A large state pension has reportedly inked a mandate with banks to issue a publicly rated collateralized fund obligation of private equity interests, eyeing the third or fourth quarter for the deal, according to a person involved with the deal. The security will be classed under the Securities and Exchange Commission’s Rule 144a and internationally marketed. It has not been rated yet, and is currently being marketed to investors, Private Funds CFO understands.
Market rumors suggest a specific US pension fund as the would-be issuer, but it could not be confirmed by press time and a spokesperson there declined to comment.
But the pension wouldn’t be the only one eyeing the CFO securitization market.
STRS Ohio had been considering issuing a CFO, but tabled the project due to cost, according to people familiar with the matter.
Banks had been pitching a deal to STRS, with one person involved saying a deal was very close to the finish line. But several sources said STRS judged the project too costly, in the end. Ohio STRS has $88.7 billion under management, according to affiliate title Private Equity International.
Ohio is said to be periodically checking in with banks as it considers a deal, however. Asked for comment, a spokesperson at the pension would only say it is not issuing a CFO.
The fund interest securitization market has been seeing a trickle of activity recently, although primarily in the form of private deals issued by private equity managers themselves, generally called rated feeder funds. Managers issue these deals as another means of fundraising, going to market with rated bonds and equity, with little or no assets in the underlying portfolio to begin with, and building that portfolio over time. Mega-fund GPs like Blackstone, Ares, Coller Capital and KKR are among active issuers, the Financial Times reported late last year.
Some asset managers, too, have issued these fund interest securitizations. GCM Grosvenor issued a publicly rated $500 million deal in 2021. A subsidiary of Singapore-based investment company Temasek has also been an issuer for some time, as reported by affiliate title Private Debt Investor. Alternative asset manager Tikehau Capital has issued one as recently as last December.
Pensive pensions, powerful potential
The concept of the CFO has existed since at least the heyday of the securitization markets in the early 2000s, though rarely seen in practice.
But the issuance of a securitization of interests held by pension funds would be a breakthrough for the market. That is because such a deal would help pension funds facing liquidity issues and the denominator effect offload interests in bulk to the special purpose vehicle that would technically issue the bonds backed by the interests. If a successful trade brings others to market, that could help PE firms struggling to raise new funds. It would also represent a boon to the fund finance market, parts of which are reeling from higher interest rates and the failures of Silicon Valley Bank, Signature Bank and First Republic Bank – all major providers of subscription credit lines to the largest part of the private equity sector, mid-sized, mid-market firms.
The fear of being the “first mover,” however, has helped keep pension funds on the sidelines. These institutional investors are highly sensitive to costs, and being the first to issue would likely mean paying a premium on the bond yields to attract investors. Triple A-rated CFO bonds from the likes of GPs and asset managers are said to price anywhere from about 6.5-8 percent, currently, depending on the deal’s sponsor, one person involved in the market says.
Private Funds CFO understands that the upcoming deal will be a securitization of primary fund interests, not interests in continuation funds. The Financial Times reported late last year that at least two unidentified pension funds were considering CFOs, but that the deals would be so-called continuation fund CFOs.
It is also not yet clear who would hold the equity – in the collateralized loan market, hedge funds and other high risk/return investors are often the equity buyers. The bonds will be tradable and cleared by the DTC – part of an effort to increase the breadth and depth of the potential investor base and create a more liquid market.
Like any capital markets transaction, the deal isn’t certain to be executed – volatile markets could see it shelved, theoretically – but it is in the formal stages of marketing to investors, with the structure of the deal already established.
Deal goes global to avoid NAIC
Insurance companies are highly active buyers of securitization bonds in other parts of that market, particularly in the highly credit enhanced, most senior bonds. They will be key to creating a lasting market for CFOs.
But in the US, many insurance companies are said to be sitting the market out until the National Association of Insurance Commissioners – the insurance industry’s regulator – issues a capital treatment framework for the bonds. To do that, it needs to decide whether they would qualify as debt, since the issuance takes the form of bonds, or equity, since they are backed by PE fund interests. The latter would entail more punitive capital requirements.
Such a ruling is not widely expected any time soon, one banker said: “I don’t expect the NAIC to make any reasonable ruling in the near term.”
Bankers on the deal are said to be quietly pitching to foreign insurance investors, Private Funds CFO understands. Bankers have been taking meetings with insurance companies, among other types of investors, in Asia, the Middle East, Canada and more. Foreign insurance companies are free from NAIC rules.
Securitizations of fund interests, much like collateralized loan obligations backed by leveraged loans and structured finance bonds, are backed by either a variable or static pool of PE fund investments. In variable structures, the manager of the securitization can sell interests and reinvest proceeds in new ones before the deal becomes static after a set number of years, and begins to amortize. It is understood that the expected deal will be static, part of a move to simplify the structure while investors get used to the asset class.
Some market observers are concerned about the CFO market increasing correlation risk, with pension funds and insurance companies investing directly in private markets, and, potentially, derivatively through CFOs. But such risk is somewhat mitigated by the risk tranching featured in securitization.
CFOs and CLOs are sometimes confused with collateralized debt obligations, most famous for magnifying exposure to the mortgage risk behind the great recession by tranching lower-rated mortgage securitization bonds into new securitizations. CFOs and CLOs differ, in that they more simply transfer risk from the issuer to bond investors, without synthetically magnifying the underlying risk.
Gregg Gethard contributed to this report