Pricing and transferability are key challenges in GP-led credit secondaries
The increase in interest in general partner-led credit secondaries is bringing a whole new complexity to private markets, with managers introducing new tools to overcome some of the challenges.
One of the primary hurdles in GP-led credit secondaries is the formulation of the purchase price. Kenneth Blazejewski, a partner at Cleary Gottlieb, explains that while the pricing mechanics in equity deals are relatively straightforward, credit secondaries require careful consideration of various financial elements.
He notes that credit secondaries raise questions about what constitutes “money in” and “money out” at the reference date. Factors like paid-in-kind (PIK) interest and accrued but unpaid interest must be meticulously accounted for in the purchase price. This complexity makes the valuation process more intricate compared to traditional equity deals.
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Adding another layer of complexity is the potential requirement for third-party agents to approve the transfer of credit assets. Unlike equities, the official books and records of ownership in credit assets can vary, complicating the transferability process. To navigate this, parties are starting to implement a participation arrangement at closing, Blazejewski said. While this instrument is common in the credit market, its application to secondaries is relatively new.
Despite the complexities, Blazejewski added: “Credit sponsors are coming to appreciate the way in which GP-led secondaries in the credit market can help deliver earlier liquidity to their investors through a transaction that doesn’t require the sponsor to fully exit the assets itself. I think as there’s more education and these increase in prevalence in the market, more and more credit sponsors are going to be interested in taking advantage of it.”
Coller Capital is among a handful of firms that have actually participated in GP-led credit secondaries, with partner Martins Marnauza saying that 2024 was an inflection point for the strategy.
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“Throughout this year, we expect to see the number of very large portfolios coming to market continue to ramp up,” he said. “That said, for most prospective sellers engaging in the credit secondary market it remains a new and novel experience.”
A key challenge for Marnauza is the level of awareness among GPs about the existence and advantages of the secondary option for credit.
When a deal does go ahead, Dan Drabkin, US funds partner at Clifford Chance, says lead and syndicate investors on the buy-side should consider portfolio composition and pricing carefully.
“In many cases, the portfolio will consist of several loans and other credit assets,” he said. “Understanding the nature of the assets and where within the spectrum of private credit these assets fall is critical and that will also impact pricing.
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“Investors in a credit continuation fund should be focused on the terms of the acquisition of the portfolio, not just the terms of their investment in the continuation fund. It’s important to ensure appropriate protections and recourse are in place.
“Investors should also understand the timing of cashflows; investors might be willing to pay a higher percentage of NAV if there is a deferral component to the purchase price or if there is leverage on the portfolio.”
