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)

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.

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)

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)

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.

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.