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   DealBook: Mortgaging the fund
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             May 11, 2024
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          Good morning. Today we delve into the little-known financial tool that was the talk of Milken. Plus, why “
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         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline;font-style:italic">
          fun-flation
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          ” could be more fun in Europe this summer and what the NFT boom (and bust) says about the broader art market. (Was this newsletter forwarded to you?
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         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline;font-style:italic">
          Sign up here.
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          )
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            <span style="color:#666;font:normal 14px georgia,serif">
             The annual Milken Institute Global Conference in Los Angeles this week.
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          A cross-collateral hazard?
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        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          At the Milken Institute’s Global Conference this week, a little-known risky financial tool became the subject of a hot debate among Wall Street titans.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          Many private equity firms have quietly begun mortgaging their investment funds, piling leverage upon leverage. In other words, they’re taking out loans against the businesses they’ve already taken out loans to buy.
         </span>
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        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
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          At a time when dealmakers are desperate to raise new cash after the boom of the pandemic era, this mechanism — known as a net asset value loan — is allowing them to do it overnight.
         </span>
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          More P.E. firms are using the tool as they set out to raise their next funds, especially those confronting a hurdle during a slow period for dealmaking: They have yet to return cash to the limited partners they tapped for their last round.
         </span>
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          “We’re having unprecedented pressure from our L.P.s to send them cash,” Jonathan Sokoloff, the founder Leonard Green, said onstage at the Milken conference. “We’ll send you cash any way we can.”
         </span>
        </p>
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          The big debate at Milken was whether private equity firms that are solving this problem with N.A.V.s are risking their future to buy some time with investors.
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          How N.A.V. loans work.
         </span>
         <span>
          Offered by banks and some smaller private credit-focused lenders, they are backed by the net asset value of select P.E. firms’ investments. They have a higher interest rate than
         </span>
         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline">
          other forms of private equity lending,
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         <span>
          which appeals to lenders.
         </span>
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        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          There is about $150 billion in N.A.V. facilities on the market today, according to the ratings agency S&amp;P Global. It expects that figure to double in the next two years. Investor liquidity is only one use of the loans, which are often invested back into portfolio companies.
         </span>
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          Lenders say they offer the loans cautiously.
         </span>
         <span>
          “When we come and lend to the portfolio, the fund will be in Year 4 or 5,” Pierre-Antoine de Selancy, a co-founder of the private equity financing firm 17Capital, told DealBook. “We have a very good source of information.”
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          Lenders and advisers who work on N.A.V. loans say they are generally structured to minimize risk, with short durations of two or three years and a low loan-to-value ratio, a measure that compares an asset’s estimated value with the size of the loan. Loans against diversified assets can be safer than ones against an individual company because the risk is spread. That can also mean better loan terms.
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          But the danger is leveraging an illiquid asset.
         </span>
         <span>
          The private equity business model relies on taking out debt against each of a fund’s businesses. But N.A.V. loans are most often borrowing against a
         </span>
         <span style="font-style:italic">
          group
         </span>
         <span>
          of businesses. That diversifies the risk, but it could effectively mean using a good business to help prop up a bad one, while also adding increasingly expensive
         </span>
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
         </span>
         <span>
          leverage to an already leveraged fund
         </span>
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          .
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          “It introduces a greater degree of risk,” Patricia Lynch, who leads the securitization practice at the law firm Ropes &amp; Gray, told DealBook.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          The quality of these loans depends in part on a private equity firm’s ability to accurately calculate the value of its businesses (often with the stamp of a third-party appraiser). If the loans sour, it is not fast or easy to sell those assets.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          Limited partners have limited recourse.
         </span>
         <span>
          Many of their agreements with private equity firms were written before N.A.V. loans were in vogue, which means these loans may be technically allowed, if not explicitly. But executives at several large pension funds who spoke to DealBook on the condition of anonymity, because they were not authorized to comment on behalf of their firms, said they had told P.E. firms that they had concerns about using N.A.V. loans for distributions. Others, like Neuberger Berman,
         </span>
         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline">
          take a measured approach.
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        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          “The general sentiment is: Why are you using them?” Liz Traxler, a managing director at Neuberger Berman, said. “If you have transparency on the usage, and that aligns with the L.P.s, things are probably going to be very positive.”
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          The worst-case scenario — that P.E. firms default on their N.A.V. loans — may be unlikely, but it is an untested risk that could hurt the very investors whom private equity firms are trying to appease in the first place. As Anne-Marie Fink, the chief investment officer of the State of Wisconsin Investment Board, put it onstage at Milken: “If I get a little bit back now, but you’ve levered the whole fund and I’m cross-collateralized all through a N.A.V. loan, and I eventually lose my money, that’s not a good way for me to get my money back.”
         </span>
         <span style="font-style:italic">
          — Lauren Hirsch
         </span>
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            <h3 style="color:#000;font:700 17px/25px arial,sans-serif;margin:5px 0 30px 0;letter-spacing:.2px">
             <span>
              IN CASE YOU MISSED IT
             </span>
            </h3>
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        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          TikTok sued to block a law that could force its sale.
         </span>
         <span>
          The company argues that the recently passed law — which requires the app to split from ByteDance, its Chinese owner, or face a ban — violates the First Amendment by effectively killing in the United States an app that millions of Americans use to share their views. The
         </span>
         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline">
          heart of the case
         </a>
         <span>
          is lawmakers’ intent to defend the nation from what they and some experts say is a security threat.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          FTX said it planned to repay all its customers.
         </span>
         <span>
          It will base their reimbursement on
         </span>
         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline">
          what they were owed as of November 2022
         </a>
         <span>
          , when the cryptocurrency exchange filed for bankruptcy, plus interest. The customers won’t benefit from the huge jump in crypto prices since then.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          More drama unfolded around a Paramount deal.
         </span>
         <span>
          If Sony Pictures Entertainment and Apollo Global Management succeed in the $26 billion acquisition they’ve expressed interest in, they plan to break up the media empire,
         </span>
         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline">
          DealBook’s Lauren Hirsch and The New York Times’s Ben Mullin reported
         </a>
         <span>
          . In other potential breakup news, T-Mobile and Verizon are said to be in talks that would divvy up U.S. Cellular,
         </span>
         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline">
          according to The Wall Street Journal
         </a>
         <span>
          .
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          U.S. authorities are reportedly examining Tesla’s claims about its Autopilot feature.
         </span>
         <span>
          The inquiry by federal prosecutors centers on whether Elon Musk’s electric carmaker
         </span>
         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline">
          committed securities or wire fraud
         </a>
         <span>
          by suggesting its cars can drive themselves, when its systems require human supervision, according to Reuters. It may again raise the question:
         </span>
         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline">
          Is it fraud, or is it puffery?
         </a>
        </p>
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        </table>
        <h2 class="css-12n1aic" style="color:#000;font:700 25px/32px arial,sans-serif;margin:0 0 10px">
         <span>
          ‘Fun-flation,’ Taylor’s version
         </span>
        </h2>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          Europe has finally gotten in on Taylor Swift’s record-breaking Eras Tour — and the economic bonanza that seems to come with it.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          The billion-dollar tour began in Europe on Thursday in Paris’s 40,000-seat La Défense arena, before moving on to Stockholm, London, Amsterdam and other major cities through August.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          Swift’s shows appear to have inspired tourists to hit Europe.
         </span>
         <span>
          Americans who missed out last summer at home are taking
         </span>
         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline">
          advantage
         </a>
         <span>
          of a strong dollar, with tickets costing less on the other side of the Atlantic.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          Airbnb rentals are up in the cities hosting concerts.
         </span>
         <span>
          Airbtics, which tracks data on Airbnb rentals, found a sharp uptick in bookings for several European stops on the Eras Tour. In Paris, rental occupancy jumped to nearly 100 percent on Thursday, up from 73 percent a week earlier. Milan, Munich, Vienna and Warsaw saw similar patterns, according to Airbtics. When European tickets went on sale in July, searches for Airbnb rentals in London, Edinburgh, Cardiff and Liverpool during concert dates increased an average 337 percent for show nights, compared with searches for those dates the previous month, according to Airbnb.
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             <span style="margin:0;font:11px/11px georgia,serif;color:#888;letter-spacing:.01em;padding-left:0">
              The New York Times
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        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          Some economists expect the Eras Tour to be the first boost for a busy European summer of events.
         </span>
         <span>
          Holger Schmieding, the Berenberg economist who coined the term
         </span>
         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline">
          “fun-flation”
         </a>
         <span>
          to describe how consumers were splashing out despite high inflation last year, predicts the trend will continue in Europe in 2024. Swift’s tour is one of several big events on the continent, including the UEFA European soccer championship, which starts in Germany next month, and the Summer Olympics, which open in Paris in July.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          Households in Europe may have even more spending firepower than last year.
         </span>
         <span>
          Food and fuel inflation is moderating more rapidly than in the United States, and interest rates could start coming down as soon as next month. “This summer, we will in Europe have significant further gains in the purchasing power of consumers,” Schmieding told DealBook.
         </span>
        </p>
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         </tbody>
        </table>
        <h2 class="css-12n1aic" style="color:#000;font:700 25px/32px arial,sans-serif;margin:0 0 10px">
         <span>
          What the NFT boom (and bust) says about the dark side of the art market
         </span>
        </h2>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          Remember NFTs? Briefly during the pandemic, the nonfungible tokens generated countless headlines and billions in sales. Now, while other crypto assets are soaring, that market is down to mere millions, and former President Donald Trump is using
         </span>
         <a class="css-sdwaa1" style="color:#286ed0;-webkit-text-decoration:underline;text-decoration:underline">
          NFTs to raise campaign funds
         </a>
         <span>
          . But the boom illuminated dark corners of the art market and economy, the 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 with Small about the upcoming book.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          What did the emergence of NFTs reveal about the art market?
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          They shed light onto the speculation and laundering that happen in the art market all the time. Sales of NFTs are recorded through the blockchain, so we could see prices in real time as they were changing and deduce what was happening. There was a lot of wash trading, where someone had set up two wallets under different signatures and was trading back and forth to elevate the price of a work until some unsuspecting rube bought into it because they thought it was doing well. Some experts and analysts say that ended up being a significant portion of the market.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          So should the art market be regulated more like the stock market?
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          The art market is often referred to as the largest unregulated market in the world. You have paintings trading for hundreds of millions of dollars. But the Bank Secrecy Act does not apply, so it’s very easy to use shell companies. Buyers don’t know sellers. Oligarchs have been very successful in using art advisers as patsies and in moving money. But federal regulators have a fundamental difficulty with the art market because it doesn’t seem serious. How do you put a price on art, and who cares? It’s a champagne problem for billionaires.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          NFTs adopted a very similar approach. It’s a genius approach to create things that look ridiculous so regulators feel they don’t really need to step in. From my reporting, that’s a very deliberate strategy on the part of companies and investors to avoid regulation, and it’s worked.
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span style="font-weight:700;font-family:arial,sans-serif;color:#000">
          What does the NFT boom tell us about the future?
         </span>
        </p>
        <p style="font:normal 17px/25px georgia,serif;color:#333;margin:0 0 15px">
         <span>
          What’s most urgent to me is that if you want to know how the 20- and 30-year-olds think about the economy, you need to know what they were doing in the NFT and crypto world. I think this acceptance of volatility and speculation as we’ve all lived through the interest rates changing and inflation and all the other economic red flags, it creates a system where speculation and volatility are more accepted. It makes it harder for regulators to safeguard the system.
         </span>
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             , Founder/Editor-at-Large, New York
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