Yahoo Finance KKR Taps Asset-Backed Debt to Kick In More Money for Its Funds
(Bloomberg) -- With commitments totaling roughly $25 billion, KKR & Co. and its executives lead the private equity industry when it comes to investing in their own funds.
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Yet there’s more to this figure than KKR reports in earnings calls and press releases. For the past several years, the firm has been financing a portion of its investments in KKR funds through an obscure corner of the market for asset-backed securities.
Behind the scenes, KKR raises some of the cash it vows to invest in new funds by selling a portion of its stakes in existing ones. The firm bundles the prior investments into what are known as collateralized fund obligations that it sells through private deals — partly to insurers, including several it owns.
While it’s unclear how much money KKR raises through CFOs, the sales tap into trends driving private equity. Firms are embracing new forms of leverage to push returns higher — at the risk of larger losses — and fund managers are investing far more capital alongside clients.
“Especially in this market, where fundraising is tough, you are seeing some general partners put outsize commitments into their funds as a catalyst,” said David Philipp, a partner who heads the fund liquidity solutions group at Crestline Investors. “It makes some investors happier that there is a large number coming from the manager.”
KKR said in a statement that the CFOs “are effective funding tools that are not material to the firm’s financial profile.”
Money managers and their executives — referred to as the general partners — have traditionally contributed about 2% of the capital when marketing a new fund to outside clients. But this average more than doubled to about 5% last year, in some instances reaching as much as 20%, Bloomberg previously reported.
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Private equity firms have also expanded their fundraising in recent years, meaning general partners have to commit more of their own money. US-based PE firms took in $2.7 trillion from 2019 through 2023, according to data provider Preqin — up from $1.3 trillion between 2014 and 2018.
“A 2% general partner commitment may not be a big percentage, but in dollar terms it’s potentially a lot of money,” said Michael Rosen, the chief investment officer of Angeles Investment Advisors.
KKR and its executives had about $25 billion committed to its funds as of year-end — including roughly $20 billion from the firm and $5 billion in personal capital from principals such as co-founder Henry Kravis and co-Chief Executive Officer Scott Nuttall.
Blackstone Inc., in contrast, listed $2.8 billion of fund commitments and investments on its balance sheet at the end of December. The firm’s senior managing directors had $2.2 billion of outstanding commitments to Blackstone funds at the end of last year, according to a filing, but the value of their existing investments couldn’t be determined.
The disparity stems in part from different approaches to running a money management firm: Blackstone and Carlyle Group both minimize the assets on their balance sheets, while KKR follows the opposite strategy, directly investing in a variety of businesses as well as its own private funds. KKR also went public through a merger with an affiliate that left the combined company with a large amount of capital.
At some firms, partners fund part of their commitment by taking out loans from private wealth divisions of banks such as JPMorgan Chase & Co. This form of credit, known as GP financing, carries a floating interest rate that’s typically set 300 to 400 basis points above a benchmark rate and is secured by the partner’s stakes in other funds, said Scott Aleali, the head of private equity finance at Citizens Private Bank.
KKR began to reference its use of the asset-backed market to finance capital commitments in the firm’s annual report in 2019, just as private equity fundraising was surging. While the firm hasn’t publicly discussed its use of CFOs, KKR’s annual reports refer to “structured transactions” involving a vehicle that invests in KKR funds with third-party financing.
CFOs first arrived on Wall Street in the early 2000s as a way for large institutional investors, such as pension plans and sovereign wealth funds, to cash out private equity holdings, said Greg Fayvilevich at Fitch, which rates these deals.
What’s more unusual is for a money manager — rather than one of its clients — to issue CFOs.
Husky and Bobcat
Here’s how it worked when KKR issued two of the deals in July 2021, according to filings and people familiar with the securities, who requested not to be identified discussing confidential details.
The firm took a portion of its commitments to about 20 KKR funds and pledged the stakes to a pair of special-purpose vehicles called Husky and Bobcat. The stakes consisted of investments KKR had already made in the funds as well as those it had promised to make when they needed more capital.
Husky and Bobcat then sold 10-year senior bonds with an effective interest rate of about 5.7% to insurers, along with a smaller amount of subordinated debt with interest of roughly 7.8%. Three KKR-owned insurers, Commonwealth Annuity and Life Insurance Co., Accordia Life and Annuity Co. and Forethought Life Insurance Co. invested about $1 billion in the two CFOs, primarily by purchasing the senior debt.
The holders of the senior bonds are first in line to be repaid from the distributions that Husky and Bobcat receive through their stakes in KKR funds. As a result, these bonds get investment-grade credit ratings and thus receive favorable capital treatment from regulators — making it easier for insurers to invest in the debt.
“Because the capital charges are lower,” Fayvilevich said, fund managers “can collect more money from insurers. And thus get more fees.”
KKR can use the proceeds from the bond sales to meet its capital commitments to newer funds that it markets to outside investors. KKR also retains equity stakes in CFOs such as Husky and Bobcat, meaning it’s first in line to absorb any losses. In effect, the firm retains most of the downside — as well as the upside — on the stakes that it sold.
At the end of 2022, KKR had about $2 billion of investments in the CFOs — up from $620 million at the end of 2019 — and had also agreed to shoulder as much as $116 million in investment losses.
While the firm stopped disclosing the amount of such investments in 2023, more are on the way. In January, KKR bundled a portion of its stakes in more than a dozen funds and partnerships, including buyout funds for North American and Asia, into a special purpose vehicle called 2023 Bear Financing.
“There has been an evolution of GP financing over the past 10 years,” Aleali said. “Not only did you have the GP commitments start to rack up in size, but the firms wanted to offer their employees the option to invest in their funds.”
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