Time of reckoning

The global financial crisis is the only guide that many industry professionals have to negotiating today’s market. But the secondaries market is broader, deeper and more sophisticated than in 2008, not least when it comes to the use of leverage to maximise returns. 

A company subject to a secondaries transaction could have at least five layers of leverage acting on it, from LBO debt up to the capital call facility employed by the secondaries fund. The test posed by coronavirus to these layers, each with their own dynamics, is the subject of a three-part series by Secondaries Investor that kicked off this week. 

In the first piece, we looked at fund-level leverage. While most LPs are well placed to remedy problems related to subscription lines even at a time of declining distributions,  shrinking net asset values mean some funds with portfolio-backed financing are already hovering close to their covenants. Exotic offerings such as distribution recap facilities, which have allowed firms to borrow a chunk of next year’s anticipated distributions today, add to the cocktail of risks. 

The second article in the series, due out next week, looks at transaction financing. Some secondaries firms routinely form special purpose vehicles around transactions and apply leverage with recourse to those assets. With the values of many of these portfolios dropping and set to be marked down even further at the end of June, could we see a litany of triggered covenants? And if credit markets remain tight, how will it affect secondaries firms that have SPV leverage at the centre of their strategies? 

The final instalment will look at leverage at the portfolio company level – how are debt-laden assets experiencing distress likely to affect returns for GP-led transactions?  

Some companies that were the subject of GP-led deals could be in need of capital to stay afloat or to take advantage of opportunities brought about by recovery. We look at what secondaries funds can do to fill this gap. Will preferred equity be as big an opportunity as many firms hope or will it prove too costly for most borrowers? 

Leverage has been used as a way to juice returns during the bull run over the past 10 years. The coronavirus crisis will sort the savvy dealmakers from those relying on a rising market to deliver performance. 

What aspect of leverage represents the biggest risk to the secondaries market? Contact the author: rod.j@peimedia.com.