Loan Note: StepStone on the credit secondaries opportunity; farewell to LIBOR

StepStone reveals why transactional volume in credit secondaries is on the up. Plus: waving goodbye to the UK's LIBOR; and Adams Street's tips on manager identification. Here's today's brief for our valued subscribers only. 

They said it

“Although the maturity wall is being chipped away, we also anticipate that some companies will struggle to refinance at higher yields in the coming years”

Taken from Fidelity International’s Private Credit Quarterly Outlook by Michael Curtis, head of private credit strategies.

First look

A bigger slice of the pie: opportunities in credit secondaries (Source: Getty)

StepStone sees credit secondaries boost
When the going gets tough and liquidity is at a premium, investors looking to raise capital or rebalance their portfolios often seek to unload their best assets first.

Among illiquid assets, private debt appears to be “it” at the moment. According to a new paper by investment manager and consultant StepStone Group, challenges in the liquid markets last year exacerbated the so-called denominator effect, causing institutional investors to be inadvertently overweight in several illiquid assets classes.

“Counterintuitively, the relatively strong performance of private debt meant that accepting a haircut on those valuations would require a comparatively modest mark down (particularly against devalued fixed income and equity holdings), and thus transactional volume arrived reaching $17 billion in 2022 (more than 30x larger 2012 levels) per Coller Capital,” according to the paper.

Indeed, secondaries’ volumes in 2022 fell in all asset classes save for private debt, where volumes increased by more than 30 percent.

Although an investor looking for liquidity today might have to sell a private equity portfolio for a 20-30 percent haircut, the asset class that has suffered least is private debt, John Bohill, the StepStone partner who authored the paper, told Private Debt Investor.

Unsurprisingly, then, StepStone and its peers “became buyers of performing direct lending LP interest at prices reflective of private equity returns”, the paper says. Bohill told PDI that StepStone’s Credit Opportunities Fund 1 is performing strongly, particularly because of its secondaries’ activity. The fund had a 17 percent IRR within a year of its first quarter 2022 closing, and is 90-95 percent invested.

“For more than 10 years, we’ve been in a very benign credit environment without much disagreement,” Bohill said. “Suddenly we’re talking about some elements of a recessionary environment, and we have people disagreeing over the quality of portfolio companies and managers, which creates a volume boost.”

In the last six months, StepStone has been talking with many pension fund trustees who are tactically selling some exposure now but who want to increase their private debt allocations in 2024.

Eleven years after the scandal, goodbye to LIBOR
The last remnants of the London Interbank Offered Rate expire as June ends.

LIBOR was first published on 1 January 1986 and soon became the dominant reference rate for adjustable-rate financial products around the world. It was published daily for more than 35 years.

LIBOR was defined as the average of the rate at which the surveyed London banks represented that they could borrow unsecured cash by asking for and accepting inter-bank offers in reasonable market size.

In May 2021, the UK Financial Conduct Authority announced that one week and two-week USD LIBOR would cease publication at the end of that year, and that the longer-term USD LIBORS would cease publication after 30 June 2023.  Accordingly, the deadline for the adjustment of the benchmarks for existing loans to SOFR expires on that day.

The significance of the transition has been enormous. Two years ago the consultant Oliver Wyman estimated that a typical US bank had between one fifth and one quarter of its balance sheet in LIBOR, and that (including commercial real estate and mortgages) there were nearly $10 trillion of LIBOR-referenced loans outstanding in the US.

Why did LIBOR have to go? Precisely because it is defined by the representations of the banks, not by actual borrowing, LIBOR proved all-too subject to manipulation. The catalyst for the demise of LIBOR was a spate of accusations in 2012 that several major financial institutions – including Barclays, JPMorgan and Citigroup – were colluding as to their rate submissions. Barclays soon admitted to the truth of the accusations. It, and several other banks, settled lawsuits with sizeable payouts.

By the time the scandal’s dust cleared, a general consensus existed among financial regulators, banks and counterparties that there had to be a new reference rate, one with transparency and a liquid underlying market. In the US, that has meant, chiefly, the gradual replacement of dollar LIBOR by the Secured Overnight Financing Rate. The transition has not always been smooth.

Early this month, Barclays said that LIBOR-linked loans still account for about 55 percent of holdings in collateralised loan obligations, and that there was a flurry of deal-switching activity underway ahead of the deadline.

Adams Street: finding managers who will avoid losses
In the private debt world, alpha derives “almost entirely from loss avoidance”, according to a new paper by Jeff Diehl and Bill Sacher of Adams Street, an employee-owned investment manager with $54 billion AUM.

The paper acknowledges that in private equity, market outperformance goes to firms that capture market upside potential above modelled returns. Private credit, though, lives and dies by the “double edged sword” of leverage, where asset-based loans enhance the yields of low-loss portfolios but punish portfolios with material default rates. This situation implies the centrality of loss avoidance.

This centrality may not have been obvious in recent years as a benign climate of macro growth and low interest rates has allowed many managers to avoid losses, creating a narrow return dispersion. To the extent this has created a false sense of security, managers are about to experience a reality check, and investors should know what to look for in a manager as return dispersions widen.

The paper suggests that investors avoid losses by looking for three key characteristics in their prospective managers: a proven approach to underwriting; a differentiated approach to originating deals; and a capital base that is a match for their opportunity set.

Due diligence directed at a fund’s portfolio and its credit agreements will allow an investor to determine whether a manager is satisfactory on all three counts. If not, and especially if a manager who fails any of these tests has been relying on leverage to boost gains, it is best to keep one’s distance.


Fund leaders survey: we’d love to hear from you! 
This year’s Fund Leaders survey is up and running and we want to hear from you! Submit your form to us by 17 July and you will get a complimentary copy of the results when they are published at the end of July, as well as entry into a prize draw to win a $250 Yeti Cooler.

Topics covered in this year’s survey are as follows:

  • Fundraising (market sentiment, factors impacting performance, performance predictions)
  • Sources of capital (private wealth capital, digital fundraising platforms, geographic distribution of investors, continuation funds)
  • Headcount and AI (changes in headcount, priority areas for increasing headcount, AI implementation across firms)
  • ESG and DE&I (factors driving ESG adoption, link between ESG and performance/value creation, DE&I in portfolio companies)
  • GP stakes (GP stakes interest, objectives and considerations in selecting buyers)

Maple launches a digital direct lending platform
Maple, a blockchain lending infrastructure provider founded in 2021, has launched Maple Direct, a direct lending platform that will issue customised deals to Web3 natives.

“Web3” is a catch-all term for the internet’s emerging infrastructure – technical, legal and economic. The term includes blockchain, cryptocurrencies and smart contracts.

In terms of the history: Web1, in the ancient period known as the 90s, was about the publishers. Web2 was, and still is, largely about the platforms. Next up, Web3 is said to be about users-as-creators, where crowdsourcing and blockchains hold the potential for making everyone an entrepreneur, trading in such digital assets as non-fungible tokens.

A Web3 native, then, is an organisation, or sometimes a brand, that was born into this world of users-as-creators. Among brands, CryptoKitties is an oft-employed example. It was released in November 2017 as an NFT trading card game. It encouraged the subsequent creation of the NBA Top Shot marketplace and the 2021 NFT explosion.

Maple Direct brings underwriting experience derived from years on Wall Street to this non-traditional domain. The platform launch on 28 June was designed to meet the growing demand, especially among institutions, for capital market solutions that meet Web3 needs. Sidney Powell, chief executive and co-founder of Maple, comes from the traditional finance world, where he was both a portfolio manager and an analyst.

In a statement Wednesday, Maple said that it is committed to compliance, quality and innovation and that it “aims to unlock the economic potential of Web3 and become the most-trusted lender within the nascent digital assets space”.

Web3-related lending is not a new idea. BlockFi was founded in 2017 and, at its peak, was valued at $3 billion. But it filed for bankruptcy last November, as part of the fall-out from the collapse of FTX. Likewise, Genesis, a subsidiary of DCG, filed under chapter 11 in January. These were both platforms: they were both designed to bridge the gap between crypto finance and sovereign-based currencies.

Maple Direct is the first Web3 lending business since the fall of those CeFis. The need they serviced otherwise threatens to go unmet. Potential users of such a platform include crypto funds, venture capital funds, high-net-worth individuals, yield aggregators and family offices, the statement said.

A Canadian point-of-sale financing empire expands
Financeit, a point-of-sale financing provider based in Toronto and backed by Intervest Capital Partners, has purchased another Canadian point-of-sale provider, Simply Group.

InterVest Capital Partners, formerly known as Wafra Capital, was founded in 1999 and has created vehicles with aggregate committed capital in excess of $15 billion. Its statement announcing the acquisition of Simply Group did not provide financial specifics.

The statement quoted Michael Gontar, InterVest chief executive, who said: “InterVest thrives on capitalising exceptional companies, enabling management teams and fuelling their growth.” Financeit’s acquisition of Simply Group is one of a series of recent acquisitions that serves these ends, he said.

Gontar said that InterVest is proud to “be at the forefront of transformative investments” revolutionising the consumer loan industry.

InterVest, then known as Wafra, bought Financeit a little more than 16 months ago, from Goldman Sachs Asset Management Private Equity, as affiliate publication PE Hub at the time reported. One noteworthy feature of Financeit at the time of that transaction was its cloud-based technology, which allowed the merchants with whom it worked to increase their close rates and transaction sizes.

Financeit was founded in 2011. Goldman Sachs acquired majority control of the company in 2017 through a recapitalisation financing.

LP watch

Institution: Ohio Police & Fire Pension Fund
Headquarters: Columbus, US
AUM: $17.1 billion
Allocation to private debt: 2.9%

Ohio Police & Fire Pension Fund has approved a commitment of $50 million to HIG WhiteHorse IV, a spokesman at the pension confirmed.

OP&F’s private debt portfolio is worth $512 million, equating to 2.9 percent of the overall portfolio. It targets an allocation of 3.5 percent for the asset class.

The commitment to HIG WhiteHorse IV brings the total commitments to private credit in the plan year of January 2022 to June 2023 to $100 million.

The pension’s recent commitments have focused on senior and subordinated/mezzanine debt strategies, with a focus on the corporate sector.

Today’s letter was prepared by Andy Thomson with John Bakie, Christopher Faille and Robin Blumenthal contributing