Private Credit and Secondaries
With the recent news that top mega-funds have seen declining PE assets and the general negative market sentiment, higher interest rates etc. that will lead to further markdowns if not already, how will private credit and secondaries fare as asset classes in the short and long term?
Is the fate of private credit largely beholden to the fortunes of private equity since many of their loans are to MM sponsor owned firms or can they go round this and originate and close successfully regardless?
As returns inevitably compress in the PC space due to the massive capital influx, how easy is it for investors to sell to secondary parties or are they locked up very similarly to PE investors.
Will secondaries prosper because they come in and take private assets with nice discounts off pension funds that want to reduce their PE exposure or is demand for secondaries a derivative and dependent on the demand for PE? Do you see the margin in secondaries eventually getting competed away to 0 since correct me if I'm wrong but the business model seems to be trading off the discounted purchase price and the "book" value of the funds you're buying into
Cheers - hopefully a good discussion
Bump
The secondary market is a derivative of PE in that a certain % of PE tends to trade every year. That % has been increasing for years, and as the overall size of PE increases, the secondary market will continue to increase, so in some sense yes a derivative. The recent development of GPs using GP-led transactions to generate liquidity and keep their best investments in house will only continue to grow the market.
"Do you see the margin in secondaries eventually getting competed away to 0 since correct me if I'm wrong but the business model seems to be trading off the discounted purchase price and the "book" value of the funds you're buying into"
Maybe for more "flow" names the returns have compressed, but large secondary buyers are putting leverage on top of deals to get back to LP-friendly returns. This isn't a new development. The discount is also only part of the return, you can pay "par" and still turn a good deal if you're aligned with the GP who is generating value for you at the company level.
And one final point on getting "nice discounts" today. Buying at a nice discount off Q1 '22 might look good at close, but with PE valuations down 5-10% at Q2 '22 (and who knows at Q3 '22) that discount will tend to go away over the next few quarters as GPs slowly adjust private valuations commensurate with public comps. If you look at secondary returns over time against discount paid, there isn't that much correlation.
Really need to get away from thinking as price as a % of NAV.
I would rather pay 110% of NAV for a business whose par-value is based on a 8x EBITDA multiple with 30%+ margin with high FCF and very low levels of debt versus paying 50% of NAV where par-value is based on 30x EBITDA for something levered to the tits with mediocre margins and high capex.
Pricing as a % of NAV is window dressing for LPs that like to see a big unrealized gain when deals close but it isn't a proper indicator of "value".
I've long said credit secondaries are bullshit and will stand behind that statement.
The way I was going to construct a response similar to this after reading the initial comment. Great way to put it!
"Is the fate of private credit largely beholden to the fortunes of private equity since many of their loans are to MM sponsor owned firms or can they go round this and originate and close successfully regardless?"
Private credit new issuance volume to private equity will go down concurrently with the lower PE deal volume. Volume to non-sponsor transactions likely flat to up due to increased stressed and distressed scenarios.
"As returns inevitably compress in the PC space due to the massive capital influx, how easy is it for investors to sell to secondary parties or are they locked up very similarly to PE investors."
Not sure what you're talking about here. Benchmark rates rising due to rate hikes are increasing PC returns. Spreads have widened this year, not compressed due to the economic environment. You can sell down positions to other investors but it depends if there is a market for your asset and pricing.
The poster is likely implying that PC used to have wider spread the broadly syndicated but that has compressed.
Also, tons of PE dry powder and default rates remain low. There isn't really a distressed wave that is coming.
The biggest factor to look at as the market cools is the syndicated loan market. So many deals are going private rather than the syndicated route - easier for big PC managers to write checks than it is for banks to distribute paper in this environment. PC managers offer certainty of close and of terms. PC provides a premium (literal and figurative) in this market. So, while direct lenders and PC folks supply many of PE's loans, they will just take up a larger share of the PE deals that are getting done. It's not necessarily a 1:1 correlation. Am I towing the industry line? You could credibly say so, but the proof is in the capital markets.
This becomes especially true given there have been a few recent scares for the banks that structure/syndicate those loans. It reminds everyone that the syndication business isn't as risk free as everyone thinks in a hot market.
.
Much more interesting since GP led deals became a thing. Working on LP led deals (both as advisor and buyer) were pretty damn boring.
.
Private credit is the buzz word these days but looks to have a brighter future all things considered. Deals volumes could still be high, but smaller in value and well diversified, and a slowdown in the gigantic headline deals by big funds could (is already) being seen. There's a lot of dry powder on the sideline and secondaries could benefit. All in all private credit started having an ability to issue debt at a lesser IR and execute faster than banks due to capital requirements. Theres just also a lot of pause in origination due to caution right now. Big pension funds and necesary liquidity outflows is a tough one to gauge, but i think in 2020 it was an average 10% of exposure? I'm sure each fund may have differing redemption rules. Marks are fickle, internal, and firms have different ways to do it. That could put the bid ask spread of secondaries decently wide. Some may price to a yield, some may price to the credit, and some of public firms have to eat it otherwise risk being in Bill Ackman's next book about BDC shorts
I don’t get what you mean return compress on PC side. Direct lending deals at least are mostly floating rate so benefit from rising interest rates. Other sub sets of PC like special situation/distressed may be more impacted by broader economic concerns as they are inherently riskier. On deal volume side, sure new deals might decrease but is sometimes offset by portfolio deals like tuck-in acquisitions and other incremental raises.
pricing models would adjust for the applicable index widening on top of the negating floating rate IRR pickup. Its either that or trying to price directly to the credit or interest coverage. You'd typically have to prove keeping the mark at par - since its illiquid pricing exercises might just be more time intensive this time around.
Dolorem voluptatem temporibus sint quo. Sit dolorum quo esse nostrum quo sed. Veniam nesciunt in voluptas aspernatur explicabo suscipit.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...