Net Asset Value-Based Fund Financings: Credit Rating Criteria and Key Structuring Considerations

As asset-backed fund financing products (ABFF Products) such as net asset value loans (NAV loans) and collateralized fund obligations (CFOs) become increasingly mainstream in private markets, insurance companies, private equity sponsors, and private credit investors must adopt more sophisticated tools to assess, structure, and monitor credit risk associated with ABFF Products. The proliferation of these products has prompted ratings agencies, including KBRA, S&P, and Fitch, to provide guidance and in some cases issue formal frameworks for evaluating ABFF Products. The publication of these ratings indicators marks a critical evolution in the development of ABFF Products and helps provide a roadmap for creating a transparent, scalable market for fund-level ABFF Products.

We reviewed rating agency considerations and structural features in the rating agency frameworks and publications. Below is a summary of takeaways, structuring and surveillance considerations, and strategic implications for institutional investors. The link to the full in-depth article can be found here.

Key Takeaways

• Growing Adoption and Complexity: Insurance and private market allocators are embracing NAV loans and CFOs as potential investments in their portfolios. With the costs of ABFF Products getting more competitive compared to alternative financing sources, asset managers are increasingly embracing ABFF Products as part of their ordinary liquidity and return-enhancement toolkit.
• Role of Ratings Agencies: Ratings guidance in this space helps map a pathway for bridging the equitylike risk associated with ABFF Products with the creditlike risk parameters historically adopted by such rating agencies. The ratings agency guidance helps to articulate features and provisions that should be part of well-structured asset-backed fund financings.
• Dynamic Risk Management: The assets backing these loans are not static, and as such structuring facilities for these assets demands a thoughtful balance of ongoing testing, active reporting, and structural tools to mitigate evolving risk.

Core Structuring and Surveillance Considerations
Based on criteria from KBRA, S&P, and Fitch, the following risk and structural features are pivotal in assessing and managing NAV loan facilities:

• Loan-to-Value (LTV) Covenants and Triggers: Initial LTVs of 10% to 30% with maximums around 40% provide essential downside buffers.
• Cash Sweep Mechanisms: These are critical to reducing refinancing risk and maintaining covenant compliance.
• Portfolio Diversification: Secondary portfolios with broad general partnership, strategy, and vintage exposure score better under ratings models.
• Carefully Structured Security Packages: Careful structuring is important because “all-asset” pledges are generally not practical. Diligence and carefully crafted collateral packages and structuring are important to having enforceable collateral rights.
• Cure Provisions: Borrower-driven cure plans vary based on asset class but are essential to mitigate default risk while preserving value.
• Understanding Subordination, Leakage, and the Ability to Incur Additional Indebtedness: Diligence, covenants, and reporting are essential for protecting collateral integrity and for understanding the potential for collateral leakage and certainty of cash flows.
• Valuation and Reporting: Initial, periodic, and event-driven reporting/testing of NAV of the underlying assets is important, as is a reality check on valuation. It is important to the rating agencies that lenders can seek third-party valuations when necessary.

Strategic Implications for Institutional Investors

• Lower Cost of Capital: Ratings enhance investor and lender confidence.
• Improved Access to Liquidity: Ratings support a broader group of potential investors participating in the market.
• Enhanced Resilience: Structural protections in the loan documents are important and stress testing as part of a rating process and provide insights into how different loans and portfolios would behave in volatile markets.

Conclusion

ABFF Products, particularly NAV loans, are rapidly becoming institutionalized. For insurance investors, private equity managers, and private credit allocators, the next generation of ABFF Products will be defined by legal sophistication, ratings-aligned documentation, and robust, dynamic portfolio surveillance. Structure, diligence, and reporting informed by both the legal and business drivers are not ancillary — they are foundational to the development and continued evolution of ABFF Products and the credit markets generally. 

Thank you to Peter S. Burke, Daniel M. Philion, and Annie C. Wallis for their contributions to this Sidley Update.