Ultimate Resource Covering The Private Equity And Credit Industry

Private-Equity Giants Settle For Bite-Size Deals. Ultimate Resource Covering The Private Equity And Credit Industry

Updated: 6-27-2023

With debt no longer cheap and abundant, Blackstone, KKR and other buyout firms look to smaller deals to build up companies they already own.

Megadeals are out. Little deals are in.

Blackstone and other buyout giants are using their record war chests to snap up smaller companies in deals that typically are easier to accomplish in an era of soaring borrowing costs and economic uncertainty.

Volatile markets and a cloudy economic outlook have made it harder for buyers and sellers to agree on the worth of a business.

More expensive debt and a dearth of bank financing is also making large buyouts more challenging, bankers and private-equity deal makers say.

So far this year, PE-backed deals have an average value of $65.9 million, the smallest for the comparable period since the global financial crisis, according to Refinitiv, a data provider.

Smaller takeovers and add-on deals are en vogue, industry participants say, because they often require no debt and allow firms to keep investing despite the tougher backdrop.

An add-on deal is one where a PE firm or other buyer acquires a business and integrates it into a company already in its portfolio.

As of Friday, the overall value of private-equity-backed deals is down over 50% in 2023 versus the prior period, at a three-year low of about $256.7 billion, according to Refinitiv.

But the number of transactions has fallen 4% to 6,458. That is the third-highest year-to-date tally in data going back more than 30 years, showing the resurgence of smaller deals.

For Blackstone, which is known for larger deals such as its $4.6 billion purchase of events-software company Cvent Holding, the shift means buying smaller companies that it can combine with those that it already owns, said Eli Nagler, a deal maker in the firm’s buyout group.

The combined company can eliminate overlapping operations and boost revenue to achieve a higher valuation in a future sale or initial public offering.

Blackstone can take advantage of portfolio companies that have existing debt facilities locked in at lower rates than are currently available.

By drawing down those facilities to finance a deal, Blackstone and the portfolio company can cut acquisition costs, Nagler said.

Companies backed by Blackstone that have recently struck add-on deals include K-12 education-technology provider Renaissance, advertising automation specialist Simpli.fi, and environmental, social and governance software provider Sphera. Values weren’t available.

Ares Management, which finances deals for PE firms, has also seen this trend play out. “For financing commitments out of our U.S. direct-lending business, we saw a smaller average transaction size in the first quarter of 2023 versus the same period in 2022,” said Kipp deVeer, the head of Ares’s credit group.

Updated: 12-18-2019

Apollo And Blackstone Are Stealing Wall Street’s Loans Business

* Growth Of Private Credit Comes At Expense Of Leveraged Lending

* Apollo Sees $200 Billion Of Debt Going Private Over Five Years

On the surface it was a classic leveraged takeover — $1.8 billion of debt to fund the acquisition of Gannett Co. And just like hundreds before it, front and center was Apollo Global Management. Except this time, the private equity giant wasn’t the borrower. It was the lender.

The deal is part of a major shift occurring in global finance. Direct lenders, including more and more hedge funds and buyout firms, are preparing to dish out billions of dollars at a time to lure borrowers away from the $1.2 trillion leveraged loan market.

It’s the latest push by alternative asset managers into what was once the exclusive territory of the world’s biggest investment banks.

And while Wall Street voluntarily ceded much of its business lending to medium-sized companies in the aftermath of the financial crisis, this time the iron grip it has on arranging the industry’s bigger loans is being pried open, jeopardizing some of its juiciest fees.

“Direct lenders have raised significant capital to allow them to commit to larger deals,” said Randy Schwimmer, head of origination and capital markets at Churchill Asset Management. “It’s an arms race.”

It’s a striking reversal of fortune for syndicated-lending desks that spent the last 10 years luring business away from the high-yield bond market, the original source of buyout financing for big, risky companies.

Even as recently as the beginning of the year, deals in excess of $1 billion were largely seen as the private domain of bulge-bracket banks, which arrange and sell them to institutional investors.

Not Anymore.

Apollo said last month that it’s looking to do deals in the $2 billion range. Rival Blackstone Group Inc. is actively pitching a trio of billion-dollar financings that it intends to hold entirely itself, according to a person with knowledge of the matter.

(The firm declined to comment.) And private-credit standouts including Owl Rock Capital and HPS Investment Partners are also setting their sights on bigger loans.

The August financing of New Media Investment Group Inc.’s acquisition of Gannett came on the heels of a $1.25 billion direct loan

by Goldman Sachs Group Inc.’s private-investment arm — one of the few of its kind under a Wall Street bank — and HPS to fund Ion Investment Group’s purchase of financial data provider Acuris.

And in October, a group of about 10 lenders including Owl Rock banded together to provide a $1.6 billion loan to refinance the debt of insurance brokerage Risk Strategies.

“There are bigger pools of capital” now, said Craig Packer, co-founder of Owl Rock, which controls more than $14 billion. “Our holdings of individual loans are therefore larger than was previously available from smaller lenders.”

Fading Fees

Investors have plowed hundreds of billions of dollars into private debt funds in recent years, lured by premiums that are more than five percentage points higher than competing public debt, according to a Goldman Sachs analysis.

Assets under management now exceed $800 billion, based on the most recent data available from London-based research firm Preqin, including over $250 billion of dry power.

In contrast, leveraged loan growth has begun to stall, with the size of the U.S. market now hovering around $1.2 trillion, up less than 4% from a year earlier.

Partly as a result of direct lenders increasingly allowing borrowers to bypass the syndication process, compensation for arranging leveraged loans has plunged.

Fees are down 29% this year through November, to about $8.5 billion, versus the same period last year, according to Freeman Consulting Services estimates.

The biggest players in the industry say the shift is just getting started.

Apollo predicts as much as 10% of the more than $2.5 trillion high-yield loan and bond market will go private over the next five years, John Zito, co-head of global corporate credit, said at the company’s Nov. 7 Investor Day.

The alternative asset manager sees the privatization of global credit mirroring a similar trend that’s swept equity markets in recent years.

In fact, many say the continued expansion of private equity will only help fuel the growth of direct lending.

“As private equity capacity increases, more deals and larger deals are being done in the private space,” Benoit Durteste, chief executive officer of Intermediate Capital Group, said in a report by the Alternative Credit Council last month.

“This is why we are seeing larger and larger deals in private debt and the limits keep on being pushed.”

Growing execution risk in the leveraged loan market is also prompting buyout firms to increasingly turn to private sources of financing, according to market participants.

Loan buyers have been drawing a line and either bypassing or demanding significant concessions to lend to companies that may struggle in an economic downturn.

On the flip side, private debt transactions can often be arranged in a fraction of the time it takes for a public-market deal, while limited scope for pricing adjustments provides sponsors with greater cost certainty.

Yet efforts to win deals away from investment banks, along with growing competition among direct lenders looking to deploy more than a quarter-trillion dollars of pent up cash, have some worried about weakening lending standards in the industry.

The club loan to Risk Strategies boosted the company’s leverage multiple to seven times a key measure of earnings, as much — if not more — than the issuer would have been able to get away with in the leveraged loan market, according to people with knowledge of the matter.

While the financing includes a maintenance covenant, its terms are loose enough that the company would likely already be struggling to meet interest obligations before the safeguard is triggered, said the people, who asked not to be identified because they aren’t authorized to speak publicly.

“We are worried about how much debt has gone there versus going to the public market, and what that means in a downturn because there’s no liquidity” in private credit, said Elaine Stokes, a portfolio manager at Loomis Sayles & Co. in Boston.

“That could seep into the public markets, if you end up having people becoming forced sellers.”

For others, the growth of direct lending is simply part of the natural evolution of credit markets.

“It’s part of a broader harmonization,” said Jeffrey Ross, chair of Debevoise & Plimpton’s finance group. “The broadly-syndicated loan market for the past 10 years has evolved to look and trade like high-yield bonds. There’s been a similar convergence between the middle-market and bulge-bracket lenders.”

Updated: 6-29-2023

Banks Have To Go Small For Best Returns In $1.5 Trillion Private Credit Industry

* Houlihan Data Shows Loans To Smaller Companies Outperform

* Some Larger Funds Prefer Bigger Deals, Hoping For Resilience

Lenders in the $1.5 trillion private credit industry generate higher returns on loans to smaller companies than on those to bigger businesses, according to data from Houlihan Lokey Inc., pointing to a trade-off faced by managers pursuing larger deals.

The smallest borrowers, as measured by earnings, consistently pay the highest returns, the investment bank found. The firm, which divided companies into quartiles, found that the biggest ones, with Ebitda greater than $50 million, pay the least in data going back to 2017.

The market for the largest direct lending deals has attracted players such as Apollo Global Management and HPS Investment Partners in the last decade.

But funds that invest in mega deals could be sacrificing higher returns, the Houlihan Lokey data shows.

“We have clients asking if they should buy big deals, but our data tells us that large borrowers pay the least,” said David Wagner, a senior adviser at Houlihan Lokey responsible for the firm’s private credit research.

Large direct lenders often tout the resilience of their assets over loans to smaller companies. They typically point to greater product and geographic diversification, as well as improved liquidity and access to debt financing.

Nevertheless, competition is still comparatively thin because few fund managers have the capacity to underwrite mega deals.

Such transactions also give managers the chance to deploy large sums, given the record amount of capital raised in recent years.

Houlihan Lokey’s Private Performing Credit Index shows the dispersion between returns is growing in favor of the smaller bracket. Wagner suggests that small businesses may require more analysis, thus warranting the higher returns.

So, fund managers could face a simple decision between higher returns and more time spent doing due diligence, or the reverse on large-cap deals.

Two dynamics make this decision more difficult. If returns continue to improve on loans to smaller companies, more players may be attracted to that size bracket and the dynamics may shift. Indeed, that process may have begun for some mid-market companies.

Rafael Calvo, chief investment officer of MV Credit, said he had recently seen a mid-market business with pricing similar to a large-cap deal. “We would always need a premium to invest in a mid-cap business,” he said.

The equation changes again if deals from either size bracket suffer disproportionately in a recession. Private credit hasn’t yet endured a prolonged recession and market participants are watching portfolios closely.

While bigger companies will tout their ability to withstand economic shocks better, lender protections have eroded in recent years in many large loans.

In a recent example, EQT AB took Dechra Pharmaceuticals Plc private with the support of a $1.6 billion direct loan deal that lacked any type of maintenance covenant, a contractual protection that allows lenders to monitor the health of businesses on a regular basis.

This trend has gone so far that some mid-market fund managers say smaller businesses are now safer to invest in.

“It’s one of the clear advantages of being a core mid-market player,” Mark Wilton, a managing director at Barings, said on a webinar Tuesday. “We’ve always had robust documentation.”

Deals

* Apollo Global Management led a $225 million private credit debt financing to direct-to-consumer marketer Golden Hippo.

* Tikehau Capital provided a €50 million loan to Milan-based marketing technology company Jakala for the acquisition of Danish firm FFW.

* PacWest Bancorp sold a $3.5 billion asset-backed loan portfolio to Ares Management Corp.

* A group led by Apollo is providing as much as $2 billion to Wolfspeed Inc. to support the semiconductor maker’s expansion in the US.

* Banks and private credit funds are working on debt financings of as much as £1 billion for the potential acquisition of Pharmanovia.

* IQ-EQ is talking to direct lending funds about raising more than €1 billion to refinance its leveraged loans.

Fundraising

* Medalist Partners raised about $600 million to invest in asset-based private credit.

* New Mexico’s sovereign wealth fund approved a bevy of commitments to strategies run by Blackstone Inc., HPS Investment Partners, and Atalaya Capital Management.

* British Columbia Investment Management Corp. deployed almost C$5 billion in private credit investments in the past fiscal year>

* ASK Group plans to raise as much as 10 billion rupees for its debut private credit fund.

* Oaktree Capital Management has raised more than $2.3 billion for its first private credit fund dedicated to life sciences companies.

* Whitehorse Liquidity Partners is seeking to raise $6 billion for a new fund that would help provide liquidity to private equity firms.

Updated: 7-6-2023

More Ways For Investors To Crack The World Of Private Equity

A decade ago, it was almost impossible for private investors to play with the professionals. On this episode of Merryn Talks Money, see how that’s changing.

A decade ago, it was almost impossible for private investors to buy into private equity with the professionals. Most PE funds require huge minimum investments and long-term commitments.
Good managers also don’t come cheap. Now, however, there are more ways for private investors to get into the unlisted sector.

There are funds and trusts that buy individual private companies alongside listed ones, but there are also a few dedicated listed PE trusts.

One of them is Pantheon International. In this week’s Merryn Talks Money, Helen Steers, a partner in Pantheon’s European Investment Team and co-manager of its listed global PE investment trust, Pantheon International Plc, joins host Merryn Somerset Webb to discuss the merits of the sector.

While the sector has a long-term record of outperformance, much of that has come in the unusual low-interest rate environment of the last decade.

Can that continue even as rates normalize? Or are tougher times here to stay for the industry? Steers addresses the questions about discounts, valuations and costs swirling around the sector.

Updated: 7-12-2023

Why Private Equity Is Chasing Plumbers and Lumber Yards

* Founder-Owned Firms Make Up Highest Share Of PE Deals In Years

* Atlanta Plumber Says Daily Investor Pitches Are ‘A Nuisance’

Local plumbers and lumber-yard owners across the US are feeling a bit like tech entrepreneurs of late — juggling multiple offers from private equity-backed firms that increasingly are targeting mom-and-pop businesses.

Wall Street has been buying into fragmented Main Street industries for years, with dental and veterinary practices among the favorite targets.

It’s known as the roll-up strategy – and it’s catching a tailwind right now, and expanding rapidly in household services and building materials.

Small firms account for the biggest share of acquisitions by PE funds and their portfolio companies since the late 2000s, according to data from industry analyst PitchBook.

They made up more than 61% of all private equity deals in the first quarter of 2023, compared with an average in the mid-50s over the past decade or so.

“If you acquire enough, you get economies of scale,” says Tim Clarke, PitchBook’s lead private equity analyst. “You just keep rolling rolling, rolling and before you know it you’ve got 10-20% of the market.”

‘They’re A Nuisance’

One reason that approach is popular now, according to Clarke, is that higher interest rates have pushed valuations down across the board.

Owners who might otherwise have considered a sale — whether they’re publicly traded companies, or private equity — are holding onto companies in their portfolios instead.

As a result, would-be buyers are turning toward smaller privately-owned firms, which also tend to be cheaper relative to their earnings.

What’s more, private equity’s enthusiasm for small firms is spreading into industries like plumbing and other trades — which have shown they’re recession-proof, even in the Covid slump, and have room for consolidation because markets are typically divided up among many businesses.

All of this Wall Street interest is a blessing for some Main Street owners looking to cash out. They don’t all see it that way, though.

In the Atlanta area, Jay Cunningham says he gets several pitches a week from PE-backed firms wanting to buy his Superior Plumbing — one of the few sizeable local firms that hasn’t already been snapped up by investors — or from investment bankers wanting to bring Superior to market. He’s not interested.

“I probably think they’re a nuisance as a whole,” Cunningham says.

In terms of dollar value, PE acquisitions of publicly traded companies or those bought from other private equity firms still make up the biggest chunk of deals.

Even by that measure, though, purchases of founder-owned businesses — which in most cases are valued at under $100 million apiece — are on the rise.

They accounted for more than 43% of deal value in the first quarter of 2023, well above the typical levels in recent years, according to PitchBook.

‘Lot of Players’

Especially prized are firms with steady revenue, subscription models and electronic billing, says John Wagner, a New Mexico-based investment banker who helps small and midsize companies find buyers.

Better yet, he says, is a locally owned firm with strong revenue but high expenses — an opportunity to cut costs, increase efficiency and quickly boost the firm’s value.

In the Denver area, Steve Swinney is constantly hunting for lumber yards, steel fabricators, drywall distributors and kitchen-interior companies.

His Kodiak Building Partners started out buying one steel fabrication firm 12 years ago, in the wake of the Great Recession.

It’s made about 40 acquisitions since then, and welded them all into a building-materials firm with sales of around $3 billion.

As it looks for more mom-and-pop firms to buy, Kodiak — which is majority owned by New York-based PE firm Court Square Capital Management — faces plenty of competition.

“There’s definitely a lot of other players out there,” Swinney says. “I wish we were alone.”

John Loud gets as many as 30 solicitations a month for his Kennesaw, Georgia-based alarm installation firm, Loud Security Systems, which has about 60 employees and more than $7 million in annual revenue.

“It’s a non-stop barrage,” Loud says, and it’s been going on for years. He used to joke with employees: “If you want job security, save me from these calls and these emails.”

Open To Offers

Nowadays, though, Loud is entertaining offers. His two kids aren’t interested in running the family business, and at 56 he feels closer to the end of his career than the start.

He expects to continue with the firm after any sale, and keep 30% equity in the company, but figures his proceeds will be enough that if things don’t work out, “I’ll never have to go create a new business, never have to go to work.”

His longtime friend Cunningham, the Atlanta-area plumber, is comfortable for now holding onto Superior Plumbing, which has about 60 employees and $10 million to $15 million in annual revenue.

A couple years ago, the 61-year-old Cunningham says, he sent a rudimentary financial brief to an investment firm and the would-buyer shot back an offer for more than $60 million. But unlike many peers, his children are interested in taking over the firm at some point.

“Right now I have five kids in my business. That’s a combined north of 60 years of time,” Cunningham says. “If I sold for $60 million, it wouldn’t enrich my life at all.”

Updated: 7-17-2023

You Rang? The Super-Rich Will Privatize Us All

A huge range of talent — from chefs to nannies to accountants — are being hired by the wealthy and managed by their family offices.

The vanishings keep on happening. Chefs who have run wonderful restaurants fold their operations and disappear from the world of haute public dining rooms.

It’s happened in New York and in London in my experience. I’m sure you’ve noticed it too wherever you are a regular — or were, until the chef up and left.

You then hear rumors. So-and-so has been snagged by a billionaire. You see an occasional post on social media clueing you in to said chef’s new lifestyle: no more endless nights bent over bookkeeping, no more customers who think orange wine is made with citrus, no more no-shows, no Yelp.

I’d once in a while get a glimpse into these new lives: a surreptitious Instagram post from a private party in some inaccessible Manhattan tower; an off-the-record walk through the enormous kitchen of a private townhouse; or just a note about how wonderful it is to be picking herbs in a lovely estate you knew the cook could never afford.

This is an option nowadays not not just for chefs burned out by the daily grind of restaurants, but accountants, investment advisers, personal shoppers, nurses, veterinarians and security guards.

It’s not a bad life. These are experts whose services have become exclusive to the super-rich who can afford to wall away them away from the rest of the world1.

While non-disclosure agreements keep the specifics of these positions confidential, there are semi-exclusive hires that give a sense of why they can be attractive. I’ve known Liam Nichols for a few years now.

He’d worked at Momofuku Ko in New York City and Tom Kerridge’s restaurant at the Corinthia Hotel in London — excellent pedigrees. He was also a warm and wonderful presence wherever he cooked. Then, one day, like the unnamed chefs above, he vanished.

For months, the photographs he posted on social media were excruciating. There he was on a beach in the Caribbean, or kitesurfing on the bluest waters, soaking up the sun by a sailboat, sporting a smile so broad it was practically solar itself.

Had he come into money? In a way, he had: Liam had been hired to cook for the billionaire Richard Branson, founder of the Virgin Group, on 74-acre Necker Island, which he owns in its entirety, in the British Virgin Islands.

Sometimes, Liam would prepare meals for Branson’s visiting neighbor, Larry Page, the co-founder of Google, and owner of Eustatia, the island next door — as well as for other rich guests at the Necker resort (where the cost is upwards of $3,700 per night per room).

Giving up on a public-facing existence is becoming more of an option nowadays. The market for privatized services is growing because there are a lot more deep-pockets everywhere. Forbes says that millionaires control about a quarter of the world’s $431 trillion total wealth.

That’s roughly $105 trillion, more than the combined GNP of the US, China, Japan, Germany and India. The total population of those countries: about 3.3 billion people.

The number of millionaires in the world: 62.5 million, according to a 2022 Credit Suisse report. That statistic is expected to grow 40% by 2027. The richest 25 families in the world alone control more than $1.5 trillion.

For people used to — and tired of — working against layers of bureaucracy toward some merciless corporate bottom line, it is liberating to have only one real task: to make a wealthy owner (and his or her family and friends) happy.

Still, to borrow from F. Scott Fitzgerald, the rich are different not just from you and me but from each other. There are mere millionaires and then there are “ultra-high net worth individuals” — people so wealthy their families can operate as virtual fiefdoms.

To qualify for the lower end of the category, you need a net worth of $30 million. Even that may not be elite enough to manage your wealth through a family office — a dowdy term that belies the assets involved.

To be able to staff the operation, the usual estimate is a net worth of $50 million.

There are now about 8,000 single-family offices in the world. Most are in the US and Canada, where many of the richest people in the world reside.

Even as 85% of the world’s humans live on $30 a day, the rich proliferate everywhere — as do their family offices. Singapore had 50 family offices in 2018 but 1,100 now (and that may be an underestimate, according to my colleague Andy Mukherjee).

The city-state and the United Arab Emirates are magnets for the burgeoning market of regional plutocrats looking to sweep up financial expertise to manage their private wealth.

Apollo Global Management Inc. has joined the scrum of financial giants (including Blackstone Inc. and KKR & Co.) offering expertise to the world’s UHNWIs and their family offices.

That kind of wealth management doesn’t just mean making more money but spending it — from investing in philanthropic and environmental causes, to mitigating the scale of a clan’s conspicuous consumption, to paying the salaries of service providers — OK, servants.

In a related phenomenon, pop stars who would never have thought of performing at bar mitzvahs, weddings and birthday parties are now doing so-called “privates” because of the many customers able to afford their once forbiddingly exorbitant prices.2

Members of the new servant class can benefit tremendously from bidding by the rich for the best in class. For example, chefs who have run critically acclaimed restaurants can pick and choose the private homes they’d rather work in.

So can nannies — and chauffeurs and butlers, veterinarians and nurses, tailors and number crunchers. The advantages can be enormous.

Those considerations can be trumped by one thing: the unhappiness of your super-rich masters. The only way to shield yourself from the ire of your employer is a well-written contract.

You can’t depend on the regulations that protect most workers in a corporation. And forget about labor union guarantees.

Happiness is a fleeting thing — and it is especially fickle among people who believe they personally control everything via money spigots.

You don’t have to work for them to know this. I used to hang with some very rich friends, and one day I jokingly disagreed with them.

Or I think that was my transgression. I can’t really tell. All I know is that the annual invitation to their villas by the sea no longer comes in the mail. Sigh.

Liam didn’t make his billionaire employer unhappy. But preparing shepherd’s pie (Branson’s favorite dish) wasn’t going to get him into any culinary hall of fame.

Liam left the world of the super-rich after six months and returned to his roots in Norfolk, where he opened a small five-table restaurant called Store in Stoke Mill. He works very hard at all the things that make restaurants difficult. But he is happy. He just won a Michelin star.

Updated: 8-2-2023

Private Equity, Hedge Funds Brace For Coming SEC Overhaul

Regulators could adopt new rules for firms such as Blackstone and Millennium as soon as this month.

WASHINGTON—Private-equity and hedge funds are bracing for what could be the biggest regulatory challenge in years to their business of managing money for deep-pocketed investors.

The Securities and Exchange Commission is preparing to adopt a rule package as soon as this month aiming to bring greater transparency and competition to the multitrillion- dollar private-funds industry, people familiar with the matter said.

SEC Chair Gary Gensler has said he hopes to bring down fees and expenses that cost hundreds of billions of dollars a year.

Since the agency first proposed new rules for the industry last year, representatives of private equity, hedge funds and venture capital have met frequently with SEC officials to try to dissuade them, SEC meeting logs show.

They have lobbied lawmakers to push back against the SEC’s plans and formed a group to fight the final rules, which could differ from the proposal.

“This is probably the single largest and most impactful of all the things that the SEC is doing,” said Drew Maloney, president of the American Investment Council, which represents private-equity firms such as Blackstone, Apollo Global Management and Carlyle.

Private funds are generally available only to wealthy individuals and institutional investors such as pensions and university endowments, which hope for returns larger than what they can get from traditional stocks and bonds.

The SEC has long considered such investors sophisticated enough to fend for themselves with minimal regulatory oversight.

In recent decades, the SEC and Congress have repeatedly loosened regulatory and disclosure requirements for private funds and companies.

This move—combined with tougher rules for banks and years of low interest rates—ushered in a boom in private fundraising that surpassed the public market in the years before the pandemic.

Gensler said in a recent speech that private funds’ gross assets recently surpassed those of the commercial banking sector at more than $25 trillion. That is up from $9 trillion in 2012, according to SEC data.

Some policy makers have grown alarmed at the burgeoning size of the lightly regulated sector. They worry that private funds could pose risks to financial stability and to pension beneficiaries such as teachers and firefighters. Other concerns are that they might charge unfair fees or overvalue their holdings.

“Investors need increased transparency, more informative and useful data, and prohibitions on abusive and conflicted practices,” Sen. Elizabeth Warren (D., Mass.) and seven other Democratic senators wrote in a May 15 letter urging Gensler to complete the rules.

The SEC’s proposed overhaul would require private funds to provide investors with quarterly statements and annual audits, increase their liability for mismanagement or negligence, and prohibit them from giving some investors more-favorable terms than others.

In the 18 months since the SEC floated those ideas, private funds and their trade associations have fought to stymie the agency’s plans.

They argued that the SEC rule would hurt minority and women-owned funds, which currently manage a tiny percentage of overall assets.

After being lobbied by the American Investment Council on this concern last year, an industry official said, the House Appropriations Committee passed language encouraging the SEC to redo its economic analysis for the new rules.

Shortly after the proposal was unveiled, a group of hedge funds including Millennium Management and HBK Capital Management formed a nonprofit in Texas called the National Association of Private Fund Managers, said Bryan Corbett of the trade group Managed Funds Association.

The former group has no website and listed no individual’s name or contact information in a comment letter it filed to the SEC calling the private-funds rule “arbitrary and capricious.”

The group’s location in Texas would place it under the jurisdiction of a federal appeals court whose predominantly Republican-appointed judges have shown a penchant for reining in regulatory authority.

Millennium and HBK didn’t respond to requests for comment.

SEC officials have acknowledged that the industry is gearing up for a court battle.

“There’s a whiff of litigation in the air,” William Birdthistle, who heads the SEC division writing the private-funds rule, said at a May conference hosted by the Managed Funds Association, which represents hedge funds. Corbett said at the event that the MFA was preparing for a potential lawsuit.

The MFA has been vetting lawyers, looking for allies and developing legal strategies against the rules in case the SEC’s final version is similar to the proposal, Corbett said in an interview.

“The negative impact on the industry is significant,” Corbett said. “The word ‘existential’ I don’t think overstates it.”

The SEC rules would come in the midst of headwinds for some asset managers. Private-equity and venture-capital funds, which tend to invest in illiquid companies and are slow to mark down their valuations, are only beginning to show the effects of last year’s downturn in financial markets.

Benchmark private-equity returns turned negative for the year ended March 31 for the first time since the 2008-09 financial crisis, according to a Burgiss Group index that excludes venture capital.

Venture funds posted their longest streak of negative quarterly returns in more than a decade, according to PitchBook Data.

Private-fund managers are particularly anxious about the SEC proposal to prohibit them from limiting their liability for negligence, which would make it easier for a fund’s investors to sue managers over making bad investments.

Industry groups said that would drive up the cost of insuring against such litigation, crimping their returns to investors.

They are also worried about the SEC proposal to ban private funds from giving preferential terms to certain investors through what are known as side letters.

That would eliminate a marketing tool used by new funds to draw in big-name investors by offering them lower costs.

Updated: 8-3-2023

Private Credit Funds Move From Mergers To Timeshares And Car Loans

As banks pull back, the investment funds—cousins of private equity—make a move on Main Street debt.

Since the fall of Silicon Valley Bank in March, banks across the US have been maneuvering to shore up their capital while deposits shrink and investors eye their balance sheets.

The easiest way to do that has been to pull back on financing for small and midsize businesses as well as consumer credit companies such as buy now, pay later and auto lenders.

That’s provided a huge opening for the new rising power on Wall Street: private credit funds.

These funds, which are similar to private equity firms but focused on lending to instead of buying companies, manage about $1.5 trillion.

Some are run by private equity giants such as Blackstone Inc. and KKR & Co., others by specialty finance shops such as Castlelake and Atalaya Capital Management. Private credit is already an important source of funding for corporate buyouts.

Now the weakness of banks means there are deals to be had on investments in more Main Street forms of debt, such as asset-based loans, which can be tied to anything from auto financing to mortgages.

“The stone has been thrown into the pond, we are watching the ripples as they come our way, and we are trying not to show the smile on our face,” says Joel Holsinger, co-head of alternative credit at Ares Management, referring to the opportunities in asset-based lending.

For years, regional banks were among the biggest buyers of consumer loans. They were also a cornerstone of stability for smaller companies hoping to grow. But all that is now over.

At US banks below the top 25, deposits shrank by nearly $133 billion from the end of December to mid-July, on a seasonally adjusted basis, according to data from the Federal Reserve.

To retain capital, banks have begun selling many of the loans on their books. California-based PacWest Bancorp—which agreed in July to be acquired by Banc of California Inc. after being shaken by a drop in deposits—in June sold a $3.5 billion debt portfolio to Ares. It included consumer loans, mortgages and receivables on timeshares.

It isn’t only regional banks getting loan-shy, especially as the Fed discusses new rules requiring big banks to manage their balance sheets more conservatively.

“Large US banks are also retrenching from consumer credit to just stick to their core clients, and this will accelerate if proposed additional capital buffers are implemented,” says Aneek Mamik, head of financial services at private lender Värde Partners.

Värde has purchased about $1 billion in consumer personal loans made by Marcus, an online banking arm of Goldman Sachs Group Inc., Bloomberg News has previously reported.

Private credit has been making inroads with financial-technology companies, becoming more embedded in the consumer economy. KKR bought as much as €40 billion ($44 billion) of buy now, pay later loan receivables from PayPal Holdings Inc.

Atlas SP Partners, the credit unit Apollo Global Management Inc. bought from Credit Suisse Group AG, was part of a deal to buy a pool of consumer loans from a US credit union.

Castlelake also agreed to purchase up to $4 billion of installment loans from online lender Upstart Holdings Inc.

Private credit funds’ willingness to offer borrowers more flexible terms than banks—not to mention their stockpiles of capital—have also gotten the attention of small- and midsize companies shopping for lines of credit or loans backed by their assets.

“It’s a completely unfair fight,” says Randy Schwimmer, senior managing director and co-head of senior lending at Churchill Asset Management, which specializes in midsize companies.

Construction company Orion Group Holdings Inc. had a $42.5 million revolving loan with Regions Bank and other lenders. It’s been replaced by a $103 million financing deal with private credit shop White Oak Global Advisors, according to White Oak partner and President Darius Mozaffarian.

When the independent filmmaker New Regency needed additional capital for new projects, it turned to private lender Carlyle Group Inc. as banks pulled back, says Ben Fund, managing director at Carlyle.

Configure Partners, a firm that helps corporate borrowers obtain financing, has already seen the shift. A year ago regional banks represented about a quarter of lenders in any given deal.

Now they’re only about 15% of the total, with private credit filling the gap, says managing director Joseph Weissglass.

Conditions that benefit private lenders are worrying for the economy more broadly. Even before Silicon Valley Bank’s collapse, rising rates were making capital more scarce and putting pressure on already-struggling companies.

“Lack of available credit is a concern—it would be bad for the consumer as well as small businesses,” says Dan Pietrzak, global head of private credit at KKR.

But private credit is unlikely to rescue everyone. Used-car dealer and subprime finance company American Car Center, which was backed by York Capital Management, reached out to private lenders at the end of 2022 when it was struggling to find traditional financing, according to a person with knowledge of the matter.

It ultimately went bankrupt in March. A representative for York Capital declined to comment.

Other consumer finance companies may follow the same trajectory. When unable to obtain debt from banks or private lenders, they’ll end up closing their doors. That could leave consumers with fewer options to access credit for purchases from cars to houses.

It’s already started to happen: A Federal Reserve survey in July showed that Americans are increasingly likely to get turned down when they apply for credit.

“Ultimately, the prospect of less competition—and the need to make profitable loans—means consumer rates will inevitably rise,” says LibreMax Capital Chief Investment Officer Greg Lippmann.

The expansion of private credit into more parts of the economy also raises questions about transparency. The managers of the funds aren’t as closely watched by regulators as banks and there is less visibility on the performance of their investments compared with public markets. But increasingly for some borrowers, private credit is the only show in town.

Updated: 8-7-2023

Private Credit’s $10 Billion Win Is Bad News For Wall Street

* Some $10 Billion Of Leveraged Loans Have Been Refinanced

* Direct Lenders Look For More Business Amid Light LBO Volume

Private credit is muscling in on another market traditionally dominated by banks: debt refinancing.

Companies with leveraged loans and junk bonds coming due soon are increasingly turning to private credit lenders to refinance their obligations, with around $10 billion of the loans having been replaced in recent weeks.

Thoma Bravo-owned Hyland Software Inc. is turning to a group led by Golub Capital to refinance about $3.2 billion of maturing debt.

That deal came after a record-breaking $5.3 billion refinancing package for Finastra Group Holdings Ltd., a financial software firm backed by Vista Equity Partners.

A group of private credit lenders stepped in after the company saw its ratings cut and faced a potentially painful negotiation with existing creditors that had organized and hired a financial adviser and legal counsel.

For years, private credit lenders have been providing financing for leveraged buyouts, funding deals that would have otherwise relied on the syndicated loan or junk bond markets.

That’s translated to Wall Street banks missing out on lucrative underwriting fees, cutting into an important stream of revenue for the firms.

But leveraged buyout volume has been relatively light this year. With fewer deals to fund, private lenders are looking for other ways to deploy their dry powder, which amounts to $443 billion globally as of September, according to estimates from research firm Preqin. Refinancing looks like an attractive opportunity to the firms.

“It’s private credit coming out of the shadows,” said Ranesh Ramanathan, co-leader of Akin Gump Strauss Hauer & Feld LLP’s special situations and private credit practice. “Private credit is now part of the recognized pool of capital you’d look to.”

For companies, refinancing with private credit lenders will often cost more in terms of interest paid. But going the direct lending route offers financing that is highly likely to close, at a time when leveraged finance markets can be all but shut for weeks.

And while banks will look to sell leveraged loans or junk bonds to dozens of investors, potentially leading to protracted conversations among many parties on pricing and other terms, private credit deals typically involve just a few lenders.

Medical device manufacturer Tecomet, backed by Charlesbank Capital Partners, recently refinanced

more than $1 billion of broadly-syndicated debt with the help of private credit lenders.

Many leveraged loan borrowers refinanced debt in late 2020 and 2021 when rates were low and credit markets were strong, but there are still companies with upcoming debt maturities.

About 2% of the roughly $1.4 trillion US leveraged loan market matures in 2024, and another 10.3% matures in 2025, according to data from Barclays Plc. Companies typically refinance debt at least one year in advance, meaning borrowers are looking closely at how to deal with loans maturing in 2025.

Competition from private credit could weigh on the growth of the leveraged loan market, according to Barclays strategists.

“With alternative financing sources such as private credit and secured bonds continuing to take share from loan primary markets,” there could be “further headwinds for growth of the loan index, which has already fallen by $38 billion from its peak of $1.436 trillion in September 2022,” wrote Barclays strategists in June.

Deals:

* A group of private lenders including Blue Owl Capital Inc. and Blackstone Inc. is providing $2.7 billion of debt to help fund BradyIFS’s acquisition of competitor Envoy Solutions.

* Vietnamese financial firm F88 Investment JSC has secured a $50 million private loan to help expand its presence in the country’s non-banking sector.’

* Blackstone’s credit unit is supporting Permira Holdings’ takeover of biopharmaceutical services firm Ergomed Plc with a £285 million debt package.

* A trio of private lenders including Blackstone agreed to provide a £180 million loan to help finance GTCR’s acquisition of compliance and supply chain management software platform Once For All.

Fundraising:

* Blackstone’s nearly $50 billion private credit fund for affluent individuals attracted the most capital in more than a year, as the asset class sees a rebound in fundraising.

* Asset manager Phoenix Holdings announced a partnership to invest as much as $2 billion with Apollo Global Management Inc. in Israel.

* Former Goldman Partners Join Private-Credit Rush In New Venture.

* New York-Based Duo To Focus On Direct Lending In US And Europe

* 5C Joins Wave Of Firms Betting On Fast-Growing Market

Former Goldman Sachs Group Inc. partners Tom Connolly and Mike Koester are betting on one of the hottest corners on Wall Street for their next act.

The New York-based duo have co-founded a new firm, 5C Investment Partners, that aims to capture a slice of the burgeoning private credit market, where alternative asset managers are increasingly displacing banks by providing multi-billion financings to companies.

“Direct lending is playing a very important role during a market dislocation that is persistent,” Koester said in an interview Thursday, referring to regulation that has curbed bank lending since 2008. “There are credit-worthy companies that need financing.”

Many Wall Street veterans have sought to capitalize on a yearslong shift that’s seen more capital flow into the hands of private credit managers.

Josh Harris’s 26North Partners and Dan Loeb’s Third Point have both made high-profile hires in recent weeks to push into direct lending.

Connolly and Koester are not new to the trade. At Goldman, they helped the bank develop its direct lending business and raised a $10 billion credit fund after Bear Stearns had collapsed.

“They have a very strong record, and it’s not a surprise they’re trying to repeat the success of their collaboration,” said Bjarne Graven Larsen, founder and CEO of Qblue Balanced, a Copenhagen-based asset manager, who recalls committing more than $4 billion to that Goldman fund during his tenure as chief investment officer at Danish pension fund ATP Group.

“It was well-timed and well-structured, and some of the first investments were credits out of the Lehman bankruptcy at roughly 30 cents on the dollar which led to great returns that I’d never seen before from a loan fund.”

Old Mantra

5C, which describes itself as a credit-centric alternative investment firm, will be initially focused on the US, with scope to expand in Europe. Connolly, who estimates an addressable market of $3 trillion in coming years, believes there’s room for independent platforms despite increased competition among direct lenders.

The firm’s name is a nod to the “five Cs of credit” a lending framework Connolly and Koester learned as young credit traders at Bankers Trust in the 1990s. The five Cs — capacity, capital, collateral, conditions and character — were emblazoned on mugs the firm’s chief credit officer handed out.

“We are fundamental investors in everything that we’re doing, and these are five incredibly important tenets for investing, underwriting and lending,” said Koester, citing character — or the reputation and behavior of borrowers — as the top principle.

Connolly, who made partner at Goldman in 2004 and held roles including global co-head of private credit, left

the firm last year. Koester, who became partner in 2008 and held roles including co-president of alternatives of Goldman Sachs Asset Management, left in April.

“I am looking forward to Mike and Tom being important clients of Goldman Sachs in their new venture and believe this is the powerful Goldman Sachs ecosystem in action,” Alison Mass, Goldman’s chairman of investment banking and leader of its alumni engagement effort, said in an emailed statement.

Updated: 8-8-2023

Private Equity Giant David Rubenstein Makes The Case For Bitcoin

Asset management leader BlackRock’s interest in a spot bitcoin ETF is among the signals that the cryptocurrency isn’t going anywhere, said the Carlyle Group co-founder.

Billionaire private equity titan David Rubenstein believes Bitcoin (BTC) is here to stay thanks to growing institutional interest as evidenced by BlackRock’s application for a spot bitcoin ETF, as well as general global demand for a form of money that can’t be controlled by governments.

“A lot of people around the world want to be able to trade in a currency that their government can’t know what they have and they want to be able to move it around rightly or wrongly and so I don’t think bitcoin is going away,” he said during an appearance on Bloomberg TV Tuesday.

The co-founder and co-chairman of private equity giant Carlyle Group, Rubenstein admitted his regrets for not having bought bitcoin when it was at $100.

He said that people who once mocked the crypto and the sector in general might be forced to take another look given recent interest from traditional finance giants like BlackRock.

“What’s happened is people made fun of bitcoin and other crypto currencies but now the establishment, Larry Fink at BlackRock, is now saying they’re going to have an ETF if approved by the government in bitcoin so you’re saying wait a second, the mighty BlackRock is willing to have an ETF in bitcoin, maybe bitcoin is going to be around for a while,” he said.

Rubenstein has previously disclosed that he is personally invested in companies that facilitate crypto trading, although not owning any cryptocurrencies directly.

Speaking about recent enforcement actions from the U.S. Securities and Exchange Commission (SEC), led by Chair Gary Gensler, Rubenstein said that Ripple’s win in a recent case proves that the agency has not yet convinced the courts that cryptocurrencies are “bad.”

Blackstone Says Private Credit Is Coming For Asset-Based Debt

* Rob Camacho Expects Lenders’ Capabilities In The Space To Grow

* Sees A ‘Symbiotic Relationship’ Between Banks, Private Credit

Private credit lenders are just getting started in the world of consumer and asset based finance, according to Rob Camacho, Blackstone Inc.’s co-head of asset based finance within the firm’s Structured Finance Group.

“Today, we are a very small portion of the whole asset based finance market,” he said in an interview. “There’s a lot of room to run.”

Camacho spoke over a series of interviews that ended on Sept. 6. Here are some highlights of the conversation, which have been condensed and edited for clarity.

Asset based finance has become the hot new thing across credit markets. Why is that?

That’s certainly true and has to do with the current environment. A couple of years after the start of my career in 2004, the Federal Reserve brought rates over 5%, so investors were getting real yield in fixed-income.

But that was short-lived. We then went through more than a decade of near-zero interest rates.

This is the first time we are seeing higher real yields. All of a sudden, you can get high returns for investment-grade paper. That hasn’t happened in almost two decades.

Second, some buyers such as insurance companies tend to prefer longer duration to match their liabilities. That dynamic has also made asset based finance much more important for firms such as ourselves, who manage money for insurers.

The regional bank asset sales have also played a role in this. What do you see coming in the next few months?

A lot of what we’re doing is partnering with regional banks. They have internal loan origination capabilities through relationships with local platforms that make auto loans, home improvement loans and any other product that is important to their deposit base.

We can buy those loans, but we can also partner with them to augment their business, meaning they originate the same or more, but don’t keep all of it on their balance sheet.

Many banks are calling us to partner with them to continue serving local consumers. This generates fee income for the bank, and provides our clients high quality loans.

As the cost of private capital is higher and there’s just less of it around, will consumers end up struggling?

Something that deserves acknowledgment is how smooth this volatility has been for consumers. In 1994, when interest rates spiked, there was a lack of credit that made the Fed cut rates by July of ’95.

This year, we’ve had both bank failures and rapid interest rate increases.

And now we are seeing a symbiotic relationship between banks and private credit, where lending gaps are being filled instantaneously.

From my perspective, it’s been remarkable that we haven’t had a larger contraction of credit at the consumer level. That’s probably one of the things encouraging a lot of people to change their calls to a soft landing – if credit was unavailable and with the consumer being two-thirds of the economy, we might have a different outcome.

The volatility of the asset backed securities markets this year and last year also contributed to more companies turning to private lenders. But is the trend here to stay?

The public ABS market is a great option for originators to distribute risk and raise capital. But we are talking with companies and banks who use ABS about how to diversify their funding models.
We’ve bought loans from these firms, be it consumer or other types of loans, when the securitization markets were active.

The volatility in the ABS market last year reinforced what we’ve supported for a long time: The importance of having a diversity of funding sources such as securitization, forward flow and balance sheet.

Partnering with private credit managers that can provide capital from longer-dated insurance liabilities is a great way to achieve this, where there isn’t the dynamic of demand deposits that can disappear overnight.

We believe that every originator should be thinking this way.

Private credit took on corporate markets first and is now handling multi-billion dollar financings, competing with banks for those transactions. Will we see something similar in asset backed financings?

I am biased, of course, but just as an anecdote: We’ve done several transactions over the past year close to a billion dollars, and one that brought our commitment over that mark. So, the capabilities of private debt within asset based finance are just going to expand.

Large-scale players who need asset based debt will prefer to work with a single manager able to commit to those transactions. It will become more appealing over time to borrowers and investors, especially if the current yield environment persists.

Today, we are a very small portion of the whole asset based finance market. There’s a lot of room to run.

Right now, most of the companies that borrow this type of debt are small- or mid-sized firms with barely any corporate debt, right?

You’re hitting the nail on the head. A loan originator’s largest liability is their ability to sell loans and continue their business. Therefore, originators tend to have very conservative capital structures.

We’re partnering with them over time and it’s important they can service their customers. That’s really what we care about. Our customers are insurance companies and pension funds.

Their customers are the consumers, and we need those consumers to have a good experience.

But to be clear, it’s not just consumer loans — it’s everything. We have aircraft loans, fund finance and renewables like commercial and industrial solar.

We have quite a large business of financing critical infrastructure such as cell towers as well as intellectual property.

We’re financing all those things, and we really have just scratched the surface. As interest rates continue to remain where they are, more and more companies are going to be more efficient with their balance sheet, so many more assets are going to become financeable.

Do you think we will see bigger originators, even ones that tap the investment-grade corporate bond markets, look for this type of financing from private lenders?

A lot of folks that utilize asset based finance are companies that don’t have access to the broadly syndicated corporate bond market. However, I think you will see investment-grade companies tapping the asset based debt market.

We certainly would love to engage in conversations with corporates and seek out places where we can provide flexibility. The corporate bond market is very standardized and that’s what makes it great and low cost.

Still, there are companies that obviously have very specific assets on their balance sheet or a specific need where a financing solution can be customized. We can offer that.

I think we are going to see some companies be quite strategic around financing and start to say, ‘Instead of issuing this huge corporate bond and risk our credit rating, why don’t we call private lenders and get customized solutions for these assets?’

Updated: 8-14-2023

Private Equity Firms Are Slow To Sell Holdings Amid Higher Rates

The market is reeling from a long series of crises including Covid, war, inflation and bank failures.

Here’s a normal thing that happens. You buy a house, renovate it, throw a housewarming party, and you stay there. For a long time. Pretty typical, right?

Well, yes. But what if the people who lent you money to buy the house don’t get repaid until you sell? If you hang on to the property, they’re stuck.

That, in a sense, is the situation in which the private equity industry finds itself. The firms are holding on to the businesses they acquire for increasingly long periods, and their investors are waiting for their payoff.

Private equity “exits”—via sales or initial public offerings—have fallen to their lowest level in a decade, excluding the pandemic-hit second quarter of 2020, when the global economy stalled.

“This slowdown came on the heels of such a hot year in 2021,” says Emily Anderson, managing director of sponsor coverage at the investment bank Union Square Advisors LLC.

“We had Covid, lots going on in the political environment, interest rates, the Silicon Valley Bank crisis, the war in Ukraine—that’s a lot of hits for one market to handle in a short time horizon.”

To be clear: Private equity firms do want to sell. But only for the right price. And caution is rampant among buyers—including the firms themselves. Every year a fair portion of companies sold by PE firms are bought by other PE firms.

Today those firms are sitting on a record pile of unspent capital: about $1.5 trillion, according to Preqin Ltd., the investment data company.

Since most deals are at least partly debt-funded and interest rates are high, private equity barons are less eager to open their checkbooks.

Amid all of this, those who’ve staked money in private equity want to see some of that money returned. That’s prompted PE firms to rifle through their portfolios to find non-plum assets to sell, even though, all things being equal, they’d probably rather wait and get a higher price further down the line.

A few are eyeing IPOs, even as the market remains tepid. SoftBank Group Corp. is targeting a prospective $60 billion September listing for its semiconductor unit Arm Ltd.; L Catterton wants to take Birkenstock to market at an $8 billion valuation at around the same time. They’ll be big tests to see if things might just start to loosen up.

Updated: 8-16-2023

Brookfield Chases Rivals For Private Equity’s New Money-Spinner

Sachin Shah is leading the giant Canadian investment firm into a business that’s earned rich rewards for its private equity peers.

Sachin Shah, a senior executive at Canadian investment giant Brookfield, could not contain his frustration.

Shah was in the company’s Toronto headquarters listening to a presentation by a group of employees who’d flown in from Brazil.

The numbers were good, but Shah was annoyed by the team members’ style and even accused them of lying, according to a person familiar with the event who asked not to be named discussing internal matters.

The next morning, at the Shangri-La hotel where the company was having an off-site meeting, Shah fired the team’s head and sent him back home.

The abrupt dismissal in 2019 rattled people within the company, but it cemented Shah’s reputation as a hard charger. Today, he’s bringing his forceful style to bear on a different assignment—helping Brookfield muscle into a new business: insurance.

It’s a market that Brookfield’s private equity peers have been playing in for years. The idea is that insurance companies generate billions of dollars in premiums that need to be invested to ensure there’s enough money to pay future claims.

Those premiums provide a rich source of so-called perpetual capital at a time when raising money from traditional clients such as pension funds and endowments is getting tougher.

And the private equity firms earn fees—1% to 2% in Brookfield’s case—for managing that money. As of the end of June, Brookfield was earning fees on $110 billion of money from its own affiliates, including the insurance unit, accounting for about a quarter of the company’s fee-bearing assets.

Those fees will help Brookfield expand its investments, which range from 4G cell towers in India, to hydro plants in Colombia, to the glittering Manhattan West development in New York.

Apollo Global Management Inc. was the first big private equity firm to dive into insurance when it co-founded annuity provider Athene in 2009. Blackstone Inc. and others soon followed. Apollo is now reaping the rewards of its bet on Athene, which it bought outright in a deal that closed last year.

The business accounts for the majority of Apollo’s earnings and propelled the firm to a record $1 billion profit in the second quarter.

Now, Brookfield Asset Management—which oversees about $850 billion, making it the world’s second-largest alternative investment manager—is trying to catch up.

Since launching Brookfield Reinsurance Ltd. three years ago, Shah, the chief executive officer, has directed a buying spree that will lift the company’s insurance assets to $100 billion.

“We all feel like the prospects for this business are really strong,” Shah says during an interview in Toronto. “The growth outlook is better than it’s ever been.”

The most recent deal, for American Equity Life Holding Co., bore the hallmarks of his aggressive style. Brookfield holds a stake of about 20% in the Des Moines-based company, and Shah had a seat on the board.

But the insurer signed a multibillion-dollar deal with New York-based private investment firm 26North Partners—run by Apollo co-founder Josh Harris—despite Brookfield’s objections.

Shah was worried about the risks of the investment. It didn’t help that Mark Weinberg, a 16-year Brookfield veteran, had just been hired by 26North.

Shah resigned his seat on the American Equity board and engineered Brookfield’s takeover of the entire company for about $4.3 billion, a deal that’s expected to close next year.

Sitting in a conference room on the first floor of Brookfield’s nondescript office, Shah, 46, hardly comes across as a shark. He’s serious, soft-spoken, unfailingly polite. Indeed, Brookfield overall tends to give off a conservative air. Men are expected to wear suits and ties.

Beards are frowned upon, as are Wall Street-style extravagances. Executives in Toronto, New York and London typically use public transportation and fly economy class.

Old-school face time is a must. Even during most of the pandemic, Brookfield maintained a strict work-from-the-office policy.

On the surface, Shah fits the mold. An accountant by training, he’s spent 21 years at Brookfield, working his way up from corporate finance to head of the renewables business and chief investment officer of the firm. Yet inside Brookfield Place, Shah stands out in several ways, including a big one: money.

In 2022 his pay package totaled $8.3 million. That exceeded the compensation of Brookfield’s chief executive officer, Bruce Flatt, who got $7.8 million. Shah declined to elaborate on his management style during an interview, and the company declined to comment.

Another Shah deal shows the synergies between insurers and PE firms. In a $5.1 billion transaction completed in 2022, Brookfield acquired American National Insurance Co., a 118-year-old insurer based in Galveston, Texas, that does business in all 50 states and Puerto Rico.

Brookfield promptly began steering American National cash into credit, including real estate and infrastructure debt —investments Shah and his team think are a good match for insurance because they represent long-term bets.

The Reward So Far: $685 million, in the form of dividends that American National has sent upstream to Brookfield. The US insurer paid $155 million in dividends the year before the acquisition.

As part of Brookfield, both American National and American Equity will direct more money into alternative assets such as private debt funds.

Brookfield Asset Management’s president, Connor Teskey, recently told analysts that the company plans to allocate about 40% of its insurance assets to its private funds over the next few years, up from 6% today.

Critics have begun to worry that everyday policyholders might get hurt if insurance money is tied up in investments that can be difficult to sell or take years to pay off.

American National, with more than 5 million policyholders, has transferred $10 billion of insurance business through reinsurance with a Brookfield affiliate in Bermuda.

Such a maneuver, which has been employed by other private-equity-backed insurers, has enabled American National to offload some of its liabilities to an entity outside the reach of US regulators.

That means US policyholders are now counting on a company that’s not regulated in the country to make good on the promises in their policies. It also reduces American National’s liabilities, which in turn reduces the capital it’s required to have on hand to meet those obligations.

“I must admit that I am disappointed that Brookfield not only chose to significantly increase American National’s risk profile, but they also seemed in quite a hurry to do it,” says Tom Gober, a forensic accountant who’s briefed the US Department of Labor and the Senate Banking Committee on private equity’s involvement with insurers.

Michael McRaith, Brookfield Insurance Solutions’ vice chair, says that delivering value to policyholders and clients in Iowa, Texas and Bermuda, where its insurance companies and affiliates are domiciled, is a high priority.

“All three of those jurisdictions are held in high regard by regulators around the world.”

Shah has no qualms about insurance becoming an increasingly important component of Brookfield’s business. “Just go back five years, Brookfield was known for infrastructure, real estate, private equity, renewables,” he says. “There’s a whole new business that was created within a few years, and now it has scale.”

Updated: 8-17-2023

Private Credit Loans Are Growing Bigger And Breaking Records

* Finastra $5.3 Billion Loan Deal Is Biggest Ever In Asset Class’

* Private Credit Funds Raising Large Cash Pools For Jumbo Deals

The $1.5 trillion private credit market just set a fresh record for the largest loan in its history. With growing firepower, direct lenders are poised to take ever more deals away from banks and from the junk bond and leveraged loan markets.

Private lenders including Oak Hill Advisors LP, Blue Owl Capital Inc. and HPS Investment Partners LLC are providing a $5.3 billion loan package to Finastra Group Holdings Ltd., a fintech firm owned by Vista Equity Partners.

Comprising a $4.8 billion unitranche, a blend of senior and subordinated debt, and a $500 million revolver facility, the financing is the biggest private credit loan ever in the US, according to data by KBRA DLD.

It’s been a dramatic rise. Even as recently as four years ago, a $1 billion private loan was a rare event and anything above $2 billion was simple aspiration. And back then, few borrowers

who could tap the junk debt markets would opt instead for a private loan.

But with banks still reluctant to commit capital to risky loans, borrowers have been flocking to direct lenders.

Now Finastra has exceeded the record set by Zendesk Inc.

a year ago with its $5 billion bundle of private debt. And private lenders and Wall Street banks are engaged in a furious battle to win over financing deals.

The fresh record underscores the growing heft of the private credit market, which saw fundraising rebound last quarter, crops of new entrants and aspirations to score ever larger piles of cash.

Now Finastra has exceeded the record set by Zendesk Inc.

a year ago with its $5 billion bundle of private debt. And private lenders and Wall Street banks are engaged in a furious battle to win over financing deals.

The fresh record underscores the growing heft of the private credit market, which saw fundraising rebound last quarter, crops of new entrants and aspirations to score ever larger piles of cash.

What sets Finastra apart from many of the recent jumbo deals is the use of proceeds. The loan for Zendesk, an unused $5.5 billion package for Cotiviti Inc. and $3.4 billion for Galway Insurance

all served to finance buyouts. But Finastra’s loan refinances existing debt that the company raised in the US and European leveraged loan market.

That’s a reflection of the collapse in mergers and acquisitions, and especially leveraged buyouts, triggered in part by the surge in interest rates over the past year.

“For non-levered buyout sponsor backed deals, we have been working on different short-term refinancing opportunities that offer a single solution that is easy and at scale,” said Mike Patterson, a governing partner at HPS. “This can allow a company to delay selling itself for when the M&A market has normalized and valuation expectations are better aligned.”

Deals:

* Blue Owl and Oak Hill are providing a record $4.8 billion fully funded direct loan as part of Vista’s refinancing of fintech firm Finastra’s debt.

* Apollo is poised to sign more than $4 billion in so-called NAV loans to private equity firms looking to raise cash in a challenging high-cost environment.

* Qualitas Ltd. has obtained an additional A$750 million ($483 million) to be incrementally invested in Australian commercial real estate via private credit.

* TPG has lined up a group of private credit funds led by Ares to help finance its acquisition of Australian funeral home operator InvoCare Ltd., with a A$800 million ($521 million) of debt.

* Sixth Street acted as agent in a financing to Carlyle’s portfolio company HireVue with $310 million
facility.

Fundraising:

* Oaktree is looking to raise more than $18 billion in what would be the largest-ever private credit fund.

* Blackstone Inc. raised $7.1 billion for a fund to finance solar companies, electric car parts makers and technology to cut carbon emissions.

* Guggenheim Investments is seeking to raise at least $1.5 billion for its newest private credit fund.

* KKR is continuing its push into asset-based financing with the launch of KKR Asset-Based Income Fund, in which it has raised at least $425 million.

Updated: 8-20-2023

Zhongzhi’s Crisis Exposes The Perils Of Private Credit

Asset quality is deteriorating, but the bigger issue is the failure to ring-fence some products.

Zhongzhi Enterprise Group Co., one of China’s largest private wealth managers, is sending shockwaves through the country’s financial system.

Its affiliates have missed payments on dozens of products. Rare public protests erupted in Beijing as investors lost patience.

Stock traders sold off shares fearing that listed companies had invested spare cash into its funds. The conglomerate, which manages about 1 trillion yuan ($137 billion), plans to restructure debt after an internal audit.

China has been cracking down on shadow banking since late 2017. So people naturally ask why this is happening now, and if we might expect more blowups in the near future.

An economic downturn, along with the real estate slump, certainly contributed to Zhongzhi’s woes. Zhongrong International Trust Co., an affiliate with 629 billion yuan under management as of 2022, has more than 10% of its investments in the property sector.

As developers’ financial distress deepens and asset disposals slow to a trickle, a trust product can hit its due date before the residential projects it had funded are completed or sold.

But a deterioration of asset quality is only part of the story. The bigger culprit is the opaque nature of private credit, whereby a non-bank institution lends directly to the real economy.

Often, these products, sold to high-net-worth individuals or company treasuries, are similar to bank loans, but without bankers’ due diligence or standardized covenants.

A lack of ring-fencing appears to be a key cause of Zhongrong’s default. For instance, the 30 million yuan trust product Nacity Property Services had bought was supposed to be similar to a money-market fund, with an expected 5.8% return.

But it turned out to be a so-called “cash pool.” Nacity’s money was put into a common pool, which the trust could use to repay older, existing investors.

By the end of 2021, Zhongzhi’s cash pools, not including that of its trust affiliate Zhongrong, had reached 300 billion yuan.

They were backed by about 150 billion yuan worth of underlying assets, reported financial media outlet Caixin. No surprise then that, when new fundraising dried up, Nacity’s money was not returned at maturity.

The government, of course, frowns upon this practice. A polite description is excessive leverage, while a more crude one is a Ponzi scheme. However, because of their complex nature, regulations covering cash pool products have only been loosely enforced, according to CreditSights.

Officials don’t get to see the lending documents — they are, by definition, private. They don’t have the resources to sift through and understand the tailor-made borrowing terms either.

Caixin cited other eyebrow-raising practices. For instance, a Zhongzhi subsidiary had raised $1 billion against a certain project.

Another subsidiary consolidates the balance sheet of the first one and also borrows $1 billion from the same project.

In other words, an asset is pledged away many times. As an outside investor, how do you conduct this level of detailed due diligence?

Zhongzhi has hired KPMG LLP to conduct an audit of its balance sheet to find out if it has enough assets it can sell to repay investors. Chances are, it’s already reached negative equity.

Most private-credit products are only available to wealthy individuals or corporate treasuries. Zhongzhi’s wealth management offerings had a minimum investment of 3 million yuan, while that of a trust was normally above 300,000 yuan.

However, just because these investors were richer, they were not necessarily savvier. Many simply got lured by the 7% to 9% yield. That’s attractive considering China’s 10-year government bond pays only 2.6%.

To be sure, after harsh regulatory crackdowns, China’s shadow-banking world has become smaller and safer. The trust industry’s exposure, for instance, to local government financing vehicles and real estate — the two areas where there’s a lot of leverage and financial distress — has diminished.

But as we’ve seen with Zhongzhi, there are still plenty of hidden perils. Private credit is, by nature, opaque, prone to loose lending standards, and difficult to regulate.

Updated: 8-23-2023

SEC Takes On Private Equity, Hedge Funds

Commission votes 3-2 to approve sweeping new rules aimed at increasing transparency, driving down fees.

WASHINGTON—Wall Street’s main regulator approved sweeping new rules aimed at overhauling the way private-equity and hedge funds deal with their investors, in the biggest regulatory challenge in more than a decade to firms such as Blackstone, Apollo Global Management and Citadel.

The Securities and Exchange Commission voted 3-2 on Wednesday to adopt new requirements for private funds, which manage more than $25 trillion in gross assets for pension plans, university endowments and wealthy individuals.

The rules restrict the ability of private-equity and hedge funds to entice large investors by offering them special deals, known as side letters, for better terms than other investors.

The SEC will also require private funds to provide their investors quarterly financial statements detailing their performance and expenses, and to undergo annual audits.

“At the core was addressing some of the opacity in this field,” SEC Chair Gary Gensler said Wednesday. “Our investors—large or small—benefit from greater transparency.”

Some portions of the final rules were eased from a proposal last year. Still, they amount to a major regulatory push into an area of finance long accustomed to minimal government oversight.

Light-touch regulation and low interest rates have enabled private funds to grow larger over the past decade than the commercial banking sector, raking in hundreds of billions of dollars a year in fees, Gensler has said.

The SEC’s two Republican commissioners voted against the rules and questioned whether the agency has the legal authority to regulate private funds more closely.

“The rule-making is ahistorical, unjustified, unlawful, impractical, confusing and harmful,” Republican Commissioner Hester Peirce said.

Industry groups have tried to fend off the rules for more than a year. They represent hedge funds such as Citadel, Bridgewater Associates and Millennium Management; private-equity firms including Apollo, Blackstone and Carlyle Group; and venture-capital firms such as Andreessen Horowitz.

They accused the SEC of trying to insert itself into a contractual relationship between sophisticated parties and, before the final rules were unveiled, signaled they might sue to overturn them.

Industry officials said Wednesday they were reviewing the rules. Bryan Corbett, chief executive of Managed Funds Association, said the hedge-fund group is concerned that the rules “will increase costs, undermine competition and reduce investment opportunities.”

MFA’s members will assess the changes and determine whether to move forward with litigation, he added.

The Investment Adviser Association, whose members include private-fund managers as well as other asset managers, called the final rules “generally more reasonable” than the SEC’s proposal last year.

Pension funds and other institutional investors typically allocate money to private funds in hopes of outperforming public stocks and mutual funds.

The SEC has traditionally viewed such investors as sophisticated enough to fend for themselves in the market, and private funds have faced much less regulatory oversight than the mutual funds available to ordinary investors.

Investors in private funds must negotiate for any information they want to receive from the asset manager—including about the fund’s performance, holdings and costs—as well as for redemption rights and other terms.

SEC staff say this creates opportunities for fund managers to charge opaque fees and expenses, give bigger investors a better deal than smaller ones, and exploit conflicts of interest.

Liberals in Washington have long been skeptical of private-equity and hedge funds’ business models, but they have often struggled to turn their views into policy.

Last year, Senate Democrats dropped a plan to raise taxes on carried interest, a key source of income for private-fund managers that many lawmakers see as a tax loophole.

Industry officials say they had a harder time dissuading Gensler, who is known for pushing aggressive regulatory changes. In the 18 months since the SEC proposed the rules, representatives of hedge funds, private-equity firms and venture-capital funds have met more than three dozen times with agency officials, SEC records show.

They have also lobbied members of Congress to push back against the agency’s plans.

One of the biggest sticking points for private-fund managers was the SEC’s proposed ban on certain side letters. These can, for example, give some investors greater flexibility to withdraw their money or offer them more information about a fund’s holdings.

Industry officials say such agreements are useful for closing deals with marquee investors whose presence can bolster a fund’s credibility.

The final version of the SEC’s rules softens some language regarding side letters. The original proposal would have required asset managers to disclose a fund’s side letters to all investors before closing a deal; the final rule requires them to disclose only those side letters that involve “material economic terms.”

Giving certain investors special redemption rights or increased information about a fund’s holdings will be prohibited unless the asset manager offers those terms to all other investors in a fund.

SEC officials in the final version of the rules dropped plans to prohibit fund managers from charging fees for unperformed services and from limiting their own liability for malfeasance or negligence.

Smaller funds also will have more time to comply with the changes than larger funds, and some of the new restrictions won’t apply to funds that were set up before the rules take effect.

Better Markets, an advocacy group, said the SEC rules marked an improvement but still left investors in private funds exposed to shady practices.

Brian Daly, a partner at Akin Gump Strauss Hauer & Feld who advises hedge funds and private-equity funds, said it is unclear if the changes will dissuade industry groups from suing the SEC.

“There was a clear effort…to trim back some of the more assertive or aggressive positions to try and find that sweet spot of fulfilling the chairman’s vision and not triggering a litigation challenge,” he said.

Updated: 11-2-2023

The Banks Are Where The Money Isn’t

Private Credit

One thing that JPMorgan Chase & Co., one of the world’s biggest banks, wants to do is lend money to big corporate and private equity clients.

In many ways, JPMorgan seems well suited to doing this: As a giant bank with more than $3 trillion of assets, it employs a lot of people who have good relationships with corporate clients and private equity sponsors, a lot of people who advise on the mergers that create the need for these loans, and a lot of people who are good at making credit decisions.

But JPMorgan’s ability to lend money to corporate clients is constrained by a simple problem: Where would it get the money?

Bloomberg’s Gillian Tan And Paula Seligson Report On JPMorgan’s Quest To Find A Source Of Money That It Can Lend To Clients:

* JPMorgan Chase & Co. is searching for a potential partner to grow its private credit business and accelerate its push into one of the hottest areas in leveraged finance, according to people with knowledge of the matter.

* The discussions with prospective partners — including sovereign wealth funds, pension funds, endowments and alternative asset managers — began in recent months and are at an early stage, the people said, asking not to be named discussing a private situation. The structure and terms of a potential partnership haven’t been finalized, and it’s possible more than one partner may be selected. JPMorgan approached some firms and received inbound inquiries from others, one of the people added.

* JPMorgan is looking for third-party capital to supplement the more than $10 billion of balance sheet cash that it has already set aside for its private credit strategy, which it began rolling out in the last year. A bigger pool of capital would allow the bank to better compete with heavyweights such as Blackstone Inc., Apollo Global Management Inc. and Ares Management Corp. by making larger commitments or participating in larger deals. …

* Wall Street banks are trying to figure out the best way to compete with private credit, which is eating into the market share of the leveraged loan and high-yield bond markets, a key fee generator. Investment banks typically sell junk-rated debt to large groups of institutional asset managers, rather than hold the risk on their balance sheet, whereas private credit lenders are specialized asset-management firms that originate the loans directly from their own funds.

Efforts by banks to compete off their own balance sheets is a return to traditional lending but comes with a high capital charge for those loans.

I am being stupid. But I do think that it is worth noticing how strange this is. In the olden days banks took deposits and made loans.

This is a notably risky business model, for reasons that everyone knows and that we have discussed a lot this year: The deposits are short-term, the loans are long-term, and if all the depositors want their money back at once, the bank can’t get it all back at once from the borrowers.

In 2023 banks still, absolutely, take deposits and make loans, but everyone sort of knows to be nervous about it. One way that regulators express nervousness about it is by imposing high capital requirements on illiquid loans made by banks.

And so if JPMorgan executives get together and say “hey, we have a huge competitive risk and opportunity here, a lot of our best corporate and private-equity clients really want to borrow money from us, and if we lend them money we’ll get really good risk-adjusted returns, but if we don’t we will lose business to competitors, so let’s do it,” and someone asks “okay but how should we fund these loans to our clients,” and someone answers “well, just spitballing here, but we could use our customers’ deposits to make the loans,” that would be, like, shocking?

You don’t just go around saying “let’s use customer deposits to make long-term loans to risky borrowers”! Look where that got Sam Bankman-Fried!

No, the correct answer is “let’s go partner with a pension fund or sovereign wealth fund, someone who has really long-term capital that they can commit to this business while we manage it.”

Or, I mean, to be fair, the actual answer is some of both; JPMorgan is using “more than $10 billion of balance sheet cash” alongside whatever it can raise from partners.

We have talked a number of times around here about this basic idea, that private credit is increasingly substituting for bank loans because it has a better funding model.

Pension funds, insurance companies, sovereign wealth funds and the alternative asset managers that do private credit investing for them have very stable long-term funding; US regional banks have flighty short-term deposits.

Private credit is a form of “narrow banking,” a model in which banks invest deposits at the Fed and lending is done by specialized firms with long-term equity funding. The specialized firms are private-credit managers, and the long-term funding comes from pensions.

But it is not just US regional banks with flighty deposits; it’s global megabanks with sticky deposits too. Even at JPMorgan, there is a push to make banking narrower.

Updated: 12-17-2023

Private Credit Rebounds In The Bitcoin Sector With A 55% Jump In 2023

* Loans Via Blockchains Are Reviving From A Deep Slump Last Year

* Supporters Claim Digital Ledgers Are Transparent And Efficient

More companies are tapping blockchain-based private credit as they hunt for financing in a world of elevated interest rates, sparking a partial revival in a sector that slumped amid last year’s crypto crisis.

Active private loans via digital ledgers are up 55% since the start of 2023 to about $408 million as of Nov. 28, according to RWA.xyz, a platform that tracks the debt.

That’s still lower than a near $1.5 billion peak last June — and a fraction of the booming $1.6 trillion traditional market for private credit.

While borrowing costs vary deal-by-deal, some blockchain protocols charge less than 10% whereas traditional providers are seeking double-digit rates in the current environment, based on figures from RWA.xyz and private-credit lenders.

Champions of digital ledgers say they make deals and repayments transparent since blockchains are open to public scrutiny, and that software called smart contracts can monitor for stress and automatically recall loans or collateral.

“Increased transparency and liquidation mechanisms onchain have reduced the risk of lending,” said Agost Makszin, co-founder of Lendary (Asia) Capital, an alternative investment management group.

“This has likely resulted in lower borrowing rates compared with traditional private credit, which is often slower and has a longer liquidation process.”

Traditional private credit has been labeled too opaque by the likes of bond giant Pimco and the European Central Bank. The industry has tripled in size since 2015, providing loans for smaller companies, buyout financing, real estate and infrastructure. Investors are clamoring for exposure to the asset class.

In the blockchain version, protocols such as Centrifuge, Maple Finance and Goldfinch can pool or provide access to investor funds, typically using the Ethereum blockchain and stablecoins like USDC that are pegged to the dollar.

Borrowers use the funds under terms codified in smart contracts.

Protocols can take steps such as structuring loans or collateralizing them with real-world assets to bolster investor confidence. RWA.xyz data shows that the consumer, auto and fintech sectors account for the bulk of active loans by value, followed by real estate, carbon projects and crypto trading.

“We’ll try and leverage the fact that we use the blockchain and smart contracts to manage our loans, take out costs and fund loans quicker, to try and get a competitive edge,” said Maple Finance’s co-founder Sidney Powell.

Turbulent History

Maple Finance was among the digital-asset outfits buffeted by last year’s $1.5 trillion crypto rout. The crash bankrupted a slew of businesses — including Sam Bankman-Fried’s FTX empire — and wiped out leveraged positions within the crypto ecosystem that were chasing too-good-to-be-true speculative yields without due care for risk.

The debacle sullied the idea of crypto lending, even if the losses stemmed from so-called decentralized lending across digital-asset projects rather than from real-world enterprises.

The total value of decentralized lending has climbed 120% year-to-date to about $22 billion but remains far below the record high of $54 billion hit in April 2022, DefiLlama data show.

The digital-asset industry is recovering from last year’s turmoil but has other problems, such as uneven access to banks, which are wary of crypto’s role in illicit activity.

The skepticism complicates the task of shifting between tokens and fiat currency. Traditional finance is also uncertain about digital ledgers and potential security risks since blockchains are relatively new and complex.

Another obstacle is that the crypto lending market lacks a credit rating system, unlike traditional finance, which prevents a full understanding of risks, said Tom Wan, a researcher at digital-asset fund provider 21.co.

Receivables Financing

Activity has still picked up. At the start of 2023, Maple Finance and AQRU enabled Intero Capital Solutions LLC to initially access $3 million in stablecoins from a blockchain-based credit pool.

Later in the year, Goldfinch provided $1.35 million in stablecoins, its first callable loan, to fintech firm Fazz in Singapore. Callable loans allow lenders to demand principal repayment at regular intervals.

Intero specializes in receivables financing and pledged its US federal tax rebates as collateral. The deal allowed the firm to “access capital quickly and at a favorable loan rate, in an immutable, transparent and predictable transaction environment, which would not always be the case with liquidity sourced from the private credit markets,” its co-founder Tom de la Rue said.

One difference between blockchain-based private credit versus traditional non-bank lending is that the former contains more fixed-rate offerings, whereas the latter is usually variable, according to Charlie You, co-founder of RWA.xyz. Digital ledgers curb manual back-office layers that can add to costs, he added.

“Some of these cost savings are passed on to issuers,” said You. “It also enables lower principal sizes to be issued that could not be done by traditional means, particularly if the financing structure is complex.”

Whether private credit will ever flow across blockchains in big amounts is an open question. While tokenization — creating digital representations of real-world assets — could lead to more collateral for lending, much depends on whether the crypto sector can repair its tarnished reputation.

Updated: 1-29-2024

Private Credit Draws BOE Scrutiny On Potential Systemic Risks

* Higher Rates Will Cause Difficulty For Private Debt: Foulger

* Interconnectedness Of Private Markets Could Pose Systemic Risk

The Bank of England is examining the potential for systemic risk in the $1.6 trillion private credit market.

The rapid growth of the sector means policymakers are exploring a number of potential issues, said Lee Foulger, the director of financial stability, strategy and risk at the BOE.

In recent years investors and borrowers have increasingly turned to private credit as sharp rises in interest rates, alongside global conflicts and financial shocks, hit public markets hard.

“The shift in the risk environment, including greater geopolitical risks, more subdued economic growth, and tighter financing conditions will pose challenges to the non-bank sector and specific challenges to private credit markets,” said Foulger, speaking Monday at the DealCatalyst European Direct Lending & Middle Market Finance conference in London.

The UK’s central bank is responsible for identifying and reducing systemic risks to the UK’s financial system, for supervising institutions and financial market infrastructure.

It warned last year that the next blow up in financial markets may be triggered by corporate credit after a massive build-up in private debt over the past decade.

The fast-growing private credit market has so far posted impressive returns in a higher interest-rate environment, but the debt burden for companies is becoming a concern for investors.

“To date, private credit market participants have reported low default rates despite the tougher macro environment,” Foulger said. “But in the past year, highly leveraged borrowers have experienced a significant decline in their interest coverage ratios.”

He said the interconnectedness of markets, when combined with a lack of transparency on private deals, could also be a problem. That “can result in losses being transmitted to counterparties in a sudden or surprising way, driven in part by the lack of certainty on overall positions held in the market.”

Other issues that regulators are looking at include the refinancing of existing debt in the higher rate era, valuations, risk management approaches, liquidity and leverage.

Foulger noted a proliferation of the use of so-called amend-and-extend refinancing transactions and pay-in-kind

(PIK) bonds, which allow borrowers to pay interest with more debt.

This “puts a premium on robust approaches to risk management and collectively could increase the risk of defaults materializing further down the road,” he said.

Updated: 2-12-2024

Private Equity Returns Plunge To Global Financial Crisis Levels

* Distributions As Percent Of Net Asset Value Fall To 11.2%

* Tough M&A, IPO Markets Impede PE Exits, Weighing On Returns

Private equity funds last year returned the lowest amount of cash to their investors since the financial crisis 15 years ago, according to Raymond James Financial Inc., hampering buyout firms in their efforts to launch new investment vehicles.

Distributions to so-called limited partners totaled 11.2% of funds’ net asset value, the lowest since 2009 and well below the 25% median figure across the last 25 years, according to the investment bank.

Higher borrowing costs, volatile markets and economic uncertainty have made it more difficult for private equity firms to exit their existing investments through sales or initial public offerings.

This in turn has hampered their ability to return capital to pension and sovereign wealth funds, besides other key investors, meaning once-reliable clients are struggling to find cash to allocate new money to the asset class.

“The cash flow math at the investor level is broken,” Sunaina Sinha Haldea, global head of private capital advisory at Raymond James, said in an interview. Because investors aren’t getting money back from their existing holdings, they’re hampered in their ability to put money to work in new funds or re-top existing investments, she said.

The median holding period for a buyout firm asset is now 5.6 years, according to Raymond James, wider than the industry norm of about 4 years.

The impact on fundraising is already visible: The median time to raise a new fund is now 21 months, compared with about 18 months just a couple of years ago, according to the bank’s research. And the number of new funds raised last year dropped 29%.

“This is the worst-ever fundraising market, worse than even during the global financial crisis,” Haldea said, adding that distributions will only likely improve in 2025 as the “tidal wave” of dealmaking forecast for this year is yet to be seen.

Still, the aggregate capital raised last year by buyout funds reached a record $500 billion, up 51% from 2022, driven by the biggest funds, Raymond James said.

A glut of fundraising in 2021 is also weighing on investors’ ability to commit to new funds, especially as the go-to private equity pitch of outsized returns is faltering. For years, pension funds could count on their returns from the asset class outpacing that of public markets.

Now, with global stock indexes booming once again and the private capital industry grappling with structural shifts, that math isn’t as straightforward.

Many institutional investors “are full to the gills from the 2021 private markets fundraising glut,” Jeff Boswell, head of alternative credit at money manager Ninety One, said in an interview.

A $700 Billion Insurance Product Is Powering The US Credit Market Rally

* Annuity Sales Could Total About $700 Billion In Next Two Years

* Funds Likely To Be Allocated To Corporate And Structured Debt

An insurance product that consumers use to help fund their retirements is selling at record levels, powering demand for corporate debt and commercial mortgage bonds.

Last year, sales of annuities, which allow consumers to effectively buy income for the rest of their lives, reached an all-time record high of $385 billion, according to life insurance trade group Limra.

That’s up 23% from the year before. The products grew more attractive as rising interest rates translate into higher potential annual payouts from the products.

Behind the scenes, the life insurers that usually sell annuities are buying bonds to generate income for the products, and in particular, corporate debt and asset-backed securities including mortgage bonds.

Their demand might decline a bit this year after bond yields have fallen, but Limra says annuity sales are still expected to remain strong by historic standards.

The insurers’ bond purchases underscore how demand for many debt securities now is driven by demographics, and illustrates why valuations for corporate bonds can remain high even as the Federal Reserve keeps monetary policy relatively tight.

“Key drivers for credit demand at the moment are retail and pensions seeking higher all-in yields, and annuity sales driven by more baby boomers retiring and by a higher level of interest rates giving policyholders higher monthly payments,” said Torsten Slok, chief economist at Apollo Global Management.

Money raised by annuities often goes toward investment-grade debt, usually fixed-rate and ranging between three to 10 years — broadly in line with annuity durations, said Deutsche Bank AG strategist Ed Reardon.

For investment-grade corporate bonds, demand from annuities and other investors catering to retirees are helping to keep valuations high. The average risk premium, or spread, on a company note rated BBB- or higher is 0.95 percentage point, close to the tightest level in the last two years.

Over the last two decades, spreads have averaged closer to 1.49 percentage point, according to Bloomberg index data.

Record inflows into fixed-rate annuities are also a strong driver of insurance demand for commercial mortgage-backed securities, Reardon wrote in a Feb. 6 note. AAA CMBS excess returns in 2024 are higher than those of both investment-grade and high-yield corporate debt, according to Reardon.

The average AAA CMBS spread versus Treasuries stood at 0.88 percentage point as of Friday, having fallen roughly 30 basis points from an October high, data compiled by Bloomberg shows.

Over the next two years, annuity sales could total as much as $693 billion, according to estimates from Limra. The group expects sales of up to $331 billion this year — a decline from 2023, but a level that would still have been a record in 2022.

“Last two years has been going gangbusters and the expectation is for this year to be the same,” said Dec Mullarkey, a managing director overseeing investment strategy and asset allocation at SLC Management, which manages $264 billion.

Falling rates “will impact demand somewhat,” he cautioned, “but they will still be at reasonable levels, that all-in yield will still be attractive versus history.”

Fixed-rate Deferred Annuities

One type of annuity that is selling particularly well are fixed-rate deferred annuities. Policyholders make an investment upfront, which accumulates interest at a fixed rate over a set amount of time. After the so-called annuitization point, they can start receiving income payments.

The product line recently had its best-ever quarterly sales, with $58.5 billion sold in the fourth quarter, up 52% from the year-ago period, according to Limra. Volume totaled $164.9 billion in 2023, up 46% from the 2022 annual high of $113 billion.

Annuities tend to be most popular among people nearing retirement or who have already left the workforce. The average age for those buying the products is around 62, according to Bryan Hodgens, head of Limra research.

Roughly 17% of the US population was over 65 years old in 2022, compared with about 12% in 2000, data from the Federal Reserve Bank of St. Louis shows.

Any rate cuts by the Fed this year would also buoy corporate debt as prices rise when yields fall.

“Credit has consistently outperformed other sectors of fixed income since mid-2020, and the surge in annuity sales is almost certainly part of the reason,” wrote Steven Abrahams, head of investment strategy at Santander US Capital Markets, in a note. “That is a positive for credit performance going forward.”

Updated: 6-5-2024

‘Everything Is Not Going To Be OK’ In Private Equity, Apollo’s Co-President Says

* Fewer Realizations And Lower Returns Are On The Horizon

* Apollo Co-President Spoke At Superreturn Conference In Berlin

The private equity industry must face up to the reality of lower valuations, according to Apollo Global Management Inc.’s Scott Kleinman.

“I’m here to tell you everything is not going to be ok,” the Apollo co-president said in a session at the SuperReturn International conference in Berlin on Wednesday.

“The types of PE returns it enjoyed for many years, you know, up to 2022, you’re not going to see that until the pig moves through the python. And that is just the reality of where we are.”

Private equity firms didn’t take significant markdowns during the recent period of rapid rate hikes which means that “investors of all sorts are going to have swallow the lump moving through the system,” he said, referring to assets that private equity firms bought up until 2022.

Funds are now holding on to these companies and will eventually have to refinance at higher rates.

That means “fewer realizations and lower returns” are on the horizon for much of the industry, said Kleinman, whose firm is known for its value-orientated strategy.

His comments are among the strongest so far from a leading figure inside the industry about the challenges it faces navigating higher borrowing costs, volatile markets and economic uncertainty.

A record $3.2 trillion was tied up in aging, closely held companies at the end of 2023, according to Preqin data. That’s a problem for private equity — which relies on the cycle of raising money to make acquisitions, exiting via a sale or IPO and then returning money to investors. Some are even looking at alternative exit strategies.

Still, Kleinman sees a bright decade ahead for new buyouts, referring mainly to take-private deal opportunities in the US where he still sees “a lot of value.”

He also expects Apollo to participate in more deals similar to the $11 billion joint venture it inked with Intel Corp. this week.

His comments follow those of other participants at the industry event, who said that dealmaking is poised to accelerate this year as buyout and private credit funds face pressure to return money to their investors.

New York-based Apollo is one of the world’s largest alternative asset managers, investing across credit, equity and real estate. The firm, which ended last year with $651 billion of assets under management, is targeting $1 trillion by 2026.

Separately, Kleinman addressed the divergence between the US and European economies. “Europe has fallen behind,” he said, noting its dependence on bank funding and relatively small securitization and private capital markets is hampering investment.

Morgan Stanley, Ares Say Private Equity Investors Want Cash Back

* Permira, Morgan Stanley IM Expect More Activity This Year

* Miller, Hirschmann spoke with Bloomberg TV At Conference

Dealmaking is poised to accelerate this year as private equity and private credit funds face renewed pressure to return money to their investors, participants at the SuperReturn International conference in Berlin said.

Activity is “going to pick up over the course of this year and into the next simply because limited partners in private equity want to see their capital back,” David Miller, Morgan Stanley Investment Management’s global head of private credit & equity said in an interview with Bloomberg TV on the sidelines of the conference.

While there is still a gap in valuation expectations between buyers and sellers, the “gap has narrowed and there is clearly a pickup in activity,” said David Hirschmann, co-head of credit at Permira, in a separate interview.

Hirschmann added that there’s been a backlog of delayed transactions that were supposed to happen in the last 12 to 18 months, but that they are now in the pipeline.

The opportunity set for private credit funds has increased in recent years, the Permira executive said, and while the industry continues to dominate mid-sized transactions, it now has the capacity to compete for larger deals.

Borrowers have more options this year thanks to the return of the broadly syndicated debt markets, Morgan Stanley’s Miller said, but investment banks skew toward larger deals and that trend benefits private credit providers.

Stricter bank regulations have also fueled the growth of private credit as traditional lenders have stepped back from making smaller loans.

“The core middle markets are still a natural place for private credit,” Miller said.

Private equity firms are evaluating current market prices and options, particularly for companies that aren’t growing as strongly, said Matt Cwiertnia, head of private equity at Ares Management.

“People want money in the private equity business,” Cwiertnia said. “Investors want money back, and I do think the drumbeat is getting louder for that.

With that, I do think GPs like ourselves will be looking to sell assets and deal flow will pick up in the back half of 2024 and into 2025.”

Higher Rates

On the question of defaults, Hirschmann added that the rise in interest rates has been factored into private credit deals, and only those companies whose debt packages were arranged beforehand with high leverage levels of 6 to 8 times earnings, have been struggling to service debt levels.

London-based investor Permira manages about €80 billion in assets across its buyout, growth equity and credit funds, according to its website. Ares oversees more than $308 billion in its credit group and $24.5 billion in private equity.

Morgan Stanley IM manages around $48 billion across private credit and equity, split half-and-half, according to representatives for the firm.

Morgan Stanley’s direct lending arm was one of the lenders that recently provided about $1 billion of debt to support Vista Equity Partners’ acquisition of Model N.

Private Equity’s Latest Move To Gin Up Cash: Borrowing Against Its Stock Holdings

* Cinven, Blackstone, KKR Borrowed Against Stock Holdings

* It Sometimes Leaves Investors At Mercy Of Markets And Rates

Cinven’s clients got some unwelcome news last year: the buyout firm’s financing tied to a lab-testing company wasn’t going well. Instead of getting a windfall, clients had to ante up more cash.

It turned out Cinven had borrowed against its stake in Synlab AG, a move that typically would boost everyone’s cash distributions. Now, though, shares of the company Cinven took public

in 2021 were plunging as sales of Synlab’s Covid tests faded along with the pandemic.

The price drop was so bad in February 2023 that Cinven faced a margin call — an ultimatum from lenders to put up more money for collateral or risk seeing the stock seized.

Cinven, with the help of clients, had to hand over 299 million euros, or about $320 million, said people familiar with the investment.

Private equity firms have used margin loans backed by shares in companies they’ve taken public to supercharge returns for more than a decade, and to return cash to clients frustrated by the recent drought in asset sales.

Industry executives estimate up to $50 billion of the debt is now outstanding.

But the risk is more than just a falling stock price. On top of the margin loans, funds have adopted more novel forms of borrowing against their holdings to free up cash for investors, adding to the proliferation of debt across private equity.

The full cost of all this debt is coming due as interest rates have drifted up. Even after an initial public offering — which clients might expect to close out a debt-heavy wager — the investors may find their stakes are still leveraged with floating-rate margin loans.

And sometimes, the loans just add new headaches.

“Any time a manager is introducing an additional layer of debt or leverage, it can create an opportunity for things to go wrong,” said Brian Dana, who leads outsourced chief investment officer services at Meketa Investment Group.

Blackstone’s Loans

Blackstone Inc., the world’s largest alternative asset manager, received a March 2022 margin call after borrowing some $860 million against its stake in dating app Bumble Inc.

KKR & Co. disclosed in 2020 that some funds received margin calls after the securities that they pledged as collateral – like shares in oil pipeline company Genesis Energy LP — lost value amid the pandemic.

Blackstone took out margin loans of about $4 billion on stakes in more than half a dozen companies during 2021 and 2022, according to Bloomberg estimates.

“This is a very common way to accelerate returning gains – while preserving value and potential upside – with large public positions,” said a spokesman for New York-based Blackstone.

In years when stock markets are volatile or when other holdings are hard to sell, margin loans help managers avoid taking a loss on a sale and still send cash back to investors.

The clients get more spare change to re-invest with the funds — and a new round of fees flow to the managers.

The flip side is that if a stock falls far enough to trigger margin calls, the borrower winds up at the mercy of market forces that they can’t control, undercutting the idea that private equity offers shelter from the turmoil of public exchanges.

To meet the Synlab margin call, Cinven was in effect asking clients to return prior payouts from the private equity firm, which had taken Synlab public in a 2021 offering that raised 671 million euros ($813 million).

The move to recall distributions just when the investors were hungry for cash caused unrest, said one of the people familiar with the matter, who asked for anonymity to discuss the private transaction.

Some clients voiced concern among acquaintances or questioned Cinven staff on whether the fund had done enough to protect their money, the person said.

Cinven has since closed out the margin loan, according to people familiar with the matter. The firm set up an entity that bought more Synlab shares, a move that supports the stock and gives the private equity firm a controlling stake so it can direct the company’s growth. It also plans to take Synlab private.

A representative for London-based Cinven declined to comment.

Useful Tool

Margin loans aren’t inherently bad. They helped build US railroads, and they’ve been used by modern swashbucklers like Elon Musk.

But they come with a stigma, too. During the Roaring Twenties, investors bought stock by paying just 10% down and borrowing the rest. When they sold en masse to meet margin calls, it fueled the crash of 1929 and left behind a high-risk taint.

Private equity began warming up to the loans some 15 years ago, as their ventures and buyouts got bigger and exit strategies became more problematic.

When buyout firms take companies public, they’re often left with capital tied up in huge piles of stock, because major shareholders typically are required to wait as long as 180 days before selling.

In theory, this helps protect underwriters and new public investors from sudden declines. Even when the lockups expire, the blocks can be too big to sell quickly.

More Fees

That’s where margin loans came in. Debt was cheap in the decade after the 2008 financial crisis, which made it easy to borrow and unlock some cash.

This also helped nudge up a metric used to calculate private equity portfolio returns — which in turn helped dealmakers start collecting their share of profits earlier.

If a fund is making only 7%, there’s little or nothing earned for the private equity sponsor, but at 9% the “carry” can be huge, said Richard Lichter, vice chairman at Newbury Partners, a secondary buyer of private equity stakes. “That definitely goes into the calculus” about whether to borrow.

Blackstone reaped the benefits of margin loans when it took hotel company Hilton Worldwide Holdings Inc. public in 2013, one of Blackstone’s most lucrative deals ever.

After the IPO, Blackstone took out a $2.25 billion loan secured by stakes in Hilton, according to regulatory filings. Most of the money was distributed to fund investors.

This allows the firm to “have our cake and eat it too,” then-Blackstone President Tony James told investors in a 2014 earnings call, adding that Blackstone expected to use the technique again.

The firm can “get some money off the table at very low cost and continue to have 100% of the upside in the stock.”

Blackstone took out at least seven margin loans in 2021 and 2022, and they all added to returns. They include borrowings against shares of Gates Industrial Corp. and Chesapeake Energy Corp.

One secured against Bumble stock helped the firm pay out twice its original invested capital on the deal by the end of 2021, said people familiar with the matter.

Collectively, the initial loan-to-value ratio for the group averaged out to less than 20%, according to a spokesman.

But there was at least one notable setback. Amid a historic growth rout prompted by rising rates, Bumble’s shares plunged as much as 52% during the first quarter of 2022 — steep enough that bankers issued a margin call, the people said.

The firm tapped reserves of funds that held Bumble to put up cash.

A Blackstone spokesman said it has tapped margin loans some two dozen times over the years “with virtually no issues.”

He called the loans a “low-cost tool” to enhance returns for its investors, adding that margin loans are generally used for less levered companies. The firm said it typically notifies investors when a margin loan occurs.

A more recent drawback is that the debt generally has floating interest rates, and the cost of existing margin loans has risen as the Federal Reserve pushed rates higher.

Blackstone negotiated new terms on the Bumble loan late in 2023, according to people familiar with the matter — and rising rates ratcheted up the cost some four-fold, to more than 8% from an original 2%.

Most of the loan had been paid down by then, according to documents and people with knowledge of the loan, who weren’t authorized to speak publicly.

Modified Terms

Margin loans can present a test of a private equity firm’s negotiating skills when things go awry.

Shares of pipeline company Genesis Energy plunged along with oil prices when the pandemic took hold in early 2020. That also reduced the value of the preferred stock that a KKR affiliate had pledged as collateral for a margin loan several years earlier.

While KKR was able to initially modify the terms, the firm had to put in more cash as Genesis shares continued to slide, according to a person familiar with the situation.

There was no default and KKR repaid the loan that March, the person said.

Investors are divided over whether the costs of the financial engineering will hurt returns over the long haul.

“As an investor in a partnership, would I be in favor of them borrowing money to get my capital back faster if that increases my return on invested capital? Sure,” said Mark Yusko, founder of Morgan Creek Capital Management, which runs money for institutional clients.

But he’d “rather them leave our money invested longer and get a higher multiple of capital.”

Updated: 6-6-2024

Private Credit And Its Investors Fret the Golden Age Has Gone

* Pluralsight Maneuver Shows Deal Protections Are Fraying

* Funds Are Hard-Pressed To Deliver 12% Returns Again This Year

In hallways and wooden huts dotted around the SuperReturn International conference in Berlin, dealmakers are meeting to drum up new business.

They’re also rehearsing answers to a question they’re hearing a lot these days: are the boom times for the $1.7 trillion private credit market over?

A year since Blackstone Inc. President Jon Gray hailed a “golden moment” for private credit, the shine is coming off Wall Street’s new money spinner.

The pace of buyouts is slowing and some private credit funds are struggling to return cash to their investors. Banks are back, contesting deals and undercutting direct lenders on margins.

“There has been an erosion of the private credit illiquidity premium,” said Matthew Bonanno, managing director at General Atlantic’s credit unit.

“I think there is some frustration from LPs on this,” he said, referring to the limited partners such as pension plans and insurance companies that allocate capital to private credit funds.

Some funds simply can’t return enough capital to their LPs. Canadian investment manager Ninepoint Partners LP temporarily suspended cash distributions in three of its private credit funds last month to cope with a liquidity crunch.

Others have exited entirely. Last month Fidelity International halted its European direct lending activities, less than a year since it held a first close on an inaugural fund.

Managers themselves acknowledge it will be hard to match 2023’s 12% return.

Investors have also started worrying about the actions of borrowers in direct lending funds. In a move reminiscent of collateral stripping more common in leveraged finance, a Vista Equity Partners-backed tech learning platform Pluralsight Inc. shifted assets away from its direct lenders.

That exposed weaknesses in direct lending documents thought to be immune from such controversial maneuvers, spurring worry the incident wasn’t just a one-off as covenants get looser.

“We think it’s become crowded given muted deal flow, and we see leverage increasing and spreads tightening,” said Emma Bewley, partner and head of credit at Partners Capital, an investor in private credit funds.

“The opportunity is no longer as attractive in upper middle market senior direct lending.”

Most of the concerns are focused on direct lending, the portion of the private credit market where funds make loans directly to companies to back acquisitions or leveraged buyouts.

To be sure, the current thinning in spreads does not present an existential threat to private credit. Returns have been strong in the last two years, beating private equity in some quarters, a trend that could be set to continue.

At the same conference in Berlin, Apollo Global Management Inc.’s Co-President Scott Kleinman warned “fewer realizations and lower returns” are on the horizon for much of the private equity industry.

“These supply and demand dynamics ebb and flow,” said Vivek Mathew, head of asset management at Antares Capital. “I think the wider expectation is that the market is going to keep growing.”

Deals are back in contention from banks, but not all of them. Direct lenders remain the go-to financiers for small and midsized companies.

Partners Capital is looking more closely at areas like credit opportunities and specialist lending. General Atlantic is targeting private financing to family-owned business and smaller entrepreneurs for growth and acquisitions.

“Given the intense competition for the limited number of new sponsor-led deals the asset class has to open its investment aperture,” Bonanno said.

Updated: 6-10-2024

Private Equity Is On Sale

Markups

Most people who buy and sell financial assets for a living need to know how much their portfolio is worth at any given time, or at least at the end of the quarter.

If you manage investments for clients, you have to send the clients periodic statements saying “your investments are worth $_____”; you have to know what number to put in the blank.

The clients want to know, for one thing, but also, how much you charge the clients might depend on the number that you put in the blank.

If you charge the clients a percentage of current assets, then you need to know what the assets are currently worth.

If you charge the clients a performance fee on unrealized gains, you need to know how much the value of the assets has increased since the last statement.

Even if you don’t manage client money, your employers will want to know how much your portfolio is worth, so they can keep an eye on risk and pay you for your performance.

Also, though, many people who buy and sell financial assets for a living are fundamentally in the business of looking for mispriced assets.

Your job is to find some situation with edge, some place where you have more expertise or patience or capacity than the market, some asset that you know is undervalued but that the market will sell to you cheap.

You See The Tension Here, Right? The Tension Is:

(1). You think a thing is worth $100.
(2). Someone is selling it for $80, because they are wrong or weak.
(3). You buy it at $80.
(4). The valuation controller comes to you and says “for various important purposes, I need to know the current fair market value of this thing.”
(5). “Oh, $100,” you say.1 Of course! That’s what it’s worth! That’s why you bought it! (For $80.)
(6). You book $20 of profits, charge performance fees, etc.

And then, oh, you know. Sometimes you sell the thing a week later for $100 and everything is great.2 Other times the thing never trades above $80, you sell it a year later for $60, and people have some questions about your valuation.

Obviously this more or less never happens with publicly traded stocks or Treasury bonds: When a thing has an active public trading market, everyone understands that you mark the thing to its current trading price, whether or not you think it’s underpriced.

If you buy GameStop Corp. stock at $28.50 and it closes the day at $28.22, you will mark it at $28.22, whatever you might think it is actually worth.

And with illiquid hard-to-value things, everyone understands this tension, so responsible investment firms (and their accountants, risk managers, auditors, etc.) will have some procedure for determining fair value that is not just “ask the trader and write down whatever she says.”

You’ll get an independent third-party valuation, or use a pricing service, or get three quotes from dealers, or something.

Also, firms that deal mostly in illiquid hard-to-value things (venture capital, private equity, private credit, etc.) are less likely to charge clients fees based on their valuations.

A private equity firm is more likely to charge fees based on committed capital and realized returns — actual cash in and cash out — while a hedge fund that trades public stocks will have an easier time charging fees based on current asset value and unrealized returns.

Still, Every So Often You Get Stuff Like This, From Jonathan Weil At The Wall Street Journal:

* The last day of September 2023 was very good for Hamilton Lane Private Assets Fund. It recorded a 39% gain on a group of investments it bought the day before for $52 million, giving a quick boost to the fund’s performance.

* Of the three dozen investments it bought on Sept. 29, nearly half had more than doubled in value on Sept. 30. The Hamilton Lane fund’s stake in a fund that focuses on Latin America rose eightfold in 24 hours.

* Welcome to the obscure secondary market for investments in private-equity funds. The Hamilton Lane fund and others buy stakes in private-equity funds from existing investors. It is a thinly traded market largely out of public view. Secondary market volume for private-equity and similar funds in 2023 was $112 billion, according to investment bank Jefferies.

* The small amount of publicly available data about the market shows buyers often get their stakes at big discounts to the official values set by the private-equity funds’ managers. In many cases, buyers quickly mark up the stakes they acquire to the official value, no matter how little they paid for them. …

* The investment funds that mark up their acquisitions benefit from instant gains, which increase assets and boost fees. Strong performance numbers draw in new investors.

To be fair, it’s not like the secondary-market buyers are just making up valuations. They are relying on official outside valuations, rather than their own subjective views:

* When the Hamilton Lane fund buys a stake in a private-equity fund, it relies on the valuation provided by the other fund’s manager, known as the general partner. “We do not adjust the GP’s valuation,” said Erik Hirsch, co-chief executive officer of Hamilton Lane. “We would have no basis to adjust that.”

No Basis? Not Any Basis At All? Weil Can Think Of One:

* Did the Hamilton Lane fund’s ability to buy a stake for so little raise any question about the higher valuation?

“Absolutely not,” Hirsch said.

Obviously market prices have nothing to do with value.

Updated: 6-11-2024

Private Equity Sees Distressed Debt Soar At Portfolio Firms

Distress in the portfolio companies of the top 50 PEs increased 18% since mid-March.

Swallow The Lump

Distressed debt in private equity-owned firms is soaring as interest rates remain stubbornly high, offering a glimpse at the pain ahead for the industry.

Leaders bemoaned the grim outlook during a gathering in Berlin last week, with Apollo’s Scott Kleinman warning that lower returns are on the horizon.

The amount of distressed debt owed by portfolio companies of the world’s 50-biggest PE firms has climbed 18% since mid-March to $42.7 billion, according to data compiled by Bloomberg News, using rankings from Private Equity International.

The increase happened over a period when the global distressed debt tally shrank overall.

The industry is sitting on a pile of companies it bought up when interest rates were low. As that debt comes due, forcing borrowers to refinance at higher rates, PE investors “of all sorts are going to have swallow the lump moving through the system,” Kleinman said at last week’s SuperReturn International conference.

Leveraged loans, which have long been the financing method of choice for private equity buyouts, have become a larger share of the world’s distressed debt universe in recent weeks.

They made up 15.6% of the Bloomberg News distressed debt tracker on June 7, up from 13.6% at the end of February.

“The growth in the speculative-debt universe after the global financial crisis was mostly in the B and B- categories, sponsor activity was high and purchase price multiples were high so even with a big equity check you needed a lot of debt,” according to Steve Wilkinson, a managing director at S&P Global Ratings.

“Capital structures that made sense in the low interest rate era are much tougher to support now, especially for companies with higher leverage levels and which aren’t operating as well.”

With a lagging M&A market, private equity firms are finding it harder to exit their investments. The longer retention period means they have to manage their portfolio companies’ debt or risk earnings being eroded by higher borrowing costs.

Strategists at Bank of America pointed out in a note last week that that the new “normal” leverage level in a buyout is closer to four times earnings, half the level that was the norm before the rise in interest rates.

That means private equity firms are having to get creative — and potentially open up their own pockets — to address the emerging problems.

One recent example is German company Kloeckner Pentaplast, which was acquired by Strategic Value Partners in 2012. Last year, SVP injected €150 million of fresh cash to bolster the packaging firm’s balance sheet.

Still, loans and bonds linked to its €2 billion debt pile come due in 2026.

Kloeckner has said it is planning a refinancing this year. That may require the owner to put even more money into the company, market watchers say.

The chances of a straight refinancing “rest with SVP and its willingness to delever the business in a non-detrimental way to bondholders,” analysts at CreditSights wrote in a note last week.

One option could be that SVP buys more unsecured debt and then swaps those holdings for equity, they said. A spokesperson for SVP declined to comment.

Most Private Equity Investors Fear Cash Is Stuck In Zombie Funds

* Three Quarters Say Their Funds Unlikely To Pay Out As Planned

* Higher Rates Have Made Liquidation Tougher For Private Equity

Investors in private equity see a rising number of “zombie funds” tying up their money, according to a survey by secondaries asset manager Coller Capital.

Almost 50% of pension funds, insurers or other investors already have money in funds that have little hope of liquidating their assets or raising a successor vehicle, while 28% expect to see such funds appear in their portfolio, the survey found.

“Recent years, marked by inflation and high interest rates, have no doubt had an unfavorable impact on portfolio companies’ growth prospects, which could lead to an increase of zombie funds,” the report said.

Coller surveyed 110 private equity investors, also known as limited partners, in North America, Europe and Asia.

The firm manages $33 billion, according to its website, making it one of the biggest investors in the secondary market, which allows investors to cash out of their private equity positions before the funds are wound up.

The findings come at a crunch moment for private equity. With higher interest rates making capital more costly for both buyers and sellers, buyout funds are struggling to get the price they want for exiting investments, while also dealing with higher financing costs for their portfolio companies.

About 64% of the surveyed limited partners also believe that at least one of the private equity managers they are currently invested with will merge with, or be acquired by, another manager in the next two years, Coller said.

The survey showed that 57% of investors are not comfortable with the use of NAV finance in the private equity industry, with one of the top concerns being the introduction of additional leverage in the system.

The sector has ramped up use of NAV financing — which allows private equity firms to borrow against a pool of their portfolio companies — as traditional borrowing options dry up.

The loans are typically costly and critics warn they are likely to dilute returns later down the line.

Updated: 6-15-2024

Pensions Piled Into Private Equity. Now They Can’t Get Out.

Retirement funds seek cash while money languishes in zombie investments.

Private-equity and pension funds seemed like a match made in heaven. U.S. companies and states handed over control of some worker retirement savings.

In exchange, they got a promise of high returns after a decade—and often received healthy cash payouts in the years before that.

Now the honeymoon is over. The payouts have dried up, creating an expensive problem for investment managers overseeing the savings of workers retired from big corporations and state and city governments.

To keep benefit checks coming on time, those managers are unloading investments on the cheap or turning to borrowing—costly measures that eat into returns.

California’s worker pension, the nation’s largest, will be paying more money into its private-equity portfolio than it receives from those investments for eight years in a row.

The engine maker Cummins took a 4.4% loss in its U.K. pension last year, in large part because it sold private assets at a discount.

It is the latest cash crunch to befall retirement funds that have piled into hard-to-sell investments in search of high returns, and spotlights the risks as Wall Street is trying to sell those investments to wealthy households.

“You’ve got a lot more money out and going out than is coming back, and I think that’s causing a lot of angst,” said Allen Waldrop, Alaska Permanent Fund Corp. private-equity director.

U.S. companies and state and local governments manage around $5 trillion in pension money.

Large public pension funds have an average 14% of their assets in private equity, while large corporate pensions have almost 13% in private equity and other illiquid assets such as private loans and infrastructure, according to data from Boston College and JPMorgan Chase.

Much of the money was committed when low bond yields were dragging down retirement portfolios.

But as private equity has grown, its lead over traditional stocks has narrowed. And during the decade before the investments pay out, it can be hard to trust interim estimates provided by fee-seeking managers.

Pensions, sovereign-wealth funds, university endowments and other institutions often promise their money to private-equity managers for a decade or so. Over that time, the managers draw down the cash and use it to buy companies, then overhaul and sell them.

Those sales and the resulting cash distributions to investors have slowed markedly as high interest rates have made buying and owning companies more complicated and expensive.

Unable to sell without denting returns, private-equity managers are keeping workers’ retirement savings locked up for longer—sometimes past the promised maturity date.

Nearly half of private-equity investors surveyed by the investment firm Coller Capital earlier this year said they had money tied up in so-called zombie funds—private-equity funds that didn’t pay out on the expected timetable, leaving investors in limbo.

So pension funds are selling private-equity fund stakes secondhand—often taking a financial hit in the process.

Secondary-market buyers last year paid an average of 85% of the value the assets were assigned three to six months before the sale, according to Jefferies Financial Group. Secondhand sales by private-equity investors increased 7% to $60 billion last year.

Columbus, Ind.-based Cummins sold private assets because its U.K. pension suddenly needed cash after derivatives bets backfired and many U.K. pensions had to post large amounts of collateral. A Cummins spokeswoman said the plan is confident in its strategy.

The Oakland, Calif.-based healthcare provider and nonprofit insurer Kaiser Permanente has sold $6.5 billion in private assets in the past two years and is preparing to sell another $3.5 billion after an aggressive push into private markets a few years ago.

Anton Orlich, who oversaw much of that push, is now supervising an expansion of the $502 billion California Public Employees’ Retirement System’s private-equity portfolio to 17% of assets.

Orlich told Calpers’s board Monday that the cash demands of the private-equity portfolio have dwarfed payouts for four years and would continue to do so for about another four years.

Calpers is investing extra money up front as a part of a strategy that will reduce sudden requests for cash later, Orlich said.

Some pension funds are borrowing to access cash. Both Calpers and the $333 billion pension serving California teachers have approved plans to take out loans equivalent to 5% and 10% of fund holdings, respectively.

The Alaska Permanent Fund Corp. has received cash from a different kind of borrowing: private-equity managers making payouts that come not from investment gains but from loans they have taken out to appease cash-starved pensions and other investors.

That is frustrating for the investment chief, Marcus Frampton. He estimated that his fund, which invests mineral revenue and other state money, could borrow on its own at lower cost.

So far, this practice doesn’t appear to be widespread.

The $80 billion Alaska fund has been getting more cash from its private-equity program than it has put in.

But it still missed out on around half a percent worth of stock gains—or about $40 million—over the past year after private equity tied up more cash than expected, causing the fund to run a smaller than planned stock portfolio, Frampton told the fund’s board last month.

Board members decided to reduce real-estate and cash holdings instead. They also voted to scrap a goal set a year ago to reduce the share of assets in private equity.

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