Private Credit Secondaries Case Study Insight

Hi all,

Given the great threads on secondaries and interest in learning more about secondaries case studies, I thought I'd share my experience as I had a 1 hour 30 case study earlier this week (based in London). Please note that this was for a private credit secondaries team so was for a bit more of a niche position.

Background / Info provided

•  Provided with an instruction sheet and a laptop with excel. The case was the potential purchase of an LP's position in a credit GP. Qualitative info provided: LP looking for 100% cash sale with limited discount; GP historical loss rate was 0.5%; GP historical return on equity was 2.0x; 0.75% annual management fee (also 15% carry after 10% hurdle but highlighted that they hadn't achieved that performance so didn't need to factor in carry); assets expected to mature one year before given maturity dates; Accounts date of Q3-2022 and expected close date of Q1-2023; 80% discount rate typically applied to 1L and 60% to 2L; and currency conversion rates provided.Two of the assets were on GP's watchlist (see below) and a brief overview of each asset was provided (what the company does)
• Excel had a table of twelve assets with the following information for each asset: Instrument (1L, 2L, Equity); Geography; Sector; Sponsor (Sponsor name or Private); Floor; Coupon; Maturity date; Currency; Local Currency Sales and EBITDA; Leverage (5,0x, 6.0x etc.); LTV %; 'Marks' (FMV); Par Value. Of the twelve assets, nine were 1L loans, one was 2L loan, and two were equity instruments - one of the equity instruments was marked to 0 and the 2L asset was marked at 85    

Tasks

• Provide an overview of the portfolio in terms of geography, sector and weighted credit and financial metrics
• Model out the portfolio. What would be the required purchase price given 10% hurdle? What discount does this represent? Would this be a good investment?
  • Think this was fine but some aspects I didn't get right which I touch on below and I definitely felt time pressure. My method was to split the portfolio by 1L, 2L and equity, then forecast quarterly interest income and expected payback (which was then discounted and summed) and for the equity instruments applied a 2.0x return on cost. Summed cash flows and removed annual management fees (needed to build a table showing AUM over time as investments realise which I didn't do so management fee was too high in later periods) to get to net cash flows and used goal seek for purchase price at 10% hurdle
  • One detail I remembered and think is worth noting was that, as a buyer, you receive the two periods of interest payments between accounts date and close date (this plays into deferral structures)    
• If the purchase was deferred by six months, how would this impact returns and the purchase price? At what purchase price would a seller be indifferent to selling now or six months?
• Sensitise deferral by timing and price
  • Didn't have time to get to this which they said was fine as other case studies hadn't either

De-brief

• Told to treat like IC but very much a relaxed discussion. Discussed portfolio composition (sectors, sponsors, geography) - noted that weighted EBITDA was c.50m EUR which is quite high, leverage was at 5.5x which you'd probably expect to be lower given relatively mature assets but relatively low LTV at 45%. Also discussed impact of floor and rising rates (i.e. the benefit of floating rate instruments)
• Moved onto the model. On reflection, key here was to focus on the bigger picture - particularly the two assets marked down. I applied the 80% discount to each asset, whereas they said it should have been to the assets marked down (reflected in my discount which ended up being 40%!). Also apply a 0.5% blanket discount to each asset to account for historical default rates. I also included the equity instrument which had been marked to 0 which should have been removed
• Discussed deferral and how it impacts IRR - typically a seller wants to minimize the discount (optics) so can use a deferral to get around this

As you can probably see I didn't quite knock it out the park but it was enjoyable and learned a lot. Hope that this will be useful to anyone preparing for case studies.