In this episode of Termgrid Talks, Dipish Rai spoke to Akshat Khaitan, Managing Director, KKR Capital Markets in late 2024.
KKR’s unique position in the market – borrower, lender and with underwriting capabilities – offers an interesting vantage point to discuss the private capital markets. Akshat discusses hybrid structures and how different pools of capital can work together. The conversation also looks at the unique characteristics of private credit particularly through the lens of emerging trends around trading of these instruments and private lenders selling down positions to LPs.
Lastly, Dipish and Akshat discuss how KKR became a pioneer in the user of capital markets technology with their partnership with Termgrid.
Disclaimer:
The views expressed herein represents the current views of Akshat Khaitan as of 31 October, 2024 nor KKR undertakes to advise you of any changes in the views expressed herein.
Opinions or statements regarding financial market trends are based on current market conditions and are subject to change without notice. This publication has been prepared solely for informational purposes.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision.
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Dipish Rai: Welcome to Termgrid Talks we are joined here today by Akshat from KKR Capital Markets in Europe.
KKR Capital Markets has a very unique perspective on the financing markets just because you are a preeminent borrower, you are also a lending business and you also have the underwriting capabilities. So from all those vantage points would be very curious to hear your perspective on where the financing markets are today for each one of those personas.
Akshat Khaitan: Thank you for having me.
From that vantage point I think we have seen through this year – particularly from the transactions we have been involved in – its been a very active and borrower friendly market.
You see all the various pools of capital back, forming incremental capital. Private credit fundraising has improved again. So you see people keen to deploy funds on the private credit side.
CLO formation has been very strong this year. So you see that backlog in CLO formation coming through. That has created a pretty good environment for issuers.
Sitting from the vantage point of a borrower, it’s a great time to be out there to raise capital for whatever you’re looking to do. Whether that be new LBOs or acquisitions for existing portfolio companies or dividend recaps. We see the market increasingly open to more creative solutions and ideas.
What we have also seen is deals where private credit and the syndicated market work hand in hand. So a syndicated deal in Euro CLOs with other currency components going to the private credit market – whether that is a sterling tranche or one of the Nordic currencies. We have seen a number of those types of deals where you are marrying very different pools of capital but into the same structure and the same document.
Dipish Rai: And do you see hybrid structures being back in the market where we are today?
Akshat Khaitan: I think historically the hybrid structures have existed in that the senior structure was
primarily syndicated and the junior structure was privately placed. So it’s not a new phenomenon. But within the same ranking of a senior cap structure that kind of phenomenon will continue to prevail primarily because large businesses, large global companies require funding in multiple different currencies.
The depth of the market is still not back to what it was, you know, I would say pre-Covid. Which means that if you’re looking to do a very large LBO, you want to tap different pools of capital, different currencies and pockets. Whether that’s bonds and loans or private capital with public capital.
Dipish Rai: And is that the lens with which you think about a new placement. Let’s say as a borrower when you’re evaluating the competitiveness of all these different structures be it bond be it private credit or be it the syndicated markets. The complexity of the business obviously is one factor of that but for a structure where all three can work independent of each other, how do you think about competition from that perspective.
Akshat Khaitan: I think what we try and focus on is trying to find the right capital structure that fits the equity investment thesis. So, although you certainly care about cost of capital, it might not always just be about finding the absolute cheapest cost of capital. It depends on what you’re trying to do with the business.
Let’s take for example a buy-and-build strategy for one of our portfolio companies. In that scenario you want ease of access to incremental capital to be able to kind of continue to deploy and raise funding for incremental M&A. So that can be either in the form of a delayed draw term loan, which is more common in the private credit world, although you are seeing some delayed draws being broadly syndicated.
So if you’re looking at a company that is very M&A focused, that’s looking to run leverage at a higher level than what may be broadly accepted in the syndicated markets, private credit might be the right solution.
Or if you had a multitude of currencies that you wanted to solve for, private credit might be the right solution. If you’re looking at a business that’s mature, well understood in the syndicated markets has been a previous issuer or something that’s very large, you might want to do the syndicated markets just to provide that kind of depth of capital. Although private credit has become increasingly large and we’re seeing multiple billions being financed in the private credit market.
Dipish Rai: So between the structures that you evaluate on each and every transaction, be it a bank structure, a bond structure, syndicated or unitranche for that matter, are there certain economic terms, certain doc terms that are particularly applicable to each one of them as you think about the pros and cons of each?
Akshat Khaitan: I would say on a broad basis, all three markets, the private credit unitranche, the high yield bond and the broadly syndicated loans work somewhat in unison in terms of overall returns.
Now, each market might not move as quickly to adjust, but over time they tend to gravitate in the same direction. So this year we’ve seen tightening of spreads across all three markets. And that’s because market forces mean that if you want to be competitive as a private lender, you need to go tighter to compete with the syndicated markets.
I would say economics wise, you have, in the loan market primarily the cost of CLO liabilities is what will drive over a longer period of time where new issuance settles. That’s because the CLO arbitrage needs to work.
If CLO pricing on a blended basis is 140 basis points, that means that the broadly syndicated loan market on average, across the portfolio will have to be somewhere in the high 300bps, low 400bps from a margin perspective.
Then what that means is for the private credit market, there will be a premium to that, but it can’t be a disconnected premium.
So going back to the 600bps over margins that we saw during the market dislocation is going to be unlikely in the near term for strong credits.
That means that the kind of high 400bps, low 500bps margin is a fair place at the moment for the private credit market.
In terms of docs, I think most markets have converged. So the high yield covenants came to the loan market quite a while ago now, and I think has become generally accepted for the large cap transactions. And I think that’s now primarily also accepted in the private credit market.
I think you’re seeing documentation across broadly syndicated term loan B and private credit converge more and more over time as the two markets compete for similar quality and size of businesses.
If you’re still looking at the mid market, I think that there’s a difference. It’s not that the terms are equal for all sponsors and for all issuers. But in general, for the really high quality large cap transactions, I think documentation is becoming less and less of a concern.
Dipish Rai: Switching gears a little bit in terms of the outlook of the deal flow. This year we’ve seen a record year for the KKR cap markets business as it was announced. So what is your in house view of what the outlook looks like for the next six to 12 months?
Akshat Khaitan: As you mentioned, we have had a strong year in terms of issuance, both for KKR portfolio companies, as well as third party clients. And we’ve continued to grow that business and win new clients and new sponsors that transact with us on our platform, which we are extremely grateful for.
I would say there’s been a good mix of new M&A driving issuance. So we’ve done five new LBOs this year on the private equity side.
We’ve done a number of transactions on the infrastructure side, including the largest one that we’ve done to date with Telecom Italia, which the team has worked through.
And a number of our sub strategies, including our growth strategies and things of that nature. So, you know, capital deployment kind of continues to be on pace for us. So we haven’t kind of seen the
slowdown in deal volume for KKR sponsored transactions.
We’ve also seen a very, very busy year in terms of portfolio activity. So whether that is extending majorities in the capital structure, re-pricing transactions, bringing transactions that were done in 2022 and 2023 in the private markets, to the broadly syndicated markets to reduce that cost of capital in line with what we’ve been discussing.
And so, across all the various themes, we’ve been quite busy as a house. And we have seen some M&A volume kind of start to pick up over the course of the year and also a lot of opportunistic transactions where people are taking dividends or raising incremental capital for M&A.
From our standpoint, I think it’s been a good year. I would say, from talking to market participants across the street, most people have had a good year and tended to meet budget.
But what we haven’t seen is that wave of M&A and large LBOs coming back where sponsors are trading existing portfolio companies with other sponsors.
It feels like we’ve been saying that for a while that that’s that’s due to start again but if you just take a step back and look at the factors that will drive that: private equity having record amounts of capital to deploy, private equity requiring a return of capital to their LPs for older vintages of funds and financing capital readily available and reasonably priced.
We feel quite good that 2025 should be a year of meaningful activity on the new LBO side which is what has been missing in 2024.
Dipish Rai: This year I think a lot of activity was re-pricing activity just because of the syndicated market really driving the re-pricing wave. Do you expect that to continue or in the portfolio itself are the majority of the re-pricings behind us now and now it’s really the M&A that has to drive the deal volume.
Akshat Khaitan: I would say a lot will depend on where CLO liabilities go. If they continue to tighten, you could potentially see another leg down.
Although if you just look at spreads in general, we’re probably at the 90th percentile of tight spreads. So there’s not that much to go from here. So you could have another 25bps or another, you know, 50 basis points at an extreme. But it’s hard to see us kind of getting to an environment where we’re talking about 200bps and 300bps from a spread perspective, just from a historical context.
What’s helping is base rates are coming down. And so anything with a fixed coupon will benefit from a new issuance or a refinancing. And overall cost of capital is coming down, which means that people can afford to borrow more for the same amount of earnings that the company has.
So I think, to your point, add-ons for M&A, add-ons for dividends, new volume for new LBOs, I think that will be the primary driver for next year.
Dipish Rai: There has been a lot of innovation that is coming to the private credit market because of, you know, it being the golden age of private credit. One such innovation is the trading aspect in the privately held loans, really grabbing headlines and some of the firms announcing initiatives and capital behind creating a secondary platform. What are your views on that? Where do you think this trend is going to go?
Akshat Khaitan: Look, it’s a super interesting topic because there’s two competing sides to this.
I think that is what’s driving a lot of private credit lenders to take a more active approach to portfolio management. So whether that is diversifying your portfolio by doing smaller tickets in lots of different deals. Or incrementally adding to your exposure over time in a transaction as you raise more capital. Or if you have outflows of capital trimming your exposure.
So I think that’s a phenomenon that will probably continue to gain prominence as that portion of the market becomes a larger and larger source of fundraising for the private credit market.
But on the flip side, as a borrower people structure private credit deals because they are bilateral private instruments. You want to have a sense of control as to who your lender is and who you’re speaking with when you have a request when you require incremental capital etc.
So I think a big topic is how easy is it to trade a private credit loan. I think you will have people that will step up to make markets in in these instruments over time. The friction costs will initially be quite high
because they’re not that liquid. So the bid ask spreads and what’s happening in the middle will probably be you know reasonably diluted from trading on a regular basis.
On the other side you know you’ll have very restrictive transfer provisions in the credit agreements. Whitelists are much smaller than the broadly syndicated loan market and there a lot more controls as to how easily you can trade this instrument.
So I think there will need to be more of a conversation between private credit providers and borrowers to kind of come to an understanding of what that instrument really is.
Part of that will feed into some of the terms that you have. So if you have a mid-market covenanted unitranche document you don’t want that to be freely tradable from a borrower perspective and in the hands of the wrong people.
But if you have a very large quasi term loan B syndicate with 10 plus private credit lenders which is cover light and very flexible you might be a little bit more comfortable with people trading in and out of those positions.
Dipish Rai. So it’s still a small market?
Akshat Khaitan: But I think a growing market and over time I think you’ll continue to see innovation around that.
Dipish Rai: One of the other phenomenons that is increasing in the market and would be good to get your perspective on is that the private credit universe, given the size of the funds that the institutions have been able to raise, are writing bigger and bigger tickets. And because of them writing bigger and bigger tickets, they’re also starting to syndicate it on the back end to sell down their positions to either private credit lenders or other institutions or LPs.
What are your thoughts on that sort of a trend? You see more of that happening. What are some concerns that you might have the same way on the liquidity question that we discussed or the secondary liquidity?
Akshat Khaitan: So it is definitely a phenomenon that has gained prominence. So I think you see a lot of private credit lenders, I would say for the most part, looking to syndicate to LPs on the back end.
I think that’s also a phenomenon driven by the fact that LPs are asking their GP relationships to provide them co-invest in transactions as a way of increasing their exposure to the asset class.
I think it’s interesting to see how that progresses because in a fully functioning market, I think that’s probably a good trade for people where everybody gets what they want. But if the markets dislocate,
you could see situations where people end up with more exposure than they would ideally like to have in a transaction if they haven’t been successful in syndicating to LPs.
And given some of the restrictions around transferring the product to other GPs or just selling it down in the broader market. That could lead to some more slightly tricky situations. But what I’ve seen and what we’ve been involved in as a firm quite a bit is underwriting to a private credit syndication.
And that’s not something that I believe is gonna be the future of the market under all circumstances.
So the private credit market is a private market. It’s a direct market, but there are some instances where people need speed and certainty on transactions. Whether that’s a public to private or a bilaterally negotiated transaction where people don’t want to approach 10-15 lenders to negotiate a club transaction or where you might approach somebody and say “I want 100% solution”.
And that’s a capability that we’ve worked very hard to develop over the last 2-3 years and provide people with that certainty. We might hold some of the transaction in our private credit pools, we might underwrite a portion of the transaction through our capital markets business and then distribute that to other participants and also to LPs in the market.
I think that’s a value proposition that’s quite attractive for people but in certain circumstances. It’s not something that I view as becoming the norm for all private credit deals.
Dipish Rai: So Akshat let’s rewind the clock back to COVID times which is the first time when we met each other. This is mid 2020 the peak of COVID and there’s a walk us take us back into that view as to what made you take that plunge.
Akshat Khaitan: For us it was about trying to find ways to work with technology to frankly make our lives easier. As capital markets professionals at the time we had a lot going on and a small team at the time, which has grown substantially since but so has our portfolio.
It was about trying to create efficiencies on how we interact with lenders. Our relationships across the market, capture data and figure out how to make the best use of that information, in a sensible way, without making it extremely manual on people in the team.
And it’s been great to be part of this journey to try and figure out what incremental features have been added over time and how the product has kind of grown and flourished. And congratulations on all your success and all the new customers you have.
But hopefully we’ll always have a special place in Termgrid history.
Dipish Rai: Absolutely. We’re always very fortunate to be working with you and it’s been an amazing journey and hopefully it continues for a long time. Thank you.
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