, it was a favorable outcome for Finastra’s lenders. But ultimately that leverage still exists somewhere. Like a slide puzzle, it just moved elsewhere within the financial system — with different counterparties, and backed by slightly different collateral.

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