The Illusion of Liquidity in « Continuation Deals » and the Dynamics of Refinanced Liabilities. Why Private Credit Firms Are Selling $15bn in Debt to Themselves

The explosion of « Continuation Deals » (rising from $4 billion to $15 billion between 2024 and 2025) signals a break in Private Credit, not healthy innovation. These « self-dealing » transactions transfer credit and duration risk from mature funds to new investors without creating real economic value, masking the deterioration of the underlying assets. As seen by our analysts, this creates « Synthetic Liquidity » that skews RWA calculations and threatens secondary market stability.

1. MARKET DYNAMICS: QUANTITATIVE ANALYSIS OF « CONTINUATION DEALS »

Private Credit ($1.7 trillion USD) is undergoing a bifurcation due to the Private Equity Exit Drought. « Continuation Deals » are internal secondary sales where a new fund (B), managed by the GP (General Partner), acquires the assets of an old fund (A) nearing maturity. The main risk is valuation bias during the transfer price (« Transfer Pricing« ): selling at book value (or with a slight discount) artificially inflates Fund A’s IRR to satisfy LPs. This mechanism introduces a moral hazard, as Fund B often inherits loans with extended maturities and degraded risk (« Zombie Loans« ), due to a lack of external refinancing. Furthermore, these transactions generate a double cost of fees (exit from A and management for B), known as « Fee Drag. » Our models show that Fund B must achieve gross returns 150 to 200 basis points higher than a direct loan to match the net return, pushing GPs towards an increased « Reach for Yield » and amplifying systemic vulnerability.

2. CREDIT RISK ANALYSIS: BEYOND DURATION (DURATION RISK)

Extending loans beyond their initial maturity (7 years) signals a macroeconomic problem. The need to « roll over » $15 billion of debt in 2025 for Private Equity firms (LBOs) indicates that these companies were unable to either refinance or proceed with an Initial Public Offering (IPO), suggesting excessive leverage and a deterioration of Debt/EBITDA ratios due to rising rates. Cost inflation has eroded free cash flows, reducing the Interest Coverage Ratio. The recent bankruptcy of assets previously considered stable (e.g., « First Brands« ) necessitates upward revision of Loss Given Default (LGD) models for middle-market private credit. A systemic risk is aggravated by the « stacking » of exposures across different vehicles: if a defaulted loan is successively transferred from Fund A to Fund B and then to Fund C, the ultimate loss will concentrate on the final holder, often the most vulnerable party in a recession.

3. SYSTEMIC IMPACT AND MARKET LIQUIDITY

« Continuation Deals » in Private Credit distort the expected illiquidity premium. They create false liquidity by allowing LPs of older funds to exit thanks to the capital of new funds, thus repaying initial investors with new funds rather than with actual repayments from the underlying companies, structurally resembling a timing Ponzi scheme. Furthermore, this asset class shows a strong correlation with interest rate risk, making it sensitive to public market movements. If rates remain high (« Higher for Longer »), the refinancing cost for LBO companies will become unsustainable, causing a wave of defaults that threatens CLOs and public High Yield markets, contradicting the diversification argument usually put forward by fund managers.

<sup>1. Valuation Adjustment (Haircuts): We apply an additional model haircut (« Model Haircut ») on Private Credit assets that have undergone continuation, reflecting the hidden risk of adverse selection.
2. Liquidity Stress Test: We simulate scenarios where cash flows are delayed by 24 months beyond the contractual maturity.</sup>

STEELLDY VIEW / Steelldy Consulting Strategy