WASHINGTON, April 27 - The market for fund finance has surpassed the $1 trillion mark this year, propelled by stronger demand from the expanding private credit sector, according to a report by Moody’s Ratings.
What began as an early-stage liquidity solution for private funds has evolved into what Moody’s analysts call a "critical backstop" for private credit lenders as they have established more funds in recent years. The report highlights how private credit managers now operate as both prominent borrowers and lenders within net asset value (NAV) loan markets, which rely on the value of a fund’s underlying investments as collateral.
NAV facilities are attractive to some lenders because they typically provide longer tenors and greater underwriting flexibility. Those features can support higher returns, but Moody’s notes that they also carry elevated risk tied to the underlying loan investments. The fund finance sector has also seen growth in hybrid financing arrangements that combine security from NAV assets with investor commitments.
Moody’s analysts raised specific concerns about the impact of recent disruption among software companies driven by artificial intelligence, and the effect that disruption has had on investor behavior toward private credit funds concentrated in that sector. As the analysts put it, "Asset quality in US direct lending is weakening, and growing disruption from artificial intelligence is introducing additional stress, particularly on software companies," they wrote.
The report also draws attention to NAV facilities' exposure to payment-in-kind (PIK) loans, describing PIKs as loans "which allow borrowers to defer interest payments and instead increase the principal due at maturity." Such loan features can amplify credit strain if underlying investments underperform.
Moody’s emphasizes that the growing acceptance of fund-level leverage among private market investors has reinforced the rise of both private credit and fund finance. "As private market fund investors are becoming more accepting of fund-level leverage, the rise of private credit and fund finance are mutually reinforcing," the report states.
With the market’s expansion, the analysts caution that maintaining disciplined underwriting standards is crucial. They advise fund managers to "maintain prudent underwriting discipline and to rigorously stress-test leverage-on-leverage structures," reflecting concern about layered exposures as leverage increases.
The report also notes an ongoing trend among banks that lend NAV facilities: bundling these loans into asset-backed securities. That practice transfers risk and opens access to capital markets, broadening the investor base for NAV-originated loans.
Context and implications
The Moody’s report tracks how the fund finance market’s maturation is linked with private credit’s growth. NAV loans and hybrid structures are expanding the product set available to managers, but the report highlights several structural and sector-specific risks that could influence asset performance and investor appetite going forward.