NAV Loan Ratings Go Formal – Fitch Publishes Master Rating Criteria

Authors: Duncan McKay, Adam Summers, Jan Sysel, Ariel Zell, Zahra Sowder

In a move that highlights the robust and sustained growth in the fund finance market of loans backed by the net asset value ("NAV") of fund investments, Fitch Ratings, Inc. ("Fitch") released its Net Asset Value Finance Rating Criteria report on February 27, 2025. The report finalizes a draft that was circulated in September 2024, and focuses in particular on loans backed by the NAV and cash flows of secondaries funds - that is, funds that invest primarily in the limited partnership interests of other closed-end (private-equity style) alternative investment funds. While in recent years several major rating agencies have formalized methodologies for rating subscription lines of credit, Fitch is, to our knowledge, the first to develop and publish a methodology that is tailored to the NAV loan space. We summarize our key takeaways from the report below.

Highlights

Fitch's approach consists of two principal aspects - first, a Quantitative Rating Indication (QRI), which anchors the rating and second, a Qualitative Assessment (QA), which further refines and modifies the indication.

QRI. The QRI provides a baseline rating of between "a" and "ccc" for the NAV loan, based on the portfolio held by the borrower of the NAV loan ("NAV Borrower"). To determine the QRI, Fitch leverages its own Private Equity Collateralized Fund Obligations ("PE CFO") model, the methodology for which is laid out in detail in its Private Equity Collateralized Fund Obligations Rating Criteria report dated January 30, 2025. The PE CFO model generates several "stressed residual loan-to-value ratios ("LTVs") at maturity" by simulating cash flows of the underlying portfolio of assets under multiple "launch year scenarios" (i.e., as if the underlying funds had launched during various historical or idealized economic cycles), and then applying the core terms (e.g., maturity, amortization and LTV-based triggers) of the NAV loan itself to generate residual LTVs that are grouped into "A", "BBB" and "BB" rating stress levels, depending on the level of stress they can pass. The highest residual LTV in each category (i.e., from the worst launch year scenario) is then mapped onto a rating grid, with the rating corresponding to the "A"- level stressed residual LTV at maturity determining the QRI unless a lower stressed residual LTV at maturity in the "BBB" or "BB" group would correspond to a higher QRI (in which case, the higher QRI is used). The NAV of the underlying funds is at the core of the PE CFO model, and Fitch generally accepts valuations as reported by general partners, though changes may be incorporated if market conditions move materially between the reported valuation date and Fitch's review.

QA. The QRI can then be increased or decreased, or "notched", by the QA, though it can never increase by more than 5 notches (decreases are not limited). While Fitch notes that the QA is holistic and that variations in specific circumstances are possible, the standard QA will consist of the following factors:

Asset Quality (-2 to +2 notches) evaluates aspects of secondaries investments not otherwise addressed by the model. Fitch looks both at the portfolio of the NAV Borrower as a whole (generally, diversified portfolios, including with respect to strategy, vintages, geography, are considered credit positive) as well as individual investments and their underlying fund managers (generally, larger, more experienced managers and funds are considered credit positive).

Additional Sources of Repayment and Liquidity (0 to +2 notches) considers NAV Borrowers that have meaningful access to funding sources other than the portfolio itself to be credit positive. These sources need not be for the specific purpose of backstopping the NAV loan. Rather, where a NAV Borrower also has, for example, a subscription line, uncalled capital commitments, or other assets outside of the portfolio of assets supporting the NAV loan, Fitch assumes the NAV Borrower will prefer to use such liquidity over defaulting on its NAV loan.

Fund and Manager (-2 to +2 notches) evaluates the NAV Borrower's own GP or manager in terms of resources, operational capabilities, experience, market access and performance record. Similar to its approach to Asset Quality, larger (including both in amount of assets under management, and size of flagship funds as well as staff), more diversified and longer established asset managers are considered credit positive.

Structure (-3 to +1 notches) considers those aspects of the loan and security documentation and limited partnership agreement ("LPA") governing a NAV loan and its NAV Borrower, respectively, that are not otherwise addressed by the model. Fitch notes that this factor will typically be neutral where the NAV Borrower's LPA and the facility documentation are "standard", but can be used to account for any aspects of the documentation that Fitch considers to be unusually strong (such as the presence of meaningful additional credit support) or weak (such as limited or no security over the underlying portfolio or collections accounts).

Rating Cap. Citing the relative newness of the product, uncertainty of cash flows, subjectivity in valuation and refinance and market risk, among other things, Fitch will not rate a pure secondaries NAV loan higher than "A+". However, Fitch notes that hybrid loans (where the borrowing base comprises both NAV as well as uncalled capital commitments) will be assessed under both these and Fitch's separate Subscription Finance Rating Criteria, and may be assigned the higher or lower of the two ratings or a rating that combines elements of both sets of criteria.

Conclusion

Fitch's formal entrance into the world of NAV loans marks a significant step for an asset class that has experienced explosive growth over the past several years. Since the start of 2024, Fried Frank has represented both borrowers and lenders in over 40 NAV-based facilities, with a combined value exceeding $13 billion. We have seen a corresponding uptick in demand for credit ratings as borrowers and sponsors court insurance companies and other sources of institutional capital, and develop structures, that are ratings-driven. Fitch continues to receive market inquires on NAV loans and, since the criteria publication in February, has privately rated several facilities. We expect that the availability of a transparent and consistent rating process for secondaries NAV loans will facilitate further development and accessibility of this product.

For more information on Fried Frank's Fund Finance team please visit Fried Frank Fund Finance.

For more information on Fitch's fund ratings please visit Fitch Ratings.

This communication is for general information only. It is not intended, nor should it be relied upon, as legal advice. In some jurisdictions, this may be considered attorney advertising. Please refer to the firm's data policy page for further information.