1. Do you have any ideas for how the lending landscape and the balance between regional banks and private credit might shift this year?

We continue to see headwinds for banks dependent on their balance sheets. Since the start of an aggressive rise in rates, we’ve seen nearly $1trn in US household deposits exit the banking system and Basel III requirements will translate to higher capital ratios potentially reducing capital available for lending.

In addition, the risk of impairment could further tighten lending activity. Commercial real estate (‘CRE’), for example, and more specifically the office market, has been suffering from remote work trends and lower demand for office space. Banks own close to 50% of all CRE debt outstanding. We’ve already seen bank lending growth slow down in areas like consumer and real estate. Overall, I expect these banking headwinds to create a favorable lending environment for private credit, particularly in the lower market and lower-middle market.

2. With the slump in LBOs, what were the type of deals that were the most common last year?

Middle market LBO volumes have fallen considerably from their peak in 2021 to the end of 2023, and lending activity was softer across the market. Over this same time period, Hamilton Lane experienced record deal flow, which was driven by our scale and the breadth of GP relationships we maintain. Our deal volume was largely dominated by incremental term loan facilities designed to support continued acquisition activity by successful sponsor-owned platform businesses. The second largest category of deal volume was refinancing activity based on upcoming loan maturities.

3. What should we be expecting in terms of the pipeline of deal activity in the first quarter of 2024?

We opened 2024 with over $1.5bn in deal flow in the first four weeks of January and continued to see demand for incremental term loans and refinancings related to upcoming maturities. The broadly syndicated market also appeared to reopen aggressively with the majority of activity dominated by repricing and refinancing activity. Change of control activity remains muted relative to broader market activity, however, we are beginning to see transaction activity.

Looking ahead, we expect market activity this quarter to be dominated by incremental term loans, repricings, and refinancing activity, however, remain optimistic that buyers and sellers will transact as macro conditions come into focus.

4. Will 2024 be another record year for deal activity?

As the market appears to be coalescing around a soft-landing scenario, there are various signs that suggest activity levels could continue. To start, leverage lending volume in the bank loan market opened aggressively and as I mentioned earlier, Hamilton Lane saw record January volume of +$1.5bn. We are continuing to see incremental term loan demand to support buy-and-build strategies and a growing maturity wall is encouraging refinancing activity. Secondly, spreads for middle market loans have contracted approximately 75bps to 125 bps and with rates expected to fall, lower borrowing costs may encourage transaction activity. Finally, LPs are growing anxious for liquidity and with the macro-economic environment coming into focus, equity sponsors may be more willing to commit to enterprise value and transaction.

5. How are GPs dealing with the aforementioned pressures to return liquidity to investors?

GPs have various tools at their disposal, but four of the more common tools include:

1. NAV-based loans: GPs take a loan using the assets of a fund as collateral, typically in the 10-20% LTV range. GPs can use the loan proceeds to issue a distribution to investors to create early liquidity and as the assets exit, the sale proceeds are used to repay the loan.
2. Dividend recapitalization: GPs will recapitalize their portfolio companies and issue a dividend with the proceeds. Dividend recapitalizations typically involve adding additional debt to a GP’s portfolio company.
3. Minority equity sales: GPs will sell a minority stake in their businesses to create partial liquidity for existing LPs.
4. Continuation vehicles: GPs will establish a fair value for an asset and sell the asset from their fund to a newly formed vehicle to extend their ownership period. Existing investors may be given the choice to roll their equity into the new vehicle or take liquidity. New investors are typically sought out to support the change of control from the fund to the continuation vehicle.

6. While interest rates are widely expected to fall this year, they remain at the highest levels in decades. What are some of the tools you anticipate the asset class will use to help borrowers handle higher interest burdens?

Structure and Paid-in-Kind (‘PIK’) interest are two tools the market has taken advantage of as interest rates started their rapid rise and I expect the market will continue to lean on these tools. Specific to structure, leverage levels and LTVs have generally been more conservative in the last couple of years to manage borrowing costs.

With respect to PIK interest, borrowers have leaned on this feature in two ways. First, companies experiencing debt service pressure as a result of higher interest expenses have typically sought relief by converting a portion of their interest to PIK to free up cash flow. Secondly, Holdco PIK notes have become a common tool in today’s environment to support large purchase price multiples or recapitalizations. Holdco notes sit between the debt and the equity and have helped to bridge debt recapitalizations where the existing debt multiple is higher than the debt capital markets are willing to support or to help reduce the equity contribution required to acquire a company. Because PIK interest is deferred, borrowers have leaned on this feature to reduce the cash flow burden on their business.

7. Hamilton Lane closed two new small business credit funds, focusing on providing loans to lower middle market businesses with EBITDA ranging from $3m to $15m. What makes that segment of the market appealing as we move into the new year?

The lower market tends to be more capital inefficient and there are generally fewer capital alternatives available to small businesses relative to the middle-market and upper market. As a result, lenders in the lower market are well-positioned to achieve lender-friendly structures and terms and generate high returns for investors.

Small businesses tend to rely on regional banks, which have seen recent headwinds causing a tightening of lending standards. SVB’s collapse and demand for high-interest savings alternatives are two examples, which contributed to a reduction in deposits for many regional banks, reducing capital availability for lending activity. Small business lending funds in the private credit community have been able to help fill the void.

8. Hamilton Lane has offered retail investors the option to invest in private credit funds using blockchain-enabled tokenization since 2022. Has it been an effective way to pull in retail investors and do you expect to see more offerings like that this year?

Hamilton Lane was an early mover, and we continue to be a leader when it comes to blockchain-enabled tokenization within private markets because we believe it has a real potential to transform the way investors access this asset class. We expect that 2024/2025 will be the “year of adoption” for digital assets – specifically tokenization via blockchain – as this technology offers several advantages, including access, flexibility, efficiency and transparency.

Because tokenization significantly reduces key barriers to entry (such as high investment minimums, excessive investment subscriptions and monitoring complexities), individual investors can participate in long-term value creation opportunities within the private markets – including private credit – for the first time in a digitally native way and with less friction.

And for managers, digital asset platforms have effectively KYC’d their customer base in an automated way, so it becomes easier to look across an aggregation of investor interests, and then come in through what is essentially a single commitment.

It’s still early days for the utilization of blockchain technology within the private markets, but what will help to develop and grow that channel is education. Wealth managers are starting to familiarize themselves with the tokenization process in order to help guide individual investors looking for a better and faster way to access this asset class.

9. What was your New Year's resolution? What are you hoping to do more of this year? What do you do in your spare time?

Great friendships are key to happiness. My New Year’s resolution is to dedicate more time to my close friends whether that’s playing tennis or enjoying good wine together. If we can laugh more, that’s a good thing.

In my spare time, I enjoy exercising and cooking — the cooking is particularly fun with my children. They are so curious and playful. I find we have the most fun making Italian food.