Maybe not so bad after all – August 2022 | Number 188 – Fundraising and the Fund’s financial outlook: it’s complicated | Cadwalader, Wickersham & Taft LLP
[author: Chris van Heerden]
Fundraising prospects have become more complicated in recent months. Without a doubt, the year-to-date data looks good. PitchBook, for example, reports that 191 U.S. private equity funds raised $176 billion in the first half, annualizing before last year’s fund value of about $340 billion. More broadly, global private capital raised in the first half of the year totaled $645 billion, according to Preqin data, which, while lower than 2021, sets the industry up for another trillion-plus year. dollars.
Those numbers, however, are in the rearview mirror at this point, and a host of factors cloud the outlook for the future:
- The record fundraising pace over the past 18 months is said to have drained the LP’s bandwidth. PitchBook highlighted the theme in its recent Breakdown of PE in Q2, noting, “It may be the busiest fundraising market in history.” Some LPs would have already exhausted their allocations for the year 2022 in the first half. PitchBook points out, however, that major platforms are successfully weathering the turmoil to shut down flagship fundraisers.
- The velocity of capital, especially in the buyout market, is slowing down. Slower deployment and decelerating outflows mean a slower return of capital to investors to recycle proceeds into new commitments. The overall economic cycle suggests that deployments and releases will likely remain weaker.
- A difficult IPO market contributes to lower exits. The 10 U.S. IPOs raised $339 million in July, which marked the slowest month since January 2016, according to Bloomberg data.
- A disconnect in valuations between public and private markets partly explains the dryness of IPOs and may have a lingering effect. This valuation disconnect is evident in the fact that only one of the more than 70 U.S. IPOs completed so far in 2022 has a price above the traded range, representing the fewest prices above the range in two decades, according to Bloomberg. Buyouts via IPOs are likely to remain subdued until private and public views on valuations converge. Reuters addressed the same theme this week in “Dreaded ‘dip’ slashes billions from startup valuations.”
- Declines in public markets may mean that LP portfolios may become more heavily weighted towards private strategies. According to the theory, LPs that unintentionally become overweight in private investments can reduce new private capital allocations in what is known as the denominator effect. Data on general market private fund performance is reported with a significant lag, but we suspect that the relative performance differences between public and private are not large enough to have a meaningful impact on fundraising at this time. stadium. Year-to-date, the S&P 500 is down 10.9% and the Bloomberg US Aggregate Bond Index has posted a total return of -8.8%. We don’t see these returns as entirely out of step with the private fund return numbers that were mentioned in the Q2 earnings calls.
In assessing how important these factors are to the fundraising market, we believe there are a few important points to keep in mind. First, buyout funds do not define the entire industry. The broader private equity category accounts for 58% of dollars raised in private markets year-to-date, according to data from Preqin, whereas 15 to 20 years ago private equity funds accounted for often 65-70% of private capital raised in a given year. We see the trend of enlargement accelerating in the future. KKR & Co. Inc., a pioneer in the buyout industry, for example, reported that 40% of new capital raised by the firm in the second quarter went to infrastructure and real estate strategies. Along the same lines, Rede Partners recently reported, in its first Private credit report, that 82% of LPs surveyed expect to increase allocations to private credit in the coming year. The challenges of raising capital for buyout funds should not automatically be blamed on other strategies.
Second, the link between fundraising and fund origination volume works with a lag. For the new facilities we closed in 2021, the date between the execution of the APL and the closing of the credit facility averaged approximately 220 days. This suggests to us that the robust fundraising activity in the first half has already laid the foundation for continued growth in fundraising origination in the second half.
This does not mean that the evolution of capital raising is unimportant. Fundraising timelines are expected to lengthen, more fundraising closures are expected to continue through 2023, and the 2023 calendar may also pile up to compete for attention and finite LP allocations. These points are, however, more important for the fund’s financing prospects for next year than for 2022.
Independent of fundraising, bank balance sheet availability will be a key determinant of fundraising volume for the remainder of the year. The specific concern is that deposit outflows could lead to greater sensitivity to the addition of risk-weighted assets. (On this point, we previously covered capital relief is traded as a balance sheet management tool.) In the second quarter, total bank assets fell 1.1% ($255.9 billion) while deposits fell 1.9 % ($369.9 billion), according to call report data compiled by BankRegData. The decline in assets was the largest since the first quarter of 2009 and the drawdown on deposits set a new all-time high.
But again, nuance matters. The overall decline in assets was largely due to reduced cash balances and securities holdings. In fact, loans and leases posted the largest dollar increase ever in the quarter, up 3.7% ($410.6 billion). C&I loans lead the growth. Exposure to C&I bank loans increased by $48.0 billion in July, while treasury bills and mortgage-backed securities decreased by $35.3 billion (exposure to home loans also increased), according to the latest H.8 data from the Fed.
The major trends that determine balance sheet allocation are intuitive. The 2022 operating environment for fee-based businesses has been challenging, with investment banking, asset management and mortgage origination revenues under pressure. The change in the interest rate regime and the uncertainty over QT made investing in fixed income securities more difficult. On the other hand, higher rates allow banks to shift to higher yielding assets through loan growth, which generates net interest margin and net interest income gains.
While the pace of deposit outflows and sensitivity to risk-weighted assets will be important to watch going forward, we see no negative impact on loan trends so far in the data. Of course, the specifics vary from institution to institution. But we expect loan growth to continue to be a key driver of bank earnings.
Headlines have become more cautious in recent weeks. We believe fundraising participants should expect a multi-speed market. Some sponsorship platforms and strategies will continue to show greater traction in fundraising than others. On the lender side, origination capacity trends will also vary from institution to institution. Although less uniformly positive than over the past two years, we expect the overall demand for fund financing credit and the supply of capital available from lenders to support sustained growth for the remainder of the year.