Private credit – playing second fiddle in secondaries? 

Secondaries, in particular GP-led deals, have become commonplace in private markets, but private equity deals are still dominating the space. With private credit becoming more popular, some have been wondering whether there will also be more GP-led secondaries. 

The secondaries market reached $69bn in 1H 2024, an increase of 57% year on year, according to Greenhill. Indeed, full year figures are estimated to reach $130bn with GP-led transactions in excess of 40% of that total. 

Greenhill’s 1H 2024 secondaries market report describes demand for private credit as “robust” driven by an influx of dedicated capital. The floating rate structure of direct lending is particularly attractive and has driven pricing up to 91% of NAV, up from 80% in 2h 2023.  

The growth of this nascent market could be seen as an inevitable consequence of the growing maturity of this asset class. There are similar fundamental drivers – in that a secondaries investment offers a quicker deployment of capital and visibility into the underlying assets. 

But there are important differences. 

“The reason that credit continuation funds have been more limited is due to the nature of the underlying assets, but that doesn’t mean they don’t exist. Credit continuation funds can be used to accelerate liquidity for investors or free up reinvestment capital” explained Delphine Jaugey, Head of Secondaries, Europe, Skadden, Arps, Slate, Meagher & Flom LLP and Affiliates. 

“What we have seen more recently is sponsors doing credit continuation funds as a way to start new business lines.” 

As the private debt market itself grows – expected to be worth $2.8tn by 2028 – many are betting that the secondaries market dedicated to it will also grow. According to Secondaries Investor, of the more than 220 secondaries funds in the market, 10 are dedicated to private debt, looking to raise at least $4.29bn combined. GPs include the likes of Coller Capital, the largest manager dedicated to secondaries, and Pantheon. 

Private Credit catch up

Deal sizes in the credit secondaries space is also increasing. Earlier this year, Ares acquired a portfolio of private credit LP stakes worth around $500m, in its largest such transaction to date. 

And while some are thinking whether GP-led deals can penetrate the private credit market as well, there have so far been only a handful of deals. 

Coller Capital participated in the creation of the largest ever continuation vehicle for a private credit fund. With $1.6bn in assets under management, the continuation fund is designed to provide liquidity to investors in Abry Advanced Securities Fund III.

Private credit specialist Brightwood Capital also raised a continuation vehicle led by Tikehau Capital. The net asset value of the special purpose vehicle was about $70m, according to media reports. 

While some question why private credit funds would put loans into continuation vehicles instead of just refinancing them through their flagship funds, others see the logic behind it. 

Therefore GP-led deals or continuation funds could play a role in filling the gap and allowing private credit managers to continue to provide debt to companies they know well and want to support. 

From credit rating agencies to industry insiders, there have been several warnings regarding private credit funds hitting a maturity wall. When that happens, one option could be to raise capital for a continuation fund and use that to solve any such issues. 

Key differences

With private equity setting the pace, there are already well established industry moves to lay the foundations for a transparent and fair market place. Market standards are evolving around the management of the conflict of interests, the election process and even carried interest. 

It’s important however, to keep in mind that although the LP-led secondary market is broadly similar in private equity and private credit, there can be crucial differences in the way GP-led deals are structured. 

In a recent note, law firm Cleary Gottlieb noted that purchase price calculations when transferring credit assets into a continuation vehicle can be tricky, because of the need to capture all different types of inflows and outflows in the adjustment provision. These will need to include any payment-in-kind interest and accrued interest.

It may also be the case that private credit continuation vehicles could look to add leverage to boost returns, which will only make the deal execution more complicated. 

How exits and follow-ons will be handled and tax sensitivity will also need to be discussed from the outset.

Although there seems to be increased interest in understanding how GP-led secondaries and how the use of continuation vehicles can benefit the private credit market, there is additional complexity that managers will need to deal with if this market is to take off and replicate the growth of the structure in private equity.