3 takeaways on the private debt secondaries market

Houlihan Lokey’s Jeff Hammer says that while there is a broad base of potential actors, that loans are repaid over a given period or refinanced likely constrains the size of the market.

Private debt has matured as an asset class, and now the private debt secondaries market could be on the precipice of growing with it. Sister publication PDI spoke with the co-head of Houlihan Lokey’s Illiquid Financial Assets group, Jeff Hammer, on what to expect next year in the private debt secondaries market.

There is a broad swath of buyers and sellers

“The secondary market for private credit includes fund stakes and loan portfolios,” Hammer said. “These are of interest to a broad group of credit managers, hedge funds, institutional investors and business development companies.”

There were notable private debt portfolio transactions this year, including Triangle Capital Corporation’s sale of its loan book to Benefit Street Partners and Alcentra’s agreement to purchase a $1 billion portfolio of US small business loans over the next three years from peer-to-peer lending platform FundingCircle.

Yet the secondaries market – mainly for fund stakes – for the asset class remains relatively young, but may mature in the coming months, which means…

2019 may be a year of growth for the private debt secondaries market

“There are secular and cyclical reasons for why the private credit secondary market may soon ramp up,” Hammer said. “We are beginning to see buyers position themselves for what could be a turn in the cycle in 2019/2020. The other side of the trade also seems to be forming. Looking across the universe of potential sellers, I can see pressures building that should drive selling in the short-medium term.”

In our PEI Perspectives 2019 survey, our annual poll of limited partners, investors surveyed expressed the potential for growth, albeit perhaps uncertain growth.

When asked about plans for secondaries transactions concerning private debt, private equity, private real estate and infrastructure, private debt was the asset class that had the fewest LPs with plans to be active in the market – whether it was plans to only buy, sell or do both.

However, private debt LPs were also the most likely to indicate that they were unsure whether they planned to be active in the secondaries market, with 30.8 percent saying so. That arguably gives the private debt secondaries market the most room to grow among the four asset classes, but…

The fundamental nature of loans likely limits the market for LPs’ stakes in credit funds

“Debt investments have their own built-in exits,” Hammer said. “If they are performing, they are likely to be refinanced or repaid. Hence, private credit LP interests are generally self-liquidating over time. This fact likely suppresses the supply of private credit LP interests that come onto the secondary market.”

The average hold period for a private equity portfolio company is several years – the upper end of a loan’s life – or more. Many lenders have been refinanced out recently, particularly with the spike of refinancings that credit managers saw in early 2018 and the compression of credit spreads. Naturally, given the longer hold period for buyout funds, it seems the private equity funds’ secondaries market would be larger.