Fifteen points of headroom sound comfortable. A markdown shrinks NAV faster than exposure, so the cap arrives sooner than the ratio suggests.
An open-ended loan-originating fund holding 400 of loans on 250 of net asset value runs at 160 per cent leverage, 15 points under the AIFMD II cap of 175 per cent. It breaches the cap after a 12.5 per cent markdown of its loans, a loss of 20.0 per cent of NAV. The formula is (cap − leverage) ÷ (leverage × (cap − 1)), and it is less forgiving than the 15 points suggest.
Worked in full in The AIFMD II Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Directive (EU) 2024/927, AIFMD II, caps the leverage of a loan-originating AIF at 175 per cent if it is open-ended and 300 per cent if it is closed-ended. Leverage is measured under the commitment method: exposure divided by net asset value, so 100 per cent means no leverage at all. Borrowing arrangements fully covered by investors' contractual capital commitments are not counted as exposure, which matters for closed-ended funds with subscription lines and much less for an open-ended fund. The cap is a ratio, and a ratio with NAV in the denominator moves the wrong way in a bad quarter.
| Input | Value |
|---|---|
| Loans at carrying value (commitment exposure) | 400.0 |
| Borrowing under the fund's facility | 150.0 |
| Net asset value | 250.0 |
| Leverage, exposure ÷ NAV | 160.0% |
| Cap for an open-ended loan-originating AIF | 175.0% |
Mark the loans down by a fraction m. Exposure falls by m × 400. NAV falls by exactly the same amount of money, because the borrowing does not move. The same euro loss is a small share of exposure and a large share of NAV, so the ratio rises.
L′ = L × (1 − m) ÷ (1 − m × L)
Set L′ equal to the cap C and solve for m:
m* = (C − L) ÷ (L × (C − 1)) = (1.75 − 1.60) ÷ (1.60 × 0.75) = 12.5%
In Excel, with leverage in B1 and the cap in B2 (both as decimals):
=(B2-B1)/(B1*(B2-1))
Check it on the balance sheet. A 12.5 per cent markdown takes the loans from 400.0 to 350.0 and NAV from 250.0 to 200.0. Leverage is 350.0 ÷ 200.0 = 175.0 per cent, exactly on the cap. The loss is 50.0, which is 20.0 per cent of the NAV the investors started with.
| Markdown of loans | Exposure | NAV | Leverage |
|---|---|---|---|
| 0.0% | 400.0 | 250.0 | 160.0% |
| 5.0% | 380.0 | 230.0 | 165.2% |
| 10.0% | 360.0 | 210.0 | 171.4% |
| 12.5% | 350.0 | 200.0 | 175.0% |
| 15.0% | 340.0 | 190.0 | 178.9% |
| 20.0% | 320.0 | 170.0 | 188.2% |
An open-ended fund has a second way to raise its leverage without losing a euro: pay redemptions from the facility. Exposure stays at 400, NAV falls by the redemption, and the ratio climbs.
Redemption R that reaches the cap when funded by borrowing: R = NAV × (1 − L ÷ C) = 250 × (1 − 1.60 ÷ 1.75) = 21.43
That is 8.57 per cent of NAV. Borrowing rises to 171.43 and NAV falls to 228.57.
Paid by selling loans pro rata with the borrowing repaid in proportion, the same redemption leaves leverage unchanged at 160 per cent. The cap does not care how good the loans are; it cares which line of the balance sheet funds the exit. In a stressed quarter both routes run at once: loans are marked down and redemption requests rise, and the facility is the easiest source of cash. A fund that has 12.5 per cent of markdown headroom on a quiet day can have much less on the day it needs it.
| Cap | Starting leverage | Breach markdown | Loss as % of NAV |
|---|---|---|---|
| Open-ended, 175% | 120% | 61.1% | 73.3% |
| Open-ended, 175% | 140% | 33.3% | 46.7% |
| Open-ended, 175% | 150% | 22.2% | 33.3% |
| Open-ended, 175% | 160% | 12.5% | 20.0% |
| Open-ended, 175% | 170% | 3.9% | 6.7% |
| Closed-ended, 300% | 150% | 50.0% | 75.0% |
| Closed-ended, 300% | 200% | 25.0% | 50.0% |
| Closed-ended, 300% | 250% | 10.0% | 25.0% |
| Closed-ended, 300% | 280% | 3.6% | 10.0% |
The budget is not linear. Moving from 150 to 160 per cent cuts the markdown the fund can absorb from 22.2 to 12.5 per cent; another ten points, to 170, cuts it to 3.9. The last points of leverage are the expensive ones, which is the argument for an internal trigger well below the legal line. A trigger is useful only if it is expressed as a markdown, because that is the number a valuation committee or a risk manager can compare with the stress scenarios they already run.
The usual shortcut reads 15 points of headroom on 160 as room for exposure to grow by 9.4 per cent, or simply assumes that a markdown cannot raise leverage because it reduces the assets. Both treat exposure as the only moving part. The markdown hits the numerator and the denominator by the same amount of money, and the denominator is smaller. The second mistake is to monitor leverage only at quarter end on the valuation date. A fund that pays a large redemption round from its facility in the middle of a quarter can cross the line on that day with no change in marks at all.
Run the test in both directions. The breach markdown tells you how bad the portfolio must get. The breach redemption, here 21.43 or 8.57 per cent of NAV, tells you how much of the exit you can fund from the facility. The first belongs in the valuation policy, the second in the liquidity management tool calibration.
The same fund-by-fund test, with the cap, the transitional position and the markdown that breaches it, is in the free workbook for this case. The liquidity side of the same open-ended credit fund is worked in how to compute a reverse stress level, and the lender's version of the same arithmetic in how far NAV can fall before a NAV facility breaches its LTV covenant.
Directive (EU) 2024/927 caps the leverage of a loan-originating AIF at 175 per cent if it is open-ended and 300 per cent if it is closed-ended, measured under the commitment method as exposure divided by net asset value. Borrowing that is fully covered by investors' contractual capital commitments is not counted as exposure. A fund at 160 per cent therefore has 15.0 points of room under the open-ended cap.
No. A markdown reduces exposure and NAV by the same amount of money, but NAV is the smaller number, so it falls by a larger percentage. In the worked case a 10 per cent markdown takes exposure from 400.0 to 360.0 and NAV from 250.0 to 210.0, and leverage rises from 160.0 to 171.4 per cent.
It depends on where it starts. Using the same formula, a closed-ended fund at 200 per cent breaches the 300 per cent cap after a 25.0 per cent markdown of its portfolio, a loss of 50.0 per cent of NAV. At 250 per cent the markdown budget is only 10.0 per cent, and at 280 per cent it is 3.6 per cent.
This article is one calculation from The AIFMD II Handbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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