Trading private credit: a market evolution or a risky mutation?

The buying and selling of existing credits offers investors the opportunity to exit a position before a loan matures or to gain exposure without being involved in the original deal, potentially improving market liquidity.

Evidence is mounting that the trading teams set up by banks or asset managers to facilitate the exchange are getting more active. Creditflux reported last month that the investment banking arm of Goldman Sachs was working to sell USD 1bn of direct loans from Apollo Global Management, after acquiring assets in an Apollo closed-end fund that was nearing the end of its life. The parties have declined to comment on the report.

The growing interest in secondary trading comes as the industry handles increasingly intricate portfolios and looks for ways to deal with heightened credit concerns that are swelling redemption requests and squeezing valuations.

Chris Mendez, a partner at law firm Akerman, has detected an uptick in the amount of loan assets changing hands, a sign that a secondary marketplace is starting to crystallise. “Portfolios are certainly getting larger and more complex,” he said. “Managers increasingly need at least portfolio management flexibility — as you would expect, secondary activity is a natural consequence of that.”

Others are less keen for direct lending to evolve into a tradeable asset class, saying that greater flexibility could bring more volatility. There is also a concern that follow-on trading could undermine the premium assigned to private credit as a relatively illiquid market compared to publicly traded debt.

David Mihalick, co-head of global investments at Barings, sees demand rising in any case. “I do think as private markets grow, you’ll see an increase in the number of strategies that try to provide secondary market liquidity. And I think that’s healthy over the long term for markets.” A significant erosion of the premium is unlikely for now, in his view.

“In the near term or medium term, I don’t see that the secondary options in the private market will offset the illiquidity premium that investors would expect coming into the asset class,” he told a Creditflux podcast.

As yet, the scope of secondary activity could remain limited, as trading may not be the best option to address redemption pressure or an urgent need to cash in assets, according to some industry sources.

The norm in direct lending is for a manager to originate a loan and hold it to maturity. Layering a secondary market onto direct lending could be viewed as a contradiction in terms, blurring the distinction between private credit and syndicated loans that are widely traded.

“I think that would hurt private credit,” said Tod Trabocco, head of private debt advisory at investment consultant ­StepStone. “The whole premise of direct lending is that the loans are bilaterally negotiated.”

Trading desks may provide some benefit in acute instances when liquidity is sorely needed, or if it can offer a good price for an end-of-life fund, but other options are usually on the table, according to Trabocco.