KBRA said that its rated fund finance instruments won’t see major disruptions due to President Donald Trump’s tariffs, or market volatility.
The agency laid out its determination in a new research note, with no downgrades expected due to the upheaval.
“Trade tensions may challenge the baseline performance of a number of investment fund debt-related transactions, but we do not see any immediate impact on ratings in our portfolio,” KBRA stated.
The agency anticipates either “minimal disruption” or even an increase in the issuance of certain instruments.
KBRA points to several guardrails in its rated fund finance portfolio. They include strong loan-to-value triggers, sizable overcollateralization, scheduled amortization and most of the instruments having low liquidity risk because they’re for closed-end funds.
Scheduled amortization means that a borrower makes regular, predetermined payments, said Eric Neglia, a senior managing director and global head of fund ratings at KBRA. This scheduled approach makes borrowing less risky and is linked to keeping required LTV levels stable, he added.
“Scheduled amortization reduces risk over time by showing that the borrower is capable of making their payments and lowering the outstanding loan balance over time,” Neglia said. “If asset values decline, built-in certain structural mechanics allow those payments to be used to pay down the note to restore the LTV requirements.”
KBRA breaks out risks that are particular to different types of existing rated fund finance instruments.
The danger zones
For private equity NAV loans, it cites the potential for valuation hits caused by comparable public companies’ own drops, along with slowing distributions due to a weakening exit environment. And secondaries NAV loans could see lower cashflows and LTV pressures due to declines in underlying NAVs and fund distributions.
For sub lines, the agency points to potential liquidity issues for LPs while they attempt portfolio rebalancing.
Collateralized fund obligations’ risks include lower distributions from older underlying funds making it more challenging to meet capital commitments for newer vehicles. Additionally, their LTV ratios could be pushed up due to drops in underlying NAVs.
And for GP stakes financing, KBRA cites the risk of distribution drops due to a myriad of causes such as weakening fundraising, co-investment returns and carry.
The bulwarks
The agency notes that LTV triggers and scheduled amortizations can act as bulwarks against risks for both types of NAV loans, collateralized fund obligations and GP stakes financing.
For sub lines, KBRA cites mitigants including diversification among LPs, risks of reputational damage and penalties for investors that default on their capital calls, along with LPs’ strong credit quality.
Secondaries NAV loan risk is also mitigated by secondaries GPs being able to acquire LP fund interests at higher discounts during turbulent markets per KBRA. And private equity NAV loan risk is partially addressed by low initial LTV levels.
Collateralized fund obligations have various additional mitigants. The agency points out that this includes exposure to secondaries and credit means that they can get more predictable cashflows.
Min Xu, a managing director at KBRA, cited further liquidity guardrails for the instruments.
“There are also often liquidity facilities in these transactions and some [collateralized fund obligations] also have liquid assets in the pool initially as they continue to ramp up by investing into new funds,” she said. “Transactions that do not have liquid assets in the collateral mix often have a pro rata draw structure that is used to match the ongoing capital call requirements.”
New activities for fundraising and fund formation may temporarily be paused, KBRA said. But certain fund finance deals may either see no drops in origination or higher levels.
As an example, it noted that sub lines originations won’t change. It added that this is because the instruments are used for liquidity and due to non-US banks are looking to get ratings ahead of the July 1 implementation deadline for Basel III Endgame.
Secondaries originations could rise, KBRA notes. It cites the potential for bigger fund discounts due to LPs turning to portfolio rebalancing or liquidity.
And origination activity for collateralized fund obligations isn’t expected to change because of rising market acceptance of the instruments, the agency noted.
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