Private equity retreats from NAV loan-fueled dividends
Buyout shops are turning away from a quick fix they used to return capital to their investors over the past couple of years.
The use of so-called net asset value loans to pay dividends fell by about 90 per cent during the second half of last year, according to specialist lender 17Capital.
It’s not that NAV loans — which are taken out at the fund level — are falling in popularity. In fact $16.4bn of NAV loans were taken out in 2023, up from $10bn the previous year. But only 3 per cent of the total was used to fund dividends in 2023, down from about a quarter in 2022, according to 17Capital.
It turns out investors were uncomfortable with the extra layer of leverage at a time when lacklustre dealmaking and IPO activity blunted private equity’s ability to return money to LPs.
The decision to shift away from NAV loans for dividends followed reporting by the FT that showed investors had misgivings about the borrowing, which had been used by a who’s who in the buyout industry.
Vista Equity Partners, HG Capital and Carlyle Group all leaned on the tactic to pay dividends.
The loans are collateralised by an entire fund’s individual investments and could be as large as a fifth of a fund’s overall value. They enabled PE firms to extract cash without having to sell a portfolio company.
But the debts exposed an entire fund’s investments to the possibility that just a few of its deals sour.
Steven Meier, chief investment officer of the New York City Retirement System, told the FT he worried some firms had turned to the deals because they were “desperate to appease underlying investors clamouring for more distributions and exits”.
The buyout industry has been able to use other manoeuvres to return cash recently: it’s been easier to raise debt against individual portfolio companies recently with markets rallying this year.
That’s meant PE firms have been able to pump cash back to investors through less complicated means, which they’re eager to do as they try to draw the same LPs back into their new funds.