Two of Dyal’s funds, last year and this week, have raised more than $2bn of debt in the US private placement market by securitizing cashflows from the funds. The money raised is distributed to each fund’s investors.
The deals have the effect of paying Dyal’s investor clients about one year’s expected return some 10 years early, at a small financing cost. They could then use this to invest in other high-returning investments.
Market sources have said other private equity firms and fund managers could replicate this model.
Publicly listed private equity firms like Apollo, KKR and Carlyle have issued bonds for similar purposes, but privately owned firms have found this difficult, according to market sources. Goldman Sachs is understood to have created the structure, and a couple of other fund managers have used it.
“Given where rates are, and the robustness of the investment grade market, Dyal saw an opportunity to get cashflow to their investors at a very low cost,” said a market source. “The public firms have bonds, but the private firms’ methods are few and far between: and that’s a real inefficiency in the market.”
Dyal Capital has raised two sets of US private placements in the past year, both via Goldman Sachs. In June, it issued a $1bn 10 year note tied to its fund Dyal Capital Partners 3. That deal was rated A- by Kroll.
This week it closed a $1.25bn 10 year deal for its Dyal Capital Partners 4 fund, rated A by Kroll. Both deals will amortise by 5% at years eight and nine, with the remaining 90% due at maturity.
The notes were issued via special purpose vehicles, which securitize the cashflows each fund receives from its stakes in other asset managers.
Dyal’s funds receive three kinds of distribution from the asset managers they invest in: pro rata shares in their management fees, carried interest and the proceeds of any investments they sell.
These revenues go up and down, but typically each of the Dyal 3 and 4 funds expects to receive $750m-$1bn a year. Roughly $250m of that is management fees, which the asset managers’ clients are contracted to pay.
The debt service cost is therefore covered about six times by just the management fee revenue. However, the PP noteholders only have recourse to the cashflows of Dyal Funds 3 and 4, not to their assets. There has been no true sale of claims to the SPVs.
In the case of Dyal Fund 3, limited partners had to give consent because the deal was increased beyond the fund’s debt limit (it also has a credit facility). In the Dyal Fund 4 deal, no consent was needed.
The PP issues were immensely popular with institutional investors, particularly insurance companies — the core of the PP buyer base. The first transaction was 3.5 times oversubscribed, the second 5.5 times.
An investor at a US insurance company who participated in one of the transactions said: “The diversification of the funds is pretty impressive, and the pricing pick-up over typical single-A borrowers was obviously helpful.”
Fund 3 owns stakes in 10 firms, while Fund 4 has exposure to 17. Those firms collectively manage more than 150 underlying funds, which in turn have thousands of portfolio companies in 35 countries around the world. On average, the asset managers in Fund 3 manage about $35bn of assets each, and those in Fund 4, $25bn-$30bn.
This week’s deal was priced at 250bp over Treasuries, a substantially wider spread than a typical single-A corporate borrower would pay. “For Dyal it seems cheap, for the investors it seems rich,” said a source familiar with the situation. The 10 year Treasury yield was about 1.37% this week, meaning Dyal’s funds are paying about a 3.87% financing cost.
Market sources said they saw no reason why other private financial firms should not follow suit. Bain Capital has issued $1.5bn of 10 to 20 year private placements this year, also via Goldman Sachs. A spokesperson for Bain Capital would not confirm whether the deal used a structure like Dyal’s.
Dyal Capital is owned by the US asset manager Neuberger Berman. It announced in December that it was seeking to merge with Owl Rock Capital Group, a US middle market direct lender founded in 2016 by alumni from GSO/Blackstone, KKR and Goldman Sachs.
Two credit asset managers Dyal’s funds have stakes in, Golub Capital and Sixth Street Partners, are suing Dyal to halt the deal. They argue that the merger would turn Dyal into a competitor with them, instead of a pure partner.
Murmurs in Europe
“The hit rate [in the financial sector] will be low, but you can generate deal flow by targeting the sector — after all, European fund managers, private equity firms and the like often don’t get marketed the product,” said a banker familiar with the situation.
Discussions were spurred by the success of the strategy in the US, coupled with the slump in issuance by regular European PP borrowers. Last summer, Vanguard, the passive asset manager, sold a $3bn US private placement — the largest issue in the market’s history. This was followed by a deal from investment data provider Morningstar, as well as several business development companies.
While some investors flinch at financial sector credit, as they consider it too close to home, most are attracted to the proposition, as these firms typically offer a pricing pick-up over regular corporate borrowers.
“Investing in financials is a great arbitrage on a ratings versus price basis — it’s a no brainer,” said an investor at a US institution. “But fund managers do need to come with a premium: as an investor you sit behind a lot of assets, and you’re potentially just providing levered returns. Say there are a lot of withdrawals, then what happens?”
The European PP market has some experience with financials. UK investment trusts like Monks and Scottish Mortgage are regular and popular PP issuers, while Intermediate Capital Group, the UK-listed leveraged debt investor, has issued a few times. The last was in February 2019, when it sold $400m-equivalent of five to 10 year PPs in dollars and euros.
Financial firms may look to the PP market for several reasons. A firm may want to term out short dated bank debt, fund an acquisition or leverage a fund. Equally, though, some may not want to be locked in to long-term debt, which carries make-whole requirements if the debt needs to be repaid early.
“We’re comfortable with looking at all reasons for funding, but what we’re looking for is a strong cashflow and sizeable assets under management,” said another investor at a US institution.
Though there are far fewer financial firms with hefty assets under management in Europe than there are in the US, agents still think it is worthwhile to look for prospective borrowers.
“Each bank looks at their budget for the year and works out how they’ll hit their target,” said a market participant. “It can pay off doing a structured [financial institution deal], as it may well pay three times more [fees] than others. It’s hard to justify a high fee for a repeat corporate issuer, but with a debut financial there’s a lot of intellectual input.”
A reason why banks are pushing further afield is that the European wing of the US private placement market has suffered from the strength of public bond markets this year.
While companies have flocked to the European bond market, only a handful have launched PPs. Moreover, these have not been awarded to banks through ‘beauty parades’, but by bank rotations for ancillary business. “We have time to focus on exploring different sectors now,” said a PP banker, “but if the market picks up again, we’ll have to push this into the long grass.”