At the Milken Institute's global conference this week, a little-known risky financial instrument became the subject of heated debate among Wall Street titans.
Many private equity firms have quietly begun pledging their investment funds, increasing leverage upon leverage. In other words, they are taking out loans against businesses that they have already taken out loans to buy.
At a time when dealmakers are desperate to raise fresh cash after the pandemic-era boom, this mechanism – known as net asset value lending – is allowing them to do so overnight.
More PE firms are using the tool as they prepare to raise their next fund, especially those facing a hurdle during a slow period for dealmaking: They have yet to return cash to those limited partners. Whom he had selected for his final round.
“We're facing unprecedented pressure from our LPs to send them cash,” said Jonathan Sokoloff, founder of Leonard Green, on stage at the Milken conference. “We'll send you cash any way we can.”
A spokesperson for Leonard Green said the firm has never used any form of NAV loan.
The big debate at Milken was whether private equity firms that are solving this problem with NAV are risking their future just to buy some time with investors.
How do NAV loans work? Offered by banks and some small private credit-focused lenders, they are backed by the net asset value of select PE firms' investments. They have higher interest rates than other forms of private equity loans, which is attractive to lenders.
According to ratings agency S&P Global, there are approximately $150 billion of NAV facilities in the market today. He expects this figure to double in the next two years. Investor liquidity is just one use of debt, which is often invested back into portfolio companies.
Lenders say they give loans cautiously. “When we come in and lend out the portfolio, the fund will be in year 4 or 5,” Pierre-Antoine de Celancy, co-founder of private equity financing firm 17Capital, told DealBook. “We have a very good source of information.”
Lenders and advisors who work on NAV loans say they are typically structured to minimize risk, with short terms of two or three years and low loan-to-value ratios, a measure that helps in reducing risk. Compares the estimated value of the asset with its size. Loans against diversified assets may be more secure than loans against an individual company because the risk is spread. It could also mean better loan terms.
But the danger is in taking advantage of an illiquid asset. The private equity business model depends on each fund making a loan against the business. But NAV loans are often borrowed against a Group Of businesses. This diversifies the risk, but can effectively mean using a good business to help prop up a bad one, which can also be increasingly costly. Taking advantage of already leveraged funds,
“It introduces a greater degree of risk,” Patricia Lynch, who leads the securitization practice at law firm Ropes & Gray, told DealBook.
The quality of these loans depends partly on a private equity firm's ability to accurately calculate the value of its businesses (often with the seal of approval of a third-party appraiser). If the loan goes bad, it is not fast or easy to sell those assets.
Limited partners have limited recourse. Many of their agreements with private equity firms were written before the prevalence of NAV loans, meaning these loans may have been permitted technically, if not explicitly. But executives at several large pension funds, who spoke to DealBook on condition of anonymity because they were not authorized to comment on behalf of their firms, said they had told PE firms that they received NAV loans for distribution. There were concerns about using. Others, like Neuberger Berman, take a measured approach.
“The general feeling is: Why are you using them?” said Liz Traxler, managing director of Neuberger Berman. “If you have transparency on usage, and it's aligned with the LP, things will probably be very positive.”
The worst-case scenario – that PE firms default on their NAV loans – is unlikely, but it is an untested risk that could harm the very investors that private equity firms are trying to please in the first place. As Anne-Marie Fink, the state's chief investment officer for the Wisconsin Investment Board, said on stage at Milken: “If I back up a little bit now, but you've leveraged the entire fund and I've cross-collateralized it all. ” Through NAV loans, and ultimately I lose my money, this is not a good way for me to get my money back.” – Lauren Hirsch
In Case You Missed It
TikTok filed a lawsuit to block legislation that could have forced its sale. The company argues that the recently passed law – which would require the app to break away from its Chinese owner ByteDance, or face a ban – violates the First Amendment by effectively eliminating the app from being used in the United States. Used by millions of Americans to share their thoughts. At the heart of the matter is lawmakers' intent to protect the country from what they and some experts are calling a security threat.
FTX said it planned to pay all of its customers. It will base their reimbursement on their outstanding balance through November 2022, when the cryptocurrency exchange filed for bankruptcy, plus interest. After this, customers will not get any benefit from the huge rise in crypto prices.
More drama unfolded over the Paramount deal. DealBook's Lauren Hirsch and The New York Times' Ben Mullin report that Sony Pictures Entertainment and Apollo Global Management plan to break up the media empire if they succeed in the $26 billion acquisition in which they have expressed interest. . In other potential breakup news, T-Mobile and Verizon are in talks to divest US Cellular, according to the Wall Street Journal.
US authorities are reportedly investigating claims about Tesla's Autopilot feature. According to Reuters, federal prosecutors' investigation is focused on whether Elon Musk's electric car maker committed securities or wire fraud by suggesting its cars could drive themselves even though its systems require human supervision. This may then raise the question: Is it fraud, or is it sham?
'Fun-Flation', Taylor's version
Europe has finally joined Taylor Swift's record-breaking Erasure Tour – and there appears to be the economic benefits that come with it.
The billion-dollar tour kicked off in Europe on Thursday at Paris's 40,000-seat La Défense arena, before heading to Stockholm, London, Amsterdam and other major cities through August.
Swift's show appears to have inspired tourists to visit Europe. Americans who missed the domestic tour last summer are taking advantage of the strong dollar, keeping ticket prices lower on the other side of the Atlantic.
Airbnb rentals have increased in cities hosting concerts. Airbtics, which tracks data on Airbnb rentals, saw a sharp increase in bookings for several European stops on the Eras tour. In Paris, rental occupancy rose to nearly 100 percent on Thursday, up from 73 percent a week earlier. According to Airbatic, similar patterns were seen in Milan, Munich, Vienna and Warsaw. When European tickets went on sale in July, searches for Airbnb rentals for show nights in London, Edinburgh, Cardiff and Liverpool during the concert dates increased an average of 337 percent compared to searches for those dates the previous month, according to Airbnb. increased by.
Some economists expect the Eraz Tour to be the first boost for a busy European summer of events. Berenberg economist Holger Schmieding, who coined the term “fun-flation” to describe how consumers were spending despite high inflation last year, predicts this trend will continue in Europe in 2024. Swift's visit is one of several big events on the continent, including the UEFA European Football Championships starting in Germany next month and the Summer Olympics starting in Paris in July.
Households in Europe may have even more spending power than last year. Food and fuel inflation is declining more rapidly than in the United States, and interest rates may begin to decline next month. “This summer, we will achieve a significant increase in the purchasing power of consumers in Europe,” Schmieding told DealBook.
What the NFT boom (and recession) says about the dark side of the art market
Remember NFTs? In short, during the pandemic, non-fungible tokens generated countless headlines and billions in sales. Now, while other crypto assets are surging, that market has dwindled to just millions, and former President Donald Trump is using NFTs to raise campaign funds. But the boom illuminated dark corners of the art market and economy, Times reporter Zachary Small writes in “Token Supremacy: The Art of Finance, the Finance of Art, and the Great Crypto Crash of 2022.” DealBook spoke to Small about the upcoming book.
What does the emergence of NFTs reveal about the art market?
They highlight the speculation and laundering that occurs all the time in the art market. NFT sales are recorded through the blockchain, so we could see prices in real time as they were changing and guess what was happening. There used to be a lot of wash trading, where someone set up two wallets under different signatures and was trading back and forth to drive up the price of one thing, until some unsuspecting rube got involved. Didn't buy because they thought it was going well. Some experts and analysts say that it became a significant part of the market.
So should the art market be regulated more like the stock market?
The art market is often described as the largest unregulated market in the world. Your paintings are traded in millions of dollars. But the Bank Secrecy Act does not apply, so it is very easy to use shell companies. Buyers don't know sellers. The oligarchs have been very successful in using art consultants as patsies and transferring wealth. But federal regulators have a fundamental difficulty with the art market because it doesn't seem serious. How do you price art, and who cares? It's a champagne problem for billionaires.
NFT took exactly the same approach. It's a genius way of making things seem ridiculous so that regulators feel like they don't really need to step in. From my reporting, this is a very deliberate strategy on the part of companies and investors to avoid regulation, and it has worked.
What does the NFT boom tell us about the future?
The most important thing for me is that if you want to know how people in their 20s and 30s think about the economy, you have to know what they were doing in the NFT and crypto world. I think this acceptance of volatility and speculation, because we've gone through all the interest rate swings and inflation and all the other economic red flags, it creates a system where speculation and volatility are more accepted. This makes it difficult for regulators to protect the system.
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