February 21, 2024 - The growth and buy-and-hold nature of private credit has raised several questions about the asset class’s liquidity, especially as a large percentage of the market is made up of closed-end fund structures with long lock-up periods. But as with other alternative assets (e.g., private equity), a buildup of dry powder in private credit continues to create a secondary market for limited partners’ (“LP”) equity interests in private credit funds. The market for credit secondaries continues to mature as an increasing number of investors seek out liquidity options at various stages of a fund’s life.

In a recent whitepaper “Second (is) Best,” Proskauer and Atalaya Credit Management explore the credit secondaries market. The paper looks at two types of credit secondaries: First, it highlights opportunistic transactions via traditional structures including discounted asset purchases, fund restructurings and continuation vehicles. Continuation vehicles are general partner (“GP”)-led sales of “under-seasoned” assets in an existing fund at the end of its lifecycle to a new fund, financed by either new LPs or existing LPs that roll their interests. Second, it discusses lending structures including Net Asset Value (“NAV”) loans – liquidity lines backed by the NAV of the fund – and preferred equity.

Though not exhaustive, the paper aims to frame the opportunity set for credit secondaries, explain why the market is uniquely poised for a continued uptick in secondary activity, and describe how secondary solutions potentially benefit both buyers and sellers of credit assets.

On the first point, the paper argues that while secondary volume grew 30x from 2012 to 2022 to around $17 billion (according to Pitchbook estimates), the new levels of private credit AUM achieved in recent years suggest secondaries volumes have room to run given they tend to lag. On the second point, the paper suggests that a challenging environment for M&A and IPOs will provide a boost to secondaries activity, paving a path for LPs to monetize holdings and for GPs to avoid prematurely exiting assets that have not yet realized their upside potential. As for the third point, the paper details how NAV loans and preferred equity can be used to solve for portfolio valuation gaps, capital needs of distressed portfolio companies, and sales from LPs when rebalancing their portfolios. These solutions provide optionality for GPs and LPs that outright sales of assets could otherwise make suboptimal.

The paper also points out that the shift of loans from banks to nonbanks and private credit funds since the Global Financial Crisis should result in less selling of assets outright (i.e., less volatility) in future downturns as funds focus instead on their options in the secondary market for weathering economic uncertainty.

The paper articulates well that while private credit funds may be thought of as illiquid, the truth is that their investors have liquidity when needed.

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