A market on the move
With a pick-up in secondaries activity, what will come next for the private credit market?
As the private credit market grows and deepens, we are starting to see a pick-up in secondaries activity. So how is the market developing? And what comes next?
The private credit secondaries market may be less mature than its private equity cousin, but it is catching up fast. “Until recently, the private credit secondaries market tended to be very small and there was little demand for this asset class,” says Sebastien Burdel, Partner in the Secondaries Group of Ares Management. “Today, that has changed as private credit has matured. LPs have started rotating managers in their portfolios and some are now seeking liquidity.”
Indeed, private debt funds were the only type of LP-led secondary to see growth in volume for 2022, according to Setter Capital – they jumped by 30% (versus a fall of 21% in buyout fund secondaries and of 51% in venture capital fund secondaries).
Yet the market’s recent development has led to more than deal volume, adds Burdel. “In private equity, real estate and infrastructure, secondaries started with LP-led deals and only evolved very slowly to include GP-led transactions, which took time to create. Private debt has been on a much steeper learning curve, and last year the market saw a roughly 50:50 split between LP-led and GP-led deals in private credit secondaries.”
The speed of growth in demand, however, is causing some issues as available capital has been unable to keep up. “Capacity and adequate capital are disproportionate challenges in private credit secondaries,” says Gopal Narsimhamurthy, Managing Director and Head of North America Funds, KBRA. Indeed, some point to a big difference between private credit and other alternatives. “In private equity, there’s circa two years’ worth of secondaries dry powder,” says Toni Vainio, Partner at Pantheon. “In private credit, in our estimate, there is just under six months – this relative supply-demand imbalance is happening at a time when LPs are seeking to manage liquidity needs and the denominator effect in their portfolios.”
Over the longer term, however, market participants are optimistic that more capital will flow toward private credit secondaries. “Managers expect to see increasing allocations this asset class,” says Burdel. “For LPs, they have the opportunity to reprice risk and have no blind pool risk, and many think that’s a great complement to their primary private credit exposure.”
And it’s these characteristics, say some, that make private credit secondaries particularly attractive in today’s more difficult environment. “You have near full visibility and can analyse the underlying portfolios,” says Vainio. “Then, if you can buy at a discount, you have an attractive and complementary way to access exposure to funds managed by top-tier private debt managers.”
Yet clearly, buyers need to drill down into the detail, given the changed interest rate environment since borrowers in portfolios were financed. “It’s important to stress-test portfolios of loans,” says Narsimhamurthy. “There can be meaningful sensitivity to interest rate rises. We’ve found there are many middle market borrowers who cannot afford a total loan cost of around 12% or higher, which is where we are headed. Lenders and sponsors will be increasing the number of companies they are monitoring regarding their ability to service their loans.”
This is even more important as fund manager assessments of company health and cash flows vary considerably. “There is a wide spread on watch lists,” says Burdel. “And that can even be true for the same assets across managers. We spend a lot of time and focus on watch list assets and work out what should be on there and what might be in future. Ability to service loans is clearly vital.”
So what of the future? “Private equity secondaries used to be around 1% of the primary market,” says Burdel. “It’s now 2% to 3%. I see no reason why we won’t see similar growth in private credit – there is a fundamental need for liquidity.”
Vainio agrees: “We will see market growth and higher deal flow as LPs increasingly look to the secondary market in order to rebalance their portfolios; similarly, on the GP liquidity solution side, we expect deal flow to increase as GPs manage their portfolios more proactively – this will require specialist expertise from the secondary buyer, given the higher level of complexity usually associated with these types of transaction.”
Secondaries transactions will also increasingly start to reflect the diversity of private credit. “The market will evolve,” says Narsimhamurthy. “Currently, the focus is on senior secured loans, but we will see more strategies emerge in secondary portfolios in areas such as asset-backed lending and special situations. This will happen alongside growth.” It looks set to be an interesting period ahead for private credit secondaries.
Private debt has been on a much steeper learning curve, and last year the market saw a roughly 50:50 split between LP-led and GP-led deals in private credit secondaries.
Bringing you the best in private capital
Connect with the people who matter in private equity, venture capital, private credit and real assets
