“Layered leverage” of private capital needs more attention, says PGIM chief

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The chief executive of $1.3 billion asset manager PGIM said he was concerned about the “layered leverage” private equity firms are using to return cash to investors and urged regulators to push for more transparency with regarding complex forms of debt.

David Hunt said that as private equity groups struggle to exit investments, they have turned to more complex and opaque forms of borrowing, such as mobilizing funds that own multiple already indebted companies to finance payments to investors their.

“Recently, because exits have been difficult, I think they (buyout groups) have had to go back to leverage” to make money, Hunt told the Financial Times. “That can help you on the positive side,” but it could “really speed things up on the downside,” he said.

“It’s complicated enough that a lot of people don’t understand,” Hunt said, adding that regulators should push for more disclosure about such debts. “I think (introducing) a common way of understanding how much leverage is in the system is a good idea.”

Buyout groups have for decades loaded debt onto the balance sheets of the companies they buy to pay for their acquisitions.

In recent years, they have increasingly used so-called net asset value loans, where a buyout fund borrows from the stakes it owns in those companies. The entities that manage these funds can also take on debt, representing another level of leverage.

Groups including Vista Equity Partners, Carlyle and Hg Capital have used NAV loans to pay dividends.

Loans can also be used to support distressed companies within a fund. However, they are controversial because they add more leverage and collateralize the fund’s investments, meaning that problems with one company can spill over to others and put the entire fund’s performance at risk.

PGIM, the asset management arm of American insurer Prudential Financial, manages $319 billion in private assets, of which $206 billion is in real estate and $103 billion in private loans.

It owns private credit group Deerpath Capital and private equity specialist Montana Capital Partners, which focuses on “secondary” deals.

Such transactions include buying second-hand stakes in private equity funds and investing in deals where a private equity group sells a company.

Hunt said that if interest rates continue to fall, “maybe it will be good”, but if not there could be problems with rising NAV loans.

His comments come after he raised his concerns last week at SuperReturn, a private equity industry conference in Singapore. “My advice to regulators is to always follow the lever,” he said at the event.

During the conference, investors discussed the decline in private equity returns since the end of the era of cheap debt.

“This wave that we’ve all been riding for the last decade and a half has passed,” said Saima Rehman, who heads private equity and venture capital investments at the International Finance Corporation.

Ed Grefenstette, chief executive of The Dietrich Foundation in Pittsburgh, which invests in private-market funds, said that as deals became rarer, investors “forced” buyout groups to sell companies too early or to borrow money to raise money. cash.

“It can really be detrimental to the total return of the portfolio,” Grefenstette said. “We would rather admit that this is a knotty business. . . you just have to be patient to get through it.”

Kutty Dutta, managing director at HSBC’s alternative investments unit, said he was “cautious” about NAV loans and that they should not be “forced” on investors. “The important thing is that (investors) must be consulted. . . their wishes must be taken into account in decisions.”

Some dealmakers struck an upbeat tone on interest rate cuts after the Federal Reserve cut rates by half a point.

“A discount of 50 basis points on a leveraged asset is actually quite a significant discount because it is . . . reducing its interest burden by a significant amount,” said Avnish Mehra, vice president of private equity at Everstone Capital.