An anonymous direct lending source quoted in the Financial Times. The implication is that lenders should not be complacent about large equity cushions in deals.

First look

AI’s latest advance in the credit world
Equipped AI, a software and analytics provider for alternative asset managers, has this month introduced a new machine-learning system for cash reconciliation in direct lending and granular credit investing.

Routine as cash reconciliation may seem, much can go wrong, including manual input error, duplication of records or overcharging for servicing fees, as thousands of transactions have to be matched to bank records and invoices each month.

The new software designed to avoid such troubles is known as Minerva 2.0. In a statement, Equipped AI’s managing director, Stephen Connolly, described it as “a multi-tiered reconciliation model that systematically executes these cash reconciliation tasks with ease and highly impressive accuracy”.

Connolly said that a recent client case study looked at the average time spent on reconciliation per portfolio per month. It found that Minerva 2.0 can reduce that time from 16 hours to one, a 94 percent efficiency saving. Arithmetic indicates that if management has 12 portfolios to account for, it can save approximately 180 hours per month servicing that data by the adoption of the new tool.

Equipped AI, based in London, was formed within private equity firm AnaCap Financial Partners in 2017 before it spun off in 2021. Although its focus is in Europe, one of its oldest external clients is Amitra Capital, a wholly owned portfolio company of Canada’s CPPIB Credit Investments.

New SEC rules: could have been worse, but still bite 
After much anticipation, “SEC Wednesday” brought with it new, stricter rules for private fund managers around reporting and transparency. While the new era will bring its challenges, the rules are not as draconian as had been feared by some. Here’s our initial take, with more reflections to come once the implications are fully digested.

Senior debt going strong
Things are looking good for senior debt, on both a performance and default basis, according to the Lincoln International Senior Debt Index for the second quarter of this year.

The index, developed by Lincoln’s Valuations and Opinions group in collaboration with Professor Pietro Veronesi of the University of Chicago Booth School of Business, found senior debt yield reaching a record high of 11.7 percent at the end of June 2023, beating the previous high of 11.6 percent in the prior quarter.

The default rate, meanwhile, declined 30 percent compared with the first quarter, breaking a six-quarter trend of increased default rates in the direct lending market. Lincoln said it had seen over 450 loan amendments so far this year, representing around 20 percent of all the companies it tracks.

The firm said this indicated that borrowers and lenders were anticipating defaults caused by higher interest rates and were intervening to address the issue by amending loan documents. One third of these amendments had some kind of payment-in-kind interest, while 31 percent saw sponsors injecting additional equity.

The continuation/co-investment conundrum
When is a co-investment not a co-investment? As structures to hold assets for longer rise in popularity, the line between whether LPs should consider these transactions to be co-investments or continuation vehicles is becoming increasingly blurred. So how does an LP know the difference, and does it matter? This is a question affiliate title Private Equity International’s Side Letter recently put to a number of senior industry participants.

The bottom line is, if an asset is new to a GP, it’s a co-investment; if they already have exposure to the asset as part of the platform, it’s a secondaries transaction, a director at an advisory firm told Side Letter. When it comes to underwriting such deals, the risks aren’t that dissimilar, as investors need to look at alignment of interest, value creation strategy and credibility.

Deal volume for continuation funds involving one asset is likely to grow even further given the dearth of exits within private equity, meaning LPs will have a wealth of opportunities for this type of transaction, a senior managing director at an investment firm told PEI. Whether this tidal wave can deliver similar returns to traditional co-investments and therefore deserves to absorb some of the LP capital allocated to the latter, however, is not entirely clear.

“A lot of those deals have really attractive return opportunities by virtue of the expert… taking the second bite and recapitalising and giving the business new ways to grow through a bigger equity base,” the executive said. “Are those net returns going to end up being the same as no fee, no carry co-invest returns? All that still has yet to play itself [out].”

Essentials