For the continuation fun[d] of it

Summary

Cloud 9fin: "For the Continuation Fun[d] of It"

Date: February 21, 2025
Host: Sunny Onsson (Senior Private Credit Reporter, 9fin)
Guest: Jemima Modenum (Private Credit Reporter, 9fin)

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Episode Overview

This episode explores the rising trend of continuation funds within private credit, particularly in response to a sluggish M&A market and challenging liquidity conditions. Building on the momentum of private equity’s success with similar vehicles, Sunny and Jemima dissect why private credit managers are now looking at continuation funds, the structural challenges involved, market reception, and what the future may hold.

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Key Discussion Points & Insights

1. Why Continuation Funds in Private Credit?

• Fund Lifecycle Pressures: Private credit funds, like private equity, are structured to hold assets for finite terms. When the end of a fund’s life approaches and assets haven’t matured or been repaid, continuation vehicles enable managers to rollover or extend asset holding periods without running afoul of fund mandates. (00:57)
  • Quote: "A continuation fund or vehicle gives private credit an opportunity to close older vintage funds...as an alternative to letting the fund run past its maturity date." – Jemima (00:57)

2. Market Conditions Prompting Their Rise

• Liquidity Crunch: 2024 saw high interest rates, escalating regulation, and thin M&A activity, limiting deployment opportunities and increasing liquidity pressures on managers. (01:35)
  • Managers turned to "artificial" solutions like continuation funds to generate liquidity and repay investors instead of playing a "waiting game." (01:55)
• Nature of Private Credit Continuation Funds: Unlike PE, continuation vehicles in private credit often don't contain "trophy assets" but rather loans that haven’t been refinanced or repaid. This complicates the narrative and makes differentiating attractive assets harder. (02:55)
  • Quote: "These are loans that haven't been repaid or refinanced and usually there's a reason for that and it's not because it's a trophy asset." – Sunny (02:36)

3. Incentives and Investor Dynamics

• Pricing and Discounts: Secondary buyers for private credit are fewer, and the returns are typically lower than in PE, creating downward pressure on fund transfer pricing. (03:58) Selling performing loans at discounts is only appealing for end-of-life funds; younger funds rarely want to take the hit. (03:23)
  • Quote: "For some funds we've spoken to, ... the discount wasn't really worth it." – Jemima (03:49)
• LP Alignment: Success hinges on strong relationships with limited partners (LPs), who must approve pricing and structural terms. Limited partner advisory committees (LPACs) can veto deals they find unfavorable. (04:18)
  • Quote: "If your LPs aren't on board, then this makes it really tricky." – Jemima (04:18)
• Sponsor Engagement: Credit managers also balance the interests and track records with private equity sponsors, as continuation funds can sometimes buy time for underperforming or distressed assets to recover. (04:41)

4. Technical Hurdles—Valuation, Fairness, and Complexity

• Valuation Challenges: Loans must be transferred at a fair value, often requiring complex, potentially expensive fairness opinions to address conflicts of interest. Fluctuations in asset value can stall deals or lead to poor market reception. (05:25)
  • Quote: "It's critical for loans to be transferred at fair value... a fairness opinion will also typically be added... price in the fund is paramount and can be really risky." – Jemima (05:25)

5. The Outlook for 2025 and Beyond

• Continued Growth but Measured Adoption: Expect more continuation funds this year—“not a flood...but like anything in this universe...people and fund managers like to follow a trend.” (06:09)
  • As the private credit market broadens, such vehicles may become commonplace, especially as managers enter the “credit secondaries” market for further diversification and liquidity options.
  • Quote: "These type of vehicles could become pretty commonplace in credit managers portfolios, especially if they're wanting to broaden their horizons to credit secondaries." – Jemima (06:09)
• Not for the Faint-Hearted: Executing these deals requires careful structuring and strong buy-in—success is not guaranteed and can be “for the faint-hearted.” (06:58)

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Notable Quotes & Memorable Moments (with Timestamps)

• "If your LPs aren't on board, this makes it really tricky." – Jemima (00:00; repeated for emphasis at 04:18)
• "One debtorvisor commented on this and said this sort of vehicle can be a bellwether for bigger problems, but this might not always be the case." – Jemima (01:55)
• "The discount wasn't really worth it." – Jemima (03:49)
• "In PE, the continuation vehicle is created to hold onto their trophy assets. That's a bit trickier in private credit." – Sunny (02:36)
• "A fund finance lawyer we spoke to said that pricing of continuation vehicles can be time consuming and expensive." – Jemima (05:25)
• "Not a flood...but like anything in this universe of direct lending and private debt, people and fund managers like to follow a trend." – Jemima (06:09)
• "Pulling something like this off successfully isn't for the faint hearted." – Jemima (06:58)

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Key Timestamps

• 00:06 — Podcast introduction; overview of the private credit continuation fund concept.
• 00:57 — Explanation of why private credit funds set up continuation vehicles.
• 01:35 — The impact of 2024’s tough market conditions on fund liquidity.
• 02:36 — The difference between continuation vehicles in private equity and private credit.
• 03:23 — Discussing incentives and trade-offs for selling into continuation funds.
• 04:18 — The importance of LP alignment and approval.
• 05:25 — The critical challenge of loan valuation and fairness opinions.
• 06:09–06:58 — Future outlook, the likelihood of increased use, and closing thoughts.

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Summary

In this concise and thought-provoking episode, Sunny and Jemima unpack the nuanced emergence of private credit continuation funds as a liquidity tool in choppy markets. They examine structural differences from PE, the importance of pricing and LP engagement, the technical and process-oriented challenges, and the cautious optimism that continuation vehicles may become standard, though complex, instruments for managers under pressure.

The takeaway: While continuation funds offer new options, their success in private credit depends on careful structuring, fair pricing, and strong stakeholder approval. This episode is a must-listen for anyone needing to understand the evolving toolkit of modern credit managers.

Transcript

[A]

If your LPs aren't on board, this makes it really tricky.

[B]

Hello and welcome to Cloud Ninefin, a podcast on all things leverage finance. We follow corporate debt from issuance to redemption, credits, from performing to distressed and everything in between. I'm Sunny Onsson, senior private credit reporter at ninefin, and today I'm sitting down with fellow private credit reporter Jemima Modenum, who is making her podcast debut today. And we're talking about private credit continuation funds in a sluggish M and A market. Continuation vehicles have been a hit in private equity, but it hasn't quite yet taken off in private credit. Following BlackRock's continuation fund last year, the biggest of its kind with 300 first lien loans, market players are expecting to see more of these this year. So Jemima, first things first. Why would a private credit fund set up a continuation vehicle?

[A]

So, like their counterparts on the other side of the fence in private equity, a continuation fund or vehicle gives private credit an opportunity to close older vintage funds which are coming to a close or even at the end of their fund terms. So really, it's an alternative to letting the fund run past its maturity date. Both private equity and private credit are structures built around the concept of holding onto assets for a number of years, then disposing or selling them, and in the process returning capital to investors. But if that realization is not triggered, that's a problem for private credit. So private credit managers may address this issue by turning to a continuation fund.

[B]

2024 was a tough year for private credit. Interest rates remained high, regulatory scrutiny intensified, and there was a lack of M and A deals to finance, making it trickier to deploy capital. So why would this pretty unfavorable environment coincide with a rise in continuation funds?

[A]

So for all the issues you just outlined, there has been a liquidity problem where private credit fund managers are being pressured to pay back investors. They began to turn to artificial solutions to this problem outside, just waiting for M and A to pick up, a waiting game that no one really likes to play in this market. One debtorvisor commented on this and said this sort of vehicle can be a bellwether for bigger problems, but this might not always be the case. So this is really where continuation funds come in. Private credit investors, usually institutional investors like your pension funds or insurance companies, have the opportunity to roll over their capital or cash out. For a lot of private credit managers, this can give them the need of funds to pay back some of their original LPs.

[B]

But it's not just as straightforward, right? Because in PE, there's often this storyline on how the continuation vehicle is created to hold onto their trophy assets. That's a bit trickier in private credit. These are loans that haven't been repaid or refinanced and usually there's a reason for that and it's not because it's a trophy asset.

[A]

Absolutely. And this also feeds into a very essential challenge for private credit continuation funds, which is differentiation. As the loans being moved over in a continuation fund are typically financing a bit more challenging end of fund assets. So to get that differentiation and something that LPs like is to add some performing loans into the mix or to perhaps put the assets into the continuation vehicle a little earlier when there is still quite a bit of diversification in the original fund.

[B]

And that's certainly a way around it. One thing that comes to mind here though is why is it interesting for investors in these performing funds to sell into a continuation fund? The continuation fund has to be at an interesting price. So why would investors sell performing loans at a discount? It might be a bit more appealing for end of life funds, but. But for younger funds, even a 10% discount would be quite significant.

[A]

You make a really good point. And for some funds we've spoken to, that is the exact reason why they didn't put their assets into a continuation vehicle. The discount wasn't really worth it.

[B]

When we get into the weeds is when you see differences compared to private equity continuation vehicles. Like the price for a private credit continuation fund is lower due to the lower return in the private credit market. And additionally there are fewer secondary buyers, meaning less competition and less negotiating power when it comes to pricing and other terms.

[A]

Definitely. Also, private credit managers are relying on LPs who are willing to keep investing and come together with secondary buyers to provide capital to the new fund. If your limited partner advisory committee feels that the price is outside of an acceptable range for whatever reason, or there are structural problems, they can obviously vote against the continuation vehicle process. So if your LPs aren't on board, then this makes it really tricky.

[B]

It's an interesting balance here too. Right? Because in addition to relying on good relationships with their LPs, private credit firms often work very closely with private equity sponsors. And with sponsors they're relying on having a strong track record in terms of how they have behaved when things are not going that well with their portfolio companies. For example, and in this instance, a continuation fund could be a pretty decent solution as it can provide more time to recover an asset. So if the LPs are on board and the right balance of loans between performing and non performing loans are going to be moved over. We then run into the next hurdle. How are these loans valued from fund to fund?

[A]

So a private debt advisor we spoke to said that it's critical for loans to be transferred at fair value during the life cycle of moving loans into a new fund. They added that a fairness opinion will also typically be added. This is a second opinion to see if there are any conflict of interest. But price in the fund is paramount and can be really risky. A fund finance lawyer we spoke to said that pricing of continuation vehicles can be time consuming and expensive. And if a manager sets up a good portfolio of loans and then something causes a position to drop in value, or a loan goes from something like trading at par to something that's more in distressed land, the buyer might end up retrading and as a result the deal might be poorly received by the market.

[B]

So taking all of this into account, what can we expect to come next for continuation funds in private credit?

[A]

Private credits on track keep growing at a rapid pace and investors of all kind are pouring their capital into this asset class, from retail investors, insurance companies to pension funds and high net worth individuals. But it's got to keep up with its strong returns. And as we outlined at the beginning, this is tricky when liquidity is stagnant. As a result, continuation vehicles have emerged as a solution to this problem. Market professionals we spoke to said that we could expect a few more initially this year. Not a flood in their words, but like anything in this universe of direct lending and private debt, people and fund managers like to follow a trend. So these type of vehicles could become pretty commonplace in credit managers portfolios, especially if they're wanting to broaden their horizons to credit secondaries. But of course, pulling something like this off successfully isn't for the faint hearted.

[B]

It will certainly be interesting to see how this pans out through the year. Thank you so much for joining Jemima, and thank you to the listeners for tuning in. Please let us know if you have any feedback. You can reach us anytime by emailing podcastinfin.com check in next week to hear the latest. Bye for now.