“The question is, if you are taking underwriting risk [on a private credit deal], shouldn’t you be adequately compensated?

Although sell downs of private debt have happened quietly since the asset class’s inception post-global financial crisis, it is now becoming a standardised feature of large private credit deals. Indeed, there are smaller funds who make it an active part of their strategy to buy into these deals post-transaction. 

And investment banks are keen to enter the game, with JP Morgan setting up a desk for the trade of secondary private credit paper, according to a source close to the bank and widely reported in the press.

Although perhaps a natural next phase of a $1.5trn AUM market that is only growing, the secondary market remains for now illiquid and relationship driven, with selldowns originating through reverse enquiries from smaller lenders, or through existing relationships held by the lender of record.

Types of selldown 

The selldown of a unitranche portion can go to a smaller credit fund, but equally to an LP in the existing lender’s fund. Both can take place in two ways: through a transfer of ownership, where the smaller lender of LP becomes the lender of record; or through a sub-participation agreement, whereby the unitranche is still ‘faced’ by the original lender, even if sold down to different parties.

The possibility of transfer of ownership is often agreed upfront in the deal’s documentation, with the sponsor specifying a whitelist of eventual buyers.

“The whitelist usually restricts against competitors, or funds who might pursue ‘loan-to-own’ strategies,” explained a second direct lending market source.

Even with a whitelist in place, there is often a requirement for borrower consent to sign off on the transfer.

For sales to a fund’s own LPs, sponsors tend to be more relaxed, said the first source. However, there are different reasons for selling to LPs post-transaction as opposed to bringing in the LP as part of a ‘co-investment’ at the time of the transaction.

“Often we will sell down to LPs post transaction for reasons of speed,” explained the first source. “We want to be agile for the sponsor get the deal done.” This can typically be done through a selldown to a special managed account (SMA) set up for the LP by the fund manager. 

Selldowns to banks are also common. “Sometimes we will help funds sell down a chunk of the senior term loan to banks on a super-senior basis, sitting pari passu to the revolving credit facility,” explained a lawyer working with private debt. To do this, a so-called ‘hollow’ tranche is put into the capital structure on a super-senior basis, with a day one commitment of zero. As the senior term loan is sold down, the hollow tranche is filled.

“We need to be upfront with the sponsor about this from day one as it affects the sponsor’s cap stack,” said the legal source. “There are lots of benefits. The banks get exposure to the credit, and the fund de-risks somewhat.” 

The possibility of selldowns open up a different model of operating for large-cap private credit funds. “We’re talking about a distributed model,” said the first source. “We can essentially use our own balance sheet to underwrite and distribute.” 

Fees for doing this can be something like a 125bps underwriting fee with the rest put forward in the OID, the second source explained. 

Then, for a selldown on a super senior basis to a bank, the fee is more like 100bps, said the legal source. Meanwhile, the loan itself can be priced at par or at a discount. 

Club selldowns 

Private credit deals are getting larger. This past quarter (Q4 2024) saw Europe’s largest ever private credit transaction, the €4.5bn unitranche backing Permira and Blackstone’s take private of Oslo-listed online advertiser Adevinta. In this deal, four large-cap private credit funds underwrote a significant chunk of the debt. 

However, size does not necessarily produce greater sell downs. “The main dynamic from the big-ticket holders is not to sell down,” said the legal source. “If you’ve got the bigger ticket, you’ll keep your majority. But smaller ticket holders, however…”

Smaller ticket holders have no majority to give up. According to a third private credit source, their fund will always underwrite with a view to a subsequent selldown — either to LPs or to smaller direct lending funds that would have been unable to absorb the €250m plus ticket needed at the outset.

“We participate in club deals with the plan being to underwrite and syndicate,” said the third private credit source, who represents a large-cap private credit fund. “We’ll put in a ticket for more than we need then syndicate the rest.”

For the sponsor, syndications post-transaction have become part of the process. There are positives and negatives to it.

“During the clubbing process, the sponsor wants [lots of lenders, and] competitive tension to push down pricing,” said the legal source. “Post transaction, however, it means you’re dealing with more parties, which is a negative. That said,” they added, “it’s still better for the sponsor than trying to get consent on a term loan.”

Lenders will very rarely sell on to another ‘tier one’ fund, such as an Ares. Instead, it will be to smaller funds and LPs. 

However, this does not always go to plan. In deals that attract a lot of interest, such as IRIS Software’s planned £1.2bn private debt to back its sale from sponsors Hg Capital and Intermediate Capital Group, credit funds have been scaled back, leaving them with little to sell down.

The smaller funds’ game

There are small private credit funds who make it their strategy to buy unitranche sell downs. Private credit needs to deploy — it is sitting on global unallocated capital of $411bn, or 28% of total assets under management, according to Preqin figures from December 2022. 

However, in Europe, tickets in large club deals are confined to 11-12 ‘tier one’ funds.

There are two reasons for this. Firstly, these are the funds that have the depth of capital to speak for large tickets. And second barrier to entry: the coveted places in the club rely on strong, pre-existing sponsor relationships. 

“We can’t get in on these club deals in primary, it’s not our investor mandate to write such large tickets,” said an asset manager active in both BSL and private credit markets. “But we do buy their sell downs.”

Unitranche selldowns also provide opportunities for BSL lenders to gain exposure in an LBO draught. Take IRIS, for example. The UK software business was the subject of a leveraged loan financing at the time of its acquisition by HG Capital in 2018, including a £440m term loan B (TLB) paying Sonia+ 450bps, subsequently accompanied by a £145m TLB, also paying S+450bps (2019), an £85m TLB at S+450bps in 2021 and a further £125m TLB, at S+450bps in 2022.

IRIS’s syndicate have been supportive of the company’s debt requirements, and news of the private credit financing has come as a disappointment. However, the rejected asset managers of those IRIS CLOs may still get to re-enter the debt through their private credit arms, through purchasing chunks of the sold-down unitranche. 

“That’s how we plan to maintain our exposure to IRIS,” the asset manager, who is a BSL holder of IRIS’s leveraged loans, but also active in private credit told 9fin. 

There are small private credit funds who make it their strategy to buy unitranche sell downs. “Private credit more competitive even that six months ago,” said the first source. “Smaller private credit funds will make reverse enquiries to enter large club deals through a sell down.”

The drawbacks 

The process of selldowns is direct and informal, according to a debt fund advisor. As it stands, it is not yet advisor-led. However, they cautioned that small funds would need to be able to carry out this transaction within their funds’ structure, and be mindful of the small position they would hold in a club deal. “If you buy 5% of the loan, you’re essentially along for the ride,” they added.

Meanwhile, those large funds that do sell down tend to have a more capital markets approach, or, as the first source put it, “BSL with a private credit flavour.”

One large cap private credit player was keen to distance themselves from selldowns. “We’ve enough scale with our captive sources,” they said. “Those that are doing it, and there are a couple of large players who underwrite and sell down, tend to have more of a capital markets business alongside.”

For private credit, a secondary market does change the initial proposition of take and hold. The funds are, after all, paid an illiquidity premium, and the sell to investors is strong borrower and sponsor relationships not compatible with an active changing of paper. 

In stressed scenarios, it is not clear how a fragmented private credit syndicate would work. “It would be interesting to see how lenders behave on Access Group (software provider Access Group’s £2.3bn cov-lite refinancing in the summer of 2022) or Adevinta if there’s a consent request. Do they club together, for example?”, ventured the legal source. 

In an increasingly competitive market, private credit lenders tote strong house points of views to their LPs. “This can conflict with one another,” the legal source added.

And, unlike the BSL market, selldowns are at present only taking place from ‘tier one’ funds down to LPs and to smaller funds. There’s no real evidence of a market beyond that, say of smaller funds selling between themselves. 

In a sense, therefore, smaller private credit funds are getting the raw end of the deal again: All of the illiquidity exposure with none of the control. 

Apollo, Blackstone and Ares declined to comment.