Shipping loans to life settlements: Houlihan Lokey on non-traditional secondaries

Investment bank Houlihan Lokey’s co-head of illiquid financial assets, Jeffrey Hammer, tells Secondaries Investor how his team views the non-traditional landscape.

How does Houlihan Lokey define ‘non-traditional’ secondaries?

At Houlihan Lokey’s Illiquid Financial Assets team, we look at the buyside as much larger than the narrowly defined private equity secondaries market. For our team, a ‘non-traditional secondaries deal’ is the sale of a portfolio of non-performing shipping loans and repossessed ships from a bank to a joint venture formed by the bank and an alternative capital provider. It is also the sale of mortgage servicing rights, life settlements, pharmaceutical royalties, litigation claims and aircraft leases, among others. The sum total of capital for all illiquid financial asset transactions is our relevant buyside universe – and it is huge

How has the buyside landscape for non-traditional deals evolved

The buyside continues to become more sophisticated and expand. The biggest story of the past five years has been the growth of special situations capital across a variety of investment platforms, led by firms like Apollo, ADIC, Blackstone, Goldman Sachs, KKR and TPG. Now traditional asset managers like BlackRock and PIMCO are entering the market as well.

The main change in the PE secondaries market in the past few years is the degree to which PE secondaries funds have become willing to accept ‘non-traditional’. This is a function of the changing composition of deals available, as a result of a decline in the number and size of traditional LP portfolio sales.

What do you expect will be the biggest drivers of non-traditional deals in 2017?

There are a host of event-driven risks that could impact the various secondaries markets around the world. Collectively or individually, these risks could affect various sellers of illiquid assets across multiple markets.

For example, sellers driven to disgorge assets due to regulatory pressure like the Volcker Rule or Solvency II may reassess pending transactions. However, if public equity market strength holds, we would expect to see a pick-up in private equity LP portfolio sales as rising public equity prices correlate with narrowing discounts.

In Europe, if slow growth rates continue – particularly in the southern regions – then bank balance sheet pressures will accelerate deleveraging programmes including asset sales.

Finally, if rising US interest rates take a toll on the economy or any of the various, growing geopolitical risks – such as elections in Europe – come home to roost, public equity markets could dislocate and depress secondaries market volume across asset classes.

The Fed has just given banks more time to comply with the Volcker Rule. How active have banks been as sellers in 2016 and what role do you see them playing in the secondaries market in 2017?

Given the prior Volcker compliance deadline of 21 July, 2017, American banks had been active in 2016 in using the secondaries market to sell assets. Two things altered the landscape in the last quarter of the year and changed the calculus for banks: the November election of Donald Trump with his administration’s perceived anti-regulatory bias; and the December Fed policy statement that extended the Volcker conformance period until 21 July, 2022. Several banks withdrew from the market in December after the Fed statement, despite having engaged in active sales processes that were moving to close. We believe that it is unlikely that banks will return to the private equity secondaries markets as large, active sellers in 2017.