The PE Bros Are Subprime?
Came across this substack. Figured this was a good place to get perspectives. Where does he get it right / wrong?
https://mispricedassets.substack.com/p/the-smart-money-is-the-subprime-this
“Start with a company marked at 100.
At the company, there is 45 of debt.
So the sponsor says the deal is 45 percent levered, and in the narrowest possible sense that is true. That is what the portfolio company owes.
Then the fund borrows.
Maybe it is a subscription line. Maybe it is a bridge loan. Maybe it is a NAV loan. Maybe, at different points, it is all of them. Add another 10 to 15.
Now the stack is 55 to 60.
Then the co-invest is financed.
Add 5 to 10.
Now it is 60 to 70.
Then the LP is financed.
The LP borrows against commitments, against fund interests, against a private-markets portfolio that is supposed to be diversified and is, in practice, full of the same marks from the same years. Add another 10.
Now it is 70 to 80.
Then the people inside the firm borrow too.
They borrow to meet capital calls. They borrow against expected distributions. They borrow against carry. They borrow against the bonus they are supposed to get when the thing finally exits. Add another 5 to 10.
Now the true stack is 80 to 90 on an asset marked at 100.
Nobody reports it that way. They silo the leverage to make it work on paper.
- The company lender sees company debt.
- The fund lender sees fund NAV.
- The co-invest lender sees a co-invest.
- The LP lender sees fund interests.
- The private banker sees a rich man with carry.
All of the debt is stacked on the same cash flows, and the same exit.
Now write the portfolio down 25 percent.”
Subprime bubble two, Quran hai tu hubahu.
Seen his content. Overall, I think he does a great job illustrating where mid-levels (including recently minted principals, MDs, and partners) may actually end up cash strapped or upside down. That is mostly lifestyle creep, which is understandable in certain HCOL markets like NY.
I think where his chain of logic has the largest leap is the assumption that ALL assets are marked materially above their marketable value. That may be true in specific sectors (e.g., software, but note that I am an industrials guy so could very well be wrong about that), but to suggest that everything everywhere is overvalued all at once strikes me as doomer copium. Fundamentally, these are NOT the same cash flows. You have to separate them by where recourse lives.
Let's start with fund-level debt. The subscription line is backed by capital calls. So it breaks if and only if, for example, Texas Teachers does not meet a capital call. I think he's overstating the likelihood this is the case.
The NAV loan is definitely darker magic and I will fully admit to not being qualified to discuss it, because this seems to me to be where recourse is the blurriest.
The GP commit financing is also very heavy stuff, but remember that these facilities are ultimately backed by the mid-levels' assets. So, yes, in a totally upside-down scenario we're talking mid-levels losing assets.
LPs also have liquid, public investments that are performing differently than fund interests. So there's other collateral to go after. Their lending is based on the cash flows they receive across their portfolio.
And the company-level is self-evident: Absent fraud, there is no recourse look-through. Solely based on the cash flows from the company.
Remember, his thesis is that this is like the GFC. On a basic level, he's right, there is leverage at each level of abstraction away from the portfolio company. Where it is different is that the counterparties are sufficiently diverse that the "house of cards" impact from a re-basing event is not going to have the same systemic issues.
TL;DR: It's the same exits, plural. That is a material difference, and it is where fund quality matters the most.
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