Portfolio Lending
Akin to margin loans secured by the portfolio assets, Portfolio Lending is a loan against one’s private asset portfolio, secured by the underlying holdings (or LP interests).
“A bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain.”Explore our funds— Robert Frost
Until recently, borrowing against a Private Equity portfolio for temporary liquidity was extremely difficult.
Nowhere to Turn
In the U.S. alone, individuals have well over $800 billion in existing margin loans, secured solely by their existing investment accounts.1 These margin loans can generate substantial profits for the lender and with limited risk. This is because the collateral, a portfolio of stocks and bonds, may be immediately liquidated to satisfy the loan balance if the price of the assets drops beyond the limits set by the lender.
Until recently, individuals (and institutions) with Private Investments have not been able to easily borrow against their existing portfolio of private assets (i.e. limited partnership interests). Coupled with the fact that private assets are generally illiquid, these investors can be left between a rock and hard place if liquidity is needed. The major multi-national banks and large custodians have shown little interest or willingness to lend against private asset portfolios regardless of the quality of the underlying investments. Regional banks are constrained by regulators, dealing with existential threats on real estate delinquencies and have little expertise in valuing Private Equity funds.
To make matters more challenging, as of mid-2024, the deal making within the Private Equity space has slowed dramatically as a partial byproduct of a rapid increase in interest rates. Less M&A activity and fewer Initial Public Offerings (“IPOs”) means less distributions to investors from the managers/sponsors. While fund managers are keen to ride out the storm and wait for better days, this creates less liquidity for investors.
Should investors need liquidity, they are left with a dilemma. They could sell their fund positions in the secondary market; however, they will most likely be required to accept a discounted price to the current Net Asset Value (“NAV”), and those discounts can be steep (think 20%+ in some cases). More importantly, by selling at a discount today, these investors lose the future potential upside. Keep in mind, some investors may still be in the capital phase of their investment which could compound the dilemma as failing to meet their capital call obligations comes with severe penalties.
This confluence of factors creates a significant opportunity for a Private Credit lending strategy we call Portfolio Lending. Akin to margin loans secured by the portfolio assets, Portfolio Lending is a loan against one’s private asset portfolio, secured by the underlying holdings (or LP interests). No personal guarantees or additional collateral posting is typically required.
This solution allows the investor to retain upside potential in the investments while accelerating cash flow and enhancing liquidity.
“Private Equity Payouts at Major Firms Plummet 49% in Two Years”
— Bloomberg, Feb 2024
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Limited Liquidity Options
Until recently, investors had limited options if they needed liquidity from their existing private market portfolios.
Default on their commitment
Sell on the secondary market
Try to borrow from a bank
3 Distinct Advantages for the Lender
For the lender, and the underlying investors providing the capital, there is the potential for stable inflation protected returns with significant collateral protections. Below are several reasons income investors may find Portfolio Lending an attractive strategy when sitting in the lender’s seat…
1. Floating Rates
Loans are most often given with a floating rate provision to protect investors/lenders against a rising interest rate environment. In addition, the terms of the loans are typically 2-3 years, giving the borrower a relatively short window for repayment.
2. Conservative Loan-to-Value Ratios
Loans are typically based on 20%-30% of the total value of the portfolio’s LP interests (as determined by the current net asset value or NAV). This is extremely conservative and offers the investor/lender a substantial cushion in the event of default.
3. Sufficient Collateral
In the event that a borrow defaults on the loan, the lender can liquidate the limited partnership interest in the secondary market. Even when selling at a steep discount, there should be a significant loan-to-value buffer to recoup principal, interest and potential additional profits if the sale exceeds the repayment amounts.
